III Year B.A., LL. B (Div.

- E) – Semester-VI

1st -Internal Assessment – Company Law II

Research Paper

NAME: Iramnaaz Khan

DIVISION: E
PRN: 20010125631
COURSE: BA LL.B. (H)
BATCH: 2020-2025
EXECUTIVES' LEGAL RESPONSIBILITY OF DIRECTOR IN LIGHT OF RECENT CASES AND

CORPORATE FRAUD

ABSTRACT:-

In light of its status as an Artificial Entity, a business requires the leadership of capable
individuals. The term "Directors" describes a board of such knowledgeable individuals. As a
result, directors are responsible for overall corporate management and wield indirect
authority over many company functions. Having a lot of authority means being responsible
for a lot of things. The Director's authority to manage the organisation creates opportunities
for corruption and personal benefit. The victims of this are the investors. With the LPG
reforms, India's business structure saw significant transformation. Several directors and
promoters committed fraud since the regulation did not go far enough to meet the
requirements for the shift. As a result, the Appellate Court issued several rulings and the
Corporations Act was amended numerous times, creating new stringent obligations. Through
the prism of Court Pronouncements, this paper provides a concise study of the liabilities of
the directors under the Companies Act, 2013.

INTRODUCTION:-

As a word, "company" covers a wide range of possible situations. A corporation must

designate an agent to act on its behalf to carry out its day-to-day operations, even though it is
treated as a separate legal entity by law. And thus, the director is introduced as a result of this.
A member of the board of directors of a company is considered to be a director under section
2(34) of the Companies Act, 2013 (the "Act"). A director is a person whose legal ownership
of any asset held by a business is vested, even if the asset is held under the company's name.

Directors play a crucial role in the decision-making process of a business and are given
extensive authority and responsibility as a result of the Act. Directors have significant
authority, but with that comes significant liability if they fail to fulfil their responsibilities.
The recent instances of corporate fraud, implicating both management and promoters,
highlight the crucial fiduciary duties entrusted to directors and underscore the growing need
for formalized best practices to safeguard the company's and shareholders' interests.

Although the Companies Act, of 1956 was created to regulate the conduct of
directors, the rapid expansion of corporations in the wake of the LPG reforms gave rise to
several scandals—among them, the Satyam Computers Scam, the Kingfisher Scam, the
Bhushan Steels Scam, etc.—that cast doubt on their honesty. For India's business sector to
keep up with its rapid expansion, drastic changes to its corporate governance were required.
Companies Act, 2013 brought about certain adjustments to re-build the Corporate
Governance system after it superseded the earlier statute of 1956.

DIRECTORS' LEGAL RESPONSIBILITIES UNDER THE COMPANIES ACT OF 2013: CRITICAL ANALYSIS

Due to their responsibilities as fiduciaries, directors are held to a very high standard. As
Justice Cardozo famously stated, this standard is "not honesty alone, but the punctilio of an
honour the most sensitive." Directors must fulfil their duties with utmost care and integrity. 1
Directors have responsibilities, and "liability" makes them follow the rules. Corporation laws
stop directors from doing wrong things.2 Laws have no power if they are not enforced3.

The Companies Act of 1956 lays down key statutory duties. To avoid removal under Section
274, a director must meet certain requirements.4 No agreement, article, or provision can free a
director from liability if negligence, default, misbehaviour, duty breach or breach of trust
toward the company occurs. A director cannot be absolved from accountability through any
means for misconduct committed against the company's interests. 5 The official liquidator
holds directors accountable if they find them intentionally involved in fraudulent business
6
conduct. During the company's general meeting, the board must present the Directors
Responsibility Statement.7 As per the Act, a director's office gets vacated if they continuously

1
Meinhard v. Salmon, 1928
2
The Corporate Opportunity Doctrine, 37 Modern Law Review, 464-468.
3
JOHN ARMOUR & JENNIFER PAYNE, RATIONALITY IN COMPANY LAW (Oxford & Potland 2009).

4
The Companies Act, 1956, §274, 1, Acts of Parliament, 1956 (India).
5
The Companies Act, 1956, §201, 1, Acts of Parliament, 1956 (India).
6
The Companies Act, 1956, §542(1), 1, Acts of Parliament, 1956 (India).
7
The Companies Act, 1956, §217(2AA), 1, Acts of Parliament, 1956 (India).
miss three consecutive board meetings or all meetings for three months, without taking leave
from the board whichever duration is longer.8

Additionally, directors take other roles in meetings. 9 Some agreements necessitate board
approval, particularly if specific directors engage. 10 The board must approve if any director
11
desires a profitable position or office. Furthermore, directors bear a hefty legal duty to
reveal interests. Directors risk penalties if failing to declare their stakes in company deals or
negotiations. 12 Directors must disclose the type and extent of any interests or rights regarding
shares or debentures requiring registration.13 The Supreme Court also said that directors can
be held indirectly liable if the law has rules for that when reviewing directors' criminal
liability under the Indian Penal Code, 1860.14

DIRECTORS' LEGAL OBLIGATIONS UNDER THE COMPANIES ACT OF 2013: CRITICAL ANALYSIS

The Companies Act of 2013 has played a significant role in revolutionizing Indian Corporate
Governance. The Act introduced new and effective measures to replace the previous
ineffective ones. Furthermore, it also placed additional responsibilities on directors to ensure
proper maintenance of Corporate Governance.

