A company is a separate legal entity managed by a set of individuals called the board of directors who are responsible for the day-to-day functioning of the company. However, the question that arises is “would they be responsible for the negligence or breaches committed by the company and would all the directors be liable or there is a set of people that are vicariously liable under the provisions of law”?
In this context, we refer to Section 179 of the Companies Act, 2013 which provides that the Board of Directors of a company shall be entitled to exercise all such powers, and to do all such acts and things, as the company is authorized to exercise and do. Upon reading of the provision, we understand that there is no differentiation between Managing Directors (“MDs”)/ Executive Directors (“EDs”) and Non-Executive Directors (“NEDs”)/ Independent Directors (“IDs”). However, in practice, these powers are exercised by the directors holding the position of EDs, MDs with IDs and NEDs kept outside the execution framework of the company.
Liability of Independent Directors
An Independent director is a person of integrity and assists the company in technical decision-making by using his/her relevant expertise and experience. The presence of IDs and NEDs is vital in terms of corporate governance. Further, the judiciary has been aware of the role played by IDs and tries to protect them from unnecessary and frivolous litigation.
However, the broad-brush approach under the Companies Act, 2013, where it merely provides for the initiation of proceeding against ‘officers in default’ without providing any distinction concerning the role performed by the officer has left the IDs clueless with last resort as the judiciary of the country.
The Hon’ble Supreme Court in the case of Chintalapati Srinivasa Raju Vs Securities and Exchange Board of India held that unless the independent directors or non-executive directors exercise a significant role in the decision-making process of the company, they cannot be held liable
Further, the Hon’ble Supreme Court in Sunil Bharti Mittal vs Central Bureau of Investigation had explained that the principle of alter ego can only be applied to make a company liable for acts of a person or a group of persons who exercise significant and pervasive control over the affairs of the company. It was further noted that directors of the company can be held responsible for the wrong done by the company only where there is sufficient evidence to prove an active role and a criminal intent or if the relevant statute has specifically imposed liability on them, such as labor and environmental law statutes.
Furthermore, the Hon’ble Supreme Court in the case of Shiv Kumar Jatia v. State of NCT of Delhi, reaffirmed its views outlined in the Sunil Mittal case and held that an individual either as a director or a managing director or chairman of the company can be made an accused, along with the company, only if there is sufficient material to prove his active role, coupled with criminal intent.
In practice, however, even after detailed clear law established by the Supreme Court on the liability of IDs and NEDs, the law enforcement agencies and lower-level judiciary keep summoning all the directors without their involvement in the defaults committed by the companies thereby causing reputational loss and inconvenience.
To curb the increased instances of litigation against IDs or NEDs, the Ministry of Corporate Affairs (“MCA”) has vide a circular dated March 20, 2020, issued directions to the registrar of companies, directing them not to initiate any civil or criminal proceedings against IDs or NEDs unless sufficient evidence exists against them. Further, registrars while initiating proceedings against the officer who is in default shall follow a standard operating procedure (“SOP”) which shall include the following:
- Nature of default and person responsible: The registrar shall determine the nature of default in a company and the person responsible for the same. The registrar shall rely on necessary documents for determining the involvement of any officer in the default.
- Caution while proceeding against IDs and NEDs: Civil and criminal proceedings shall not be initiated against IDs and NEDs without sufficient proof of their involvement.
- MCA Guidance: If there are any doubts at the time of conducting the investigation, clarification from the Director General of Corporate Affairs shall be available.
The step taken by MCA is a laudable step. However, the current framework of liability of directors without distinction between MD and IDs puts IDs in a disadvantageous position and causes reputational loss to IDs and NEDs without their knowledge or involvement in the said default. Reputational loss, mental stress, and hardships caused by these frivolous legal proceedings demotivate several professionals from accepting board positions. Therefore, there is an urgent need to bring clearer amendments in the laws making a clear distinction between the roles and the liabilities of executive and non-executive directors.
Authored by Kritika Krishnamurthy, Partner & Anushree Jugade, Associate