Liabilities of Directors

Shruti Gupta
The liability of a director arises due to his fiduciary position with the company and the shareholders. Directors are criminally liable under various laws. The general principle for making directors criminally liable is, only those persons who were in charge of and responsible for conduct of business of the Company at the time of commission of an offence, will be liable for criminal action. The Companies Act lays down various statutory provisions for prosecution of directors. If a prospectus contains some untrue statement and if on the basis of which a person has subscribed the shares of that company then the directors of the company are liable to compensate the person who has subscribed shares on the faith of the prospectus, which contained untrue statement. The Director should compensate every such subscriber for any loss or damage he may have sustained by reason of such untrue statement in an action in tort and also under section 62 of the Act to pay compensation. If the Director discovers a mistake in the prospectus, it is his duty to specifically point it out. The Director may also have to face criminal prosecution for untrue statement in the prospectus. He may be imprisoned for two years and fined Rs.50000.

The Directors are liable to criminal prosecution for inducing or attempting to induce a person by statement or even forecast which is false or misleading to enter into or to offer to enter into any agreement to buy shares of the company. They shall be punishable with imprisonment for a term which may extend to five years, or with fine which may extend to Rs.1,00,000, or with both.

Where directors manage a company then each director shall be responsible (if there is no managing director) that the company should maintain and keep proper books of

account. Default or non-compliance will make the Director punishable with imprisonment for a term not exceeding six months or fine of Rs.10,000 or both.

The directors shall be punishable for falsification of books with a term of imprisonment which may extend to seven years and shall also be liable to fine.

Where directors within the twelve months before the commencement of the winding up or at any time thereafter, have by false representation or other fraud, obtained on credit, for or on behalf of the company, any property which the company does not subsequently pay for or pawned, pledged or disposed of any property of the company which has been obtained on credit and has not been paid for (unless such pawning, pledging or disposing is in the ordinary course of the business of the company), they shall be punishable with imprisonment for a term which may extend to five years, or with fine, or with both.

Liabilities of Directors under various circumstances

1. Liability for illegal acts: Where directors have used their powers to part with moneys of their company in a manner or for a purpose which the law forbids, it is not a defense to proceedings to make them liable for their act to plead merely that they acted in ignorance of law. 2. Director receiving secret commission or bribe: A similar prohibition would also exist against the Director obtaining any secret commission or any illegal gratification for the award of a contract with the company.

3. Liability for negligence: There are no objective standards of skill and care which will help in determining whether a Director has been negligent; instead, there are only general principles which may be applied depending on the facts of each case. The director are not liable for negligence if they act honestly for the benefit of the company, and within their powers with such care as is reasonably expected of them, having regard to their knowledge and experience. The directors are not bound to bring any special qualification into their office. The mere omission to take every possible care will not amount to negligence. 4. Negligent misrepresentation: A company Director who knowingly makes a false representation whilst acting as Director can be held personally liable not only in deceit, but also for negligent misrepresentation. 5. Liability for breach of warranty of authority: A Director is not personally liable for his companys failure to perform a contract which he had made on its behalf, but he is liable in damages to a person with whom he purports to make a contract which is not binding on his company at all. When a director representing a company negotiates a contract he impliedly represents to the other contracting party that he has authority to bind the company as its agent. 6. No personal liability under contracts signed for company: Where all the contracts for services were in the name of the companies trading under their trade names and the Director sought to be made liable merely appended his name to authenticate the contracts on behalf of the companies, he could not be held personally liable. For the signatory director to be made liable there should have been an intention on the part of the parties that he should be a party to the various contracts.

7. Liability for fraud: The Court of Appeal held that in an action for deceit against a company officer, it is necessary to show that the officer in question made the statements and the plaintiff relied upon them. There must also be an assumption of responsibility so as to create a special relationship between the plaintiff and defendant Director. 8. Liability in respect of companys debts: There is no provision in the Companies Act making the managing director of a company personally liable for the companys debts. Such liability will turn upon the application of agency principles to the transaction in quest ion. 9. Liability in respect of breach of trust: A director who assisted his company to commit a breach of trust, or procured it to do so, was held liable for any loss caused to the beneficiaries of the trust as a result of his actions. It was necessary for this liability to arise that those actions could be characterized as dishonest rather than negligent. It was not necessary that the company as trustee be acting dishonestly. 10. Liability for personal profits: The Directors are liable to the company for all personal profits and gains made by them taking advantage of their position as directors. 11. Directors are not liable for incidental profits: The directors are not liable for a profit they make incidentally as a consequence of exercising the powers for a perfectly proper purpose in the interests of the company.

