(12.14.11) Liabilities of Directors

The liabilities of directors may be considered under the following heads: 1,. Liability to the company. 2. Liability to third parties. 3. Liability for breach of statutory duties. 4. Liability for acts of co-directors.5. Criminal Liability.

Liability to the company. The liability to the company may arise from: (a) breach of fiduciary duty; (b) ultra-vires acts; (c) negligence; and (d) breach of trust and misfeasance.

  (a) Breach of fiduciary duty. Where a director acts dishonestly in disregard to the interests of the company, he will be Held liable for breach of fiduciary duty. Most of the powers of directors are ‘powers in trust’ and therefore, should be exercised in the interest of the company and not in the interest of the directors or any section of members. Thus, where the directors, in order to forestall a take-over bid, transferred the unissued shares of the company to trustees to be Held for the benefit of the employees and an interest-free loan from the company was advanced to the trustees to enable them to pay for the shares, it was Held to be a wrongful exercise of the fiduciary powers of the directors [Hogg v. Cramphorn Ltd. (1966) 3 AII ER420].

  (b) Ultra-vires acts. Directors are supposed to act within the parameters of the

provisions of the Companies Act, Memorandum and Articles of Association since these lay down the limits to the activities of the company and accordingly to the powers of the Board of Directors. The directors shall be Held personally liable for acts beyond the aforesaid limits, being ultra-vires. Thus, where the directors pay dividends or interest out of capital, they will be liable to indemnify the company for any loss or damage suffered due to such act.

  (c) Negligence. The directors shall be deemed to have acted negligently in discharge of their duties and consequently liable for any loss or damage resulting therefrom where they fail to exercise reasonable care, skill and diligence. However, error of judgement will not be deemed as negligence. It may be noted that the directors cannot be absolved of the liability for negligence by any provision in the Articles (s.201). The court may award relief to directors against such liability under s.633.

  (d) Breach of trust and misfeasance. Directors are the trustees for the money and property of the company handled by them, as well as the exercise of the powers vested in them. If they act dishonestly or mala fide in the exercise of their powers and performance of their duties, they will be liable for breach of trust and may be required to make good the loss or damage suffered by the company by reason of such mala fide acts. They are also accountable to the company for any secret profits they might have made in transactions on behalf of the company.

Directors can also be Held liable for their acts of ‘misfeasance’, i.e., misconduct or willful misuse of powers. However, misconduct which is not willful shall not amount to ‘misfeasance’. Moreover, the directors are entitled to relief against liability for breach of trust or misfeasance under s.633.

Where a director has misapplied or misappropriated money or property of the company or has been guilty of breach of trust or misfeasance, the court may order him to repay the money or restore the property or to pay compensation [P.K. Nedungadi v. Malayalee Bank Ltd., AIR (1971) S.C. 829].

Liability to third parties. The discussion on liability of directors towards third parties may be grouped as under: (a) Liability under the provisions of the Act. (b) Liability for breach of warranty of authority.

  (a) Liability under the act. The following provisions make directors personally liable to third parties:

   (i) With regard to prospectus. Failure to state any particulars as per the requirements of s.56 or misstatement of facts in a prospectus renders a director personality liable of damage to the third party. Section 62 provides that a directors shall be liable to pay compensation to every person who subscribes for any shares or debentures on the faith of the prospectus for any loss or damage he may have sustained by reason of any untrue statement included therein. He may, however, escape liability where he proves his innocence.

   (ii) With regard to allotment. Directors may also incur personal liability for:

- irregular allotment, i.e., allotment minimum subscription is raised or

without filing a copy of the statement in lieu of prospectus [s.71(3)].

- for failure to repay application money in case of minimum subscription having

not been received [s.69(5)].

- for failure to repay application money when application for listing of securities is not made or is refused (s.73).

   (iii) Unlimited liability. Directors will also be Held personally liable to the third

parties where their liability is made unlimited in pursuance of s.322 (i.e., vide memorandum) or s.323 (i.e., vide alteration of memorandum by passing special resolution).