The Directors shall be accountable for any default done by the company, as defined by
Section 2(60) of the Act. Directors have a vital responsibility to act diligently and with care
when making decisions for the company. They must make choices in good faith and with
reasonable effort. If directors fail to fulfil this duty, they may be held accountable for any
harm caused to the firm or its shareholders due to their actions. In the Centro Properties
Group case from 201815, it was determined that the directors had failed in their duty of care
by not providing enough information about the company's financial situation to shareholders.
The outcome of this was a settlement worth A$200 million.

8
The Companies Act, 1956, §283(1)(g), 1, Acts of Parliament, 1956 (India)
9
The Companies Act, 1956, §165, 1, Acts of Parliament, 1956 (India).
10
The Companies Act, 1956, §297, 1, Acts of Parliament, 1956 (India).
11
The Companies Act, 1956, §297, 1, Acts of Parliament, 1956 (India).
12
The Companies Act, 1956, §297, 1, Acts of Parliament, 1956 (India).
13
The Companies Act, 1956, §307, 1, Acts of Parliament, 1956 (India).
14
Maksud Saiyed v. State of Gujarat & Others, (2008) 5 SCC 668.
15
ASIC V HEALEY
They need to behave honestly and lawfully, which is another facet of director liability. The
directors of Bellamy's Australia were found to have violated this obligation in 2019 when it
was discovered that they had kept shareholders in the dark about important company news
that had led to a drop in the stock price. The board members had to pay an A$1.5 million fine.
Director liability may arise from a corporation's continued operations despite its inability to
pay its debts when they become due.

LIABILITIES UNDER VARIOUS STATUTES

Directors often struggle to comprehend the legal obligations tied to their roles within Indian
companies. In addition to corporate rules, the duties and obligations of a director encompass a
wide range of regulations related to business, tax, and labour laws, which may result in civil
and, in certain situations, criminal penalties. The potential for personal accountability for
corporate conduct under vicarious liability adds to the director's obligations and duties.16

Liabilities under the Companies Act, 2013:

The Companies Act, 2013 revolutionized directors' duties by codifying them in Section 166.
These duties include acting in good faith, promoting the company's objectives, exercising
reasonable care and skill, avoiding conflicts of interest, and refraining from taking undue
advantage.

Liability under the Income Tax Act, 1961:

Directors of private companies can be jointly and severally liable for tax non-recovery.
Directors must prove they aren't grossly negligent to absolve themselves of liability.

Central Goods and Service Tax Act, 2017:

Similar to the Income Tax Act, directors can be personally liable for non-recovery of tax,
interest, and penalty. The GST Act also holds directors responsible for offences committed
with their consent or negligence.

Foreign Exchange Management Act, 1999:

16
Directors’ liabilities in Indian companies: Here are various statutes under the Indian laws, Sandeep
Jhunjhunwala, https://www.financialexpress.com/business/industry-directors-liabilities-in-indian-companies-
here-are-various-statutes-under-the-indian-laws-2628332/
"Person in charge" during contraventions is deemed guilty. Directors can be excused if they
prove a lack of knowledge or exercise due diligence.

Insolvency and Bankruptcy Code (IBC), 2016:

Directors' authority is suspended during the insolvency resolution process, and they may be
required to undo transactions or contribute to the company's assets.

INTERPRETATION OF DIRECTORS' DUTIES BY INDIAN COURTS

In India, the judiciary serves as the primary authority guiding directors' actions, drawing upon
interpretations and principles from common law jurisdictions. In landmark cases like
Nanalal Zaver v. Bombay Life Assurance Company Limited 17, the court affirmed directors'
obligations under Section 105(C), emphasizing their duty to act in the company's best
interest. The court invoked the trustee-beneficiary relationship between directors and the
company, intervening when directors act against its interests.

The Court then referred to the Needle Industries Case18 and cited various old English cases,
19
endorsing the principle established in Piercy v. S. Mills and Company Limited. This
principle dictates that directors cannot misuse their authority to issue shares solely to
maintain control over the company or to undermine the wishes of the majority shareholders.
Considering precedents like Needle Industries and Tea Brokers 20, the court applied a similar
test to assess directors' exercise of powers, ultimately concluding that the motive behind the
allotment was malicious, thus warranting its nullification.

JUDICIAL REVIEW AND REAL-WORLD CASES:-

India's 2013 Companies Act governs director liability. Directors must follow the law with
care, effort, and competence. They must do what's fair and best for the firm and shareholders.
If these duties aren't met, legal action may result.