Liability in case of statutory violations

1. Liability of Directors under the Negotiable Instruments Act Section 141 of this Act imposes a vicarious liability on the directors of a company who are prosecuted in respect of dishonor of cheque. Section 141 reads as follows: Offences by companies: (1) If the person committing an offence under section 138 is a company, every person who, at the time the offence was committed, was in charge of, and was responsible to the company for the conduct of the business of the company, as well as the company, shall be deemed to be guilty of the offence and shall be liable to be proceeded against and proceeded against and punished accordingly; Provided that nothing contained in this sub-section shall render any person liable to punishment if he proves that the offence was committed without his knowledge, or that he had exercised all due diligence to prevent the commission of such offence. Provided further that where a person is nominated as a Director of a company by virtue of his holding any office or employment in the Central Government or State Government or a financial corporation owned or controlled by the Central Government or the State Government, as the case may be, he shall not be liable for prosecution under this Chapter. (2) Notwithstanding anything contained in sub-section (1), where any offence under this Act has been committed by a company and it is proved that the offence has been committed with the consent or connivance of, or is attribute to, any neglect on the part of, any director, Manager, secretary, or other office of the company, such director, manager, secretary or other officer shall also be deemed to be guilty of

that offence and shall be liable to be proceeded against and punished accordingly. Explanation: For the purpose of this section. (a) Company means any, body corporate and includes a firm or other association of individuals; and (b) Director, in relating to a firm, means a partner in the firm. There have been various judicial pronouncements affirming the vicarious liability of the directors in cases of dishonor of cheques. In the case of Asith Kumar Mukherjee and Ors. v. T.T.K. Pharma Ltd. and Anr1, it was contentended that Section 141 of the Act contemplates is that the person sought to be proceeded against must have been, at the time of the offence, in charge of and responsible to the company for the conduct of the business of the company. Whether a particular person proceeded against was in charge of and was responsible to the company for the conduct of its business is a question of fact which is obviously required to be decided during the trial. The Andhra Pradesh High Court held that where the directors are responsible for the affairs of the company and the day-to-day management, they are liable to be prosecuted under Section 141 of the Act. The court further observed that literal meaning of Section 141 is not to be construed but circumstantial evidence is enough to prove liability. The Honble Supreme Court held in the case of S.M.S. Pharmaceuticals Ltd. v. Neeta Bhalla and Anr2 that Section 141 of the Act does not say that a Director of a Company shall automatically be vicariously liable for commission of an offence on behalf of the Company. What is necessary is that sufficient averments should be made to show that the person who is sought to be proceeded against on the premise of his being vicariously liable for commission of an offence by the Company must be incharge and shall also be responsible to the Company for the conduct of its business.

1 2

Asith Kumar Mukherjee and Ors. v. T.T.K. Pharma Ltd. and Anr, 2000 (1) ALD Cri 891 S.M.S. Pharmaceuticals Ltd. v. Neeta Bhalla and Anr, (2005) 6 CLJ 144 (SC)

Making Directors liable for the offences committed by the company under Section 141 of the Act, there must be specific averments against the Directors, showing as to how and in what manner the Directors were responsible for the conduct of the business of the company. The Supreme Court also laid down the following principles in regard to the same: (i) The primary responsibility is on the complainant to make specific averments as are required under the law in the complaint so as to make the accused vicariously liable. For fastening the criminal liability, there is no presumption that every Director knows about the transaction. (ii) Section 141 does not make all the Directors liable for the offence. The criminal liability can be fastened only on those who, at the time of the commission of the offence, were in charge of and were responsible for the conduct of the business of the company. (iii) Vicarious liability can be inferred against a company registered or incorporated under the Companies Act, 1956 only if the requisite statements, which are required to be averred in the complaint/petition, are made so as to make accused therein vicariously liable for offence committed by company along with averments in the petition containing that accused were incharge of and responsible for the business of the company and by virtue of their position they are liable to be proceeded with. (iv)Vicarious liability on the part of a person must be pleaded and proved and not inferred. (v) If accused is Managing Director or Joint Managing Director then it is not necessary to make specific averment in the complaint and by virtue of their position they are liable to be proceeded with. (vi) If accused is a Director or an Officer of a company who signed the cheques on behalf of the company then also it is not necessary to make specific averment in complaint. (vii) The person sought to be made liable should be in- charge of and responsible for the conduct of the business of the company at the relevant time. This has to be averred as a fact as there is no deemed liability of a Director in such cases. Very recently, the Honble Supreme Court while deciding a case under a case of Sec. 138 of Negotiable Instruments Act, 1881 for cheque bouncing has discussed the circumstances when a Director can be held vicariously liable. This judgment is a comprehensive judgment laying