   (iv) Fraudulent trading. Directors may also be made personally liable for the debts or liability of a company by an order of the court under s.542. Such an order shall be made by the Court where directors have been found guilty of fraudulent trading.

  (b) Liability for breach of warranty. Directors are supposed to function within the scope of their authority. Thus, where they transact business in respect of matters ultra-vires the company or ultra-vires the Articles, they maybe proceeded against personally for any loss sustained by the third party.

Liability for Breach of Statutory Duties. The Act, imposes numerous statutory duties on the directors under its various sections. Default in compliance of these duties attracts penal consequences. For instance, they are liable as ‘officer-in default’ for default in filing return of allotments (s.75); for failure to comply with the provisions of the Act relating to issue of redeemable preference shares or redemption of irredeemable preference shares, etc. (s.80,80A).

Liability for acts of co-directors. A director is the agent of the company and not of the other members of the Board. Accordingly, nothing done by the Board can impose liability on a director who did not participate in their action or did not know it. His liability shall not arise even where he attends the subsequent Board meeting at which minutes recording the wrongful action of the earlier meeting are confirmed. To incur liability he must either be a party to the wrongful act or later acquiesce (consent) to it. Thus, the absence of a director from Board meetings does not make him liable for the fraudulent acts of a co-director on the ground that he ought to have discovered the fraud [Dovey v. Cory (1884) 25 Ch. D.725].

Where a director is made liable for the acts of co-director he is entitled to contribution from the other director or co-director who were a party to the wrongful act [Ramskil v, Edwards (1885) 31 Ch.D.100]. However, where the director seeking contribution alone benefited from the wrongful act, he is not entitled to contribution.

Criminal liability. Apart from civil liability under the Act or under the general law, directors of a company may also incur criminal liability under common law, as well as under the Companies Act and other statutes. Some of the provisions of the Companies Act which make directors criminally liable (fine or/and imprisonment) are:

S.44(4) - Filing of prospectus or statement in lieu of prospectus (to be filed by private company on ceasing to be private company) containing untrue statement.

S. 58.A(5) - Failure to repay deposits within the prescribed time limits.

S. 58A(6) - Accepting deposits or inviting deposits in excess of the prescribed limits.

S. 63 - Issuing a prospectus containing untrue statement.

S. 68 - Knowingly making a false, deceptive or misleading statement and thereby inducing persons to invest money.

S. 84(3) - Fraudulently renewing a share certificate or issuing a duplicate certificate.

S. 210(5) - Failure to lay balance-sheet, profit & loss accounts, etc. at the annual general meeting.

S. 240(3) - Failure or refusal to produce books to inspector or furnish information or to appear before inspector conducting investigation.

S. 295(4) - Granting loan to directors without approval of the Central Government.

Criminal liability under SEBI. The directors of a company may also be Held criminally liable for contravention of the provision of SEBI.

Criminal liability under economic legislations. Directors are also made criminally liable for various lapses and non-compliances under MRTP Act, I(D&R) Act FEMA, Income-tax Act, etc.

Audit Committee ( s. 292A)

It provides that every public company having paid up capital of Rs 5 crore or more shall constitute a committee of the board of directors known as Audit Committee. It will consist of three or more directors as decided by the board. Two thirds of the members shall be other than managing or whole time director. Its members shall elect a chairman from amongst themselves. It shall act in accordane with the terms of reference as specified in writing by the board.

The meetings of the audit committee still also be attended and participated by auditors, internal auditors and director-in-charge of finance with no voting right. The committee shall discuss the company’s internal control system, scope of audit, auditors’ observations and review the half-yearly and annual financial statements before submission to the board. The committee shall also have authority to investigate into the terms specified or referred to and for this purpose it shall have access to the company’s records and external professional advice.

The recommendations of the committee relating to financial management including the audit report shall be binding on the board and if not accepted, the board shall record the reasons therefore and communicate the same to the shareholders through its report.

The chairman o theAudit Committee shall attend every annual general meeting of the company to provide classification on matters relating to audit.

For non-compliance of the provisions of s. 292A, the company and every officer in default shall be punishable with imprisonment upto one year or fine upto Rs 50,000. The offence is compoundable