17
Nanalal Zaver And Another vs Bombay Life Assurance Co. Ltd 1950 AIR 172.
18
Needle Industries (India) Limited and Others v. Needle Industries Newey (India) Holding Limited and Others,
1981.
19
Piercy v. S.Mills & Company Ltd[1920] 2 Ch 77 at 84.
20
Tea Brokers (P) Limited and Others v. Hemendra Prosad Barooah (1998) 5 CLJ 463.
The Satyam Scandal21: In 2009, a huge accounting scam involving overstated profits and
bogus assets was revealed at Satyam Computer Services. Ramalinga Raju, the company's
founder and chairman, along with several other directors, were eventually arrested on fraud
charges and given prison terms. Directors' fiduciary duties of care, attention, and commitment
to the corporation were brought into sharp relief by the events of this case.

The recent IL&FS case22 illustrates directors' duty in India. IL&FS, a large Indian
infrastructure development and finance corporation, went bankrupt in 2018 due to financial
mismanagement and fraud. Consequently, director liability is fundamental to corporate
governance, and recent cases like the IL&FS case demonstrate the importance of holding
directors accountable. Ethical and sustainable company practices require strong legal
structures that enforce directors' commitments and punish violations.

The Reserve Bank of India (RBI) fined Videocon Industries Limited and its directors Rs 2.5
crore in 2021 for breaking several articles of the Banking Regulation Act, of 1949. This
situation emphasises the need for directors to be well-versed in the law and to take the
necessary steps to ensure that all applicable rules and regulations are followed.

CONCLUSION:

Companies rely heavily on their board of directors. They are the driving force behind any
company's achievements. Corporate leadership should consist of trustworthy individuals. It's
crucial so they can direct their authority properly and refrain from abusing it. The board of
directors is in charge of running a firm. All decisions are made by the board as a whole. In the
event of mismanagement, the corporation will look primarily to the directors for
compensation. There are previous examples of the public bearing the costs of corporate
mismanagement. Thus, safeguards are needed to avoid such an occurrence.

REFERENCE:-

21
M/S. Satyam Computer Services Limited vs Directorate of Enforcement (31st December 2018), WP No.
37487 of 2012.
22
Infrastructure Leasing And Financial Services LTD. VS HDFC BANK LTD. & ANR.
Swati Koul & Chahana Charles, Critical analysis of the Satyam Computers Scam: India’s
biggest Accounting Fraud, July 27, 2020, https://lexforti.com/legal-news/satyam-computers/

David Jacobson, Centro (asic v healey) case note: directors’ duties for financial statements,
29th June, 2011, https://www.brightlaw.com.au/centro-asic-v-healey-case-note-directors-
duties-for-financial-statements/

Mohammad Kamran and Ashish Kabra , Director Liability: Supreme Court Quashes Case
Against Managing Director, 23 September 2019, https://www.mondaq.com/india/directors-
and-officers/847298/director-liability-supreme-court-quashes-case-against-managing-director

Rajashree Devchoudhury , A critical analysis on a director’s liabilities and recent legal developments,
https://ksandk.com/corporate/to-be-or-not-to-be-prosecuted-a-critical-analysis-on-a-directors-liabilities-and-
recent-legal-developments/#:~:text=Any%20vicarious%20liability%20cannot%20be,liable%20and%20can
%20be%20prosecuted

Randall Morck , Behavioral Finance in Corporate Governance, http://www.economics.harvard.edu/pub/

hier/2004/HIER2037.pdf (Last visited on March 16, 2010).

M P RAM MOHAN & URMIL SHAH, Director Liability Framework During Borderline Insolvency and
Corporate Failure in India, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3914977

Shipra Saya, Duties & liabilities of director, https://lawtimesjournal.in/duties-liabilities-of-

director/#_ftn16

Devendra Gajanan Bankar, A Brief Analysis of Liabilities of Directors under Companies Act
through the lens of Judicial Pronouncements, November 23, 2021, https://ijclp.com/a-brief-
analysis-of-liabilities-of-directors-under-companies-act-through-the-lens-of-judicial-
pronouncements/

A director’s liability in the face of corporate insolvency: what you need to know, August 4
2020,https://www.lexology.com/library/detail.aspx?g=5099ab91-cbee-46a4-9726-
7a5bce778619
Directors’ liabilities in Indian companies: Here are various statutes under the Indian laws,
August 15, 2022, https://www.financialexpress.com/industry/directors-liabilities-in-indian-
companies-here-are-various-statutes-under-the-indian-laws/2628332/

Meetings of Board Of Directors – Overview of Corporate Governance Provisions & Judicial

Decisions, Anshul Ramesh, 3rd July ,2020, https://taxguru.in/company-law/meetings-board-
directors-overview-corporate-governance-provisions-judicial-decisions.html