down the general scope of making Directors vicariously liable and follows a catena of decisions laid down by the Supreme Court prior to passing of this Judgment. The said circumstances are reproduced herein below. (i) The primary responsibility is on the complainant to make specific averments as are required under the law in the complaint so as to make the accused vicariously liable. For fastening the criminal liability, there is no presumption that every Director knows about the transaction. (ii) Section 141 does not make all the Directors liable for the offence. The criminal liability can be fastened only on those who, at the time of the commission of the offence, were in charge of and were responsible for the conduct of the business of the company. (iii) Vicarious liability can be inferred against a company registered or incorporated under the Companies Act, 1956 only if the requisite statements, which are required to be averred in the complaint/petition, are made so as to make accused therein vicariously liable for offence committed by company along with averments in the petition containing that accused were incharge of and responsible for the business of the company and by virtue of their position they are liable to be proceeded with. (iv) Vicarious liability on the part of a person must be pleaded and proved and not inferred. (v) If accused is Managing Director or Joint Managing Director then it is not necessary to make specific averment in the complaint and by virtue of their position they are liable to be proceeded with. (vi) If accused is a Director or an Officer of a company who signed the cheques on behalf of the company then also it is not necessary to make specific averment in complaint. (vii) The person sought to be made liable should be in- charge of and responsible for the conduct of the business of the company at the relevant time. This has to be averred as a fact as there is no deemed liability of a Director in such cases. The liability of a director arises due to his fiduciary position with the company and the shareholders. Directors are criminally liable under various laws. The general principle for making directors criminally liable is, only those persons who were in charge of and

responsible for conduct of business of the Company at the time of commission of an offence, will be liable for criminal action. It also needs to be borne in mind that Directors are vicariously liable only when an Act clearly spells it out and in absence of any provision laid down under the statute, a Director of a company or an employee cannot be held to be vicariously liable for any offence committed by the company itself. 2. Liability of Directors under Information Technology Act The IT Act also places a criminal liability on the directors of the company. Section 85 of the Act makes the Directors of a company liable for offences by the companies. Section 85 reads as follows: Offences by companies. - (1) Where a person committing a contravention of any of the provisions of this Act or of any rule, direction or order made thereunder is a company, every person who, at the time the contravention was committed, was in charge of, and was responsible to, the company for the conduct of business of the company as well as the company, shall be guilty of the contravention and shall be liable to be proceeded against and punished accordingly: Provided that nothing contained in this sub-section shall render any such person liable to punishment if he proves that the contravention took place without his knowledge or that he exercised all due diligence to prevent such contravention. (2) Notwithstanding anything contained in sub-section (1), where a contravention of any of the provisions of this Act or of any rule, direction or order made thereunder has been committed by a company and it is proved that the contravention has taken place with the consent or connivance of, or is attributable to any neglect on the part of, any director, manager, secretary or other officer of the company, such director, manager, secretary or other officer shall also be deemed to be guilty of the contravention and shall be liable to be proceeded against and punished accordingly. Explanation.-For the purposes of this section(a) company means and body corporate and includes a firm or other association of individuals; and (b) directors, in relation to a firm, means a partner in the firm.

This provision has been affirmed by the Delhi High Court in the landmark case of Avnish Bajaj v. State3. In this case the Managing Director of the company that owned the website Bazee.com was prosecuted under sections 67 and 85 of the IT Act (which relate to the transmission of obscene material through electronic media) following the posting of an obscene video on the website by a third party. The court while upholding the prosecution of the Director, recognized the principle of deemed criminal liability of the directors of the accused company, which meant it was not necessary for the company itself to be a party to the case in order to proceed against its directors. 3. Liability under Pollution Laws: The managing director and the members of the Board of Directors can be prosecuted under the respective Pollution Control laws and it is not necessary that the company should also be prosecuted along with them. 4. Liability under ESI, EPF, Gratuity and Minimum Wages Act There is no specific provision permitting the initiation of recovery proceedings against an occupier (Director ) in his personal capacity for the failure of the company to remit contributions under the laws like Employees State Insurance Act, 1948 and other personnel laws. Vicarious Liability of Directors As noted above, the directors have been made vicariously liable for offences by the companies and have been subject to prosecution. However the basic test for determining this has been provided for by the courts in various judgments. The Honble Supreme Court of India laid down in the case of Maksud Saiyed v. State of Gujarat and Ors 4that the vicarious liability of the Managing Director and Director would arise provided any provision exists in that behalf in the statute. The Court further observed that statutes indisputably must contain provision fixing such vicarious liabilities and even for the said

3 4

Avinash Bajaj V. State ,(2005) 3 CompLJ 364 Del Maksud Saiyed v. State of Gujarat and Ors , 2008 (5) SCC 688

purpose it is obligatory on the part of the complainant to make requisite allegations which would attract the provisions constituting vicarious liability. This was re-iterated by the Supreme Court once again in S.K. Alaghs case5 where it held that in absence of any provision laid down under the statute, a Director of a company or an employee cannot be held to be vicariously liable for any offence committed by the company itself.

Criminal Liability of Independent Directors in light of the recent judgments: The Companies Act, 1956 has no separate definition for Independent Directors and as such even Independent Directors come within the purview of the definition of Directors as described in The Companies Act, 1956. Independent Directors are outside Directors who are not the employees of a company but outside personnel, holding expertise in certain areas .It is their duty to provide an unbiased, independent, varied and experienced perspective to the board of directors. But since these directors are not directly involved in the company affairs can they be held liable for the criminal acts of the company, which have been committed without their knowledge. In the recent judgment passed by the Bhopal District Court in the matter of the Bhopal gas tragedy, the court held Mr. Keshub Mahindra, ex-chairman, Union Carbide India, guilty and sentenced him to two years of imprisonment. This judgment has brought this primary question in light - How can Independent Directors/ Non- Executive Directors be held legally responsible for something which may go wrong or lapses in compliance on the part of the management, including the whole-time directors. This has given rise to a series of arguments and has posed a major cause of concern for the independent directors/ non-executive directors who are apprehensive about meeting a similar fate for misdemeanors on the part of others executives who are solely responsible for the dayto-day running of the corporations. Those responsible for such a tragedy should be held accountable but what is the extent of accountability for a non-executive director. One direct consequence of the Bhopal verdict could
5

S.K.Algah V State of UP, (2008) 5 SCC 662

be that it further deters qualified men and women from serving as independent directors on corporate boards if their service is likely to dog them for decades and they can be held accountable in a criminal court for operational failures. The likely outcome of this could be a number of them resigning en masse and none would come forward henceforth to take up the responsibility of acting as independent Directors. Qualified individuals would be reluctant in accepting the positions of Independent directors in such an atmosphere of uncertainty. If pinning the blame on the non executive directors for criminal acts which were beyond their control or due to a management failure becomes a practice, it will surely deter qualified individuals to accept such positions due an increased risk and the accountability associated with their position. A set of recommendations have been put forth by the Confederation of Indian Industry to Indias Ministry of Corporate Affairs on limiting the legal liability of independent directors. In this the CII has recommended immunity to non-executive directors, to exclude them from any vicarious criminal liability for offences committed by the company, by changing the law. On the other hand there is a separate set of arguments which upholds the verdict and supports absolute criminal liability on the Independent Directors. According to this view the ultimate legal responsibility lies with these directors and when a crime takes place, it is their collective responsibility to be liable. The Companies Act, or no other legislation excludes Independent Directors from criminal liability. Being an independent director does not mean being independent of law. Sleeping, non-executive and independent are just pretentious terms to restrict the legal responsibility of a director in the company, there are no restrictions in the law to cut down liability. This debate has sparked off a controversy which will not rest unless, the legislature enacts certain provisions which specify the role of Independent Directors and the scope of their responsibility attached to their positions. The term Independent Directors or Non executive Directors has yet to be defined specifically in the Companies Act and should they be treated any different from the Executive Directors.