Legislative Design of Director’s Responsibility in India: in Search of Clarity

Duties of directors under the corporate governance framework received significant overhaul pursuant to the introduction of reformatory clauses in the Companies Act, 2013 (hereinafter ‘the 2013 Act’). Satyam Computer Services’ financial fraud is often considered the Indian counterpart of Enron.¹ In the aftermath of the scam, in 2009, anticipating legal scrutiny and high liabilities; almost 620 independent directors resigned from the board of Indian companies.² Increasing numbers of non-executive directors exited fearing being held responsible indiscriminately for the acts and decisions of executive directors and promoters.³ While the Satyam fiasco concerned financial fraud, this turn of events invited scrutiny by national and global players attracting momentous public attention. This episode became the trigger for a much-needed regulatory overhaul.

The erstwhile Companies Act, 1956 (hereinafter ‘the 1956 Act’) lacked clarity on the duties and liabilities owed by the director of a company. An updated responsibility and liability regime to regulate corporate governance laws for the directors in the 2013 Act was passed by the parliament. Section 166 of this legislation elaborates on the duties of directors. Effective corporate governance and efficient discharge of duties by the directors of a company are co-related. The proactive role by the judiciary in filling up these statutory gaps is commendable considering the application of common law principles for determining fiduciary liabilities. Post-2013, the legal framework witnessed a transition from a shareholder’s approach to a stakeholder’s approach. Though the primary objective of codification of the director’s duties in the 2013 Act was to introduce clarity and certainty,⁴ our analysis suggests contrary outcomes.

This article portrays the changes ushered in through the new legislative codification and examines certain disregarded dimensions deserving attention in the Indian context. This article highlights an interesting phenomenon in India, namely a numerical and percentage increase year on year in resignations of directors from Indian companies, a trend that has been going on since 2009 and that independent directors form a disproportionate part of these resignations. While the 2013 Act, to some extent, facilitates an objective assessment of the directors’ duties by the courts of law, certain glaring inadequacies persist.

While deliberating upon the director’s responsibility, the attempt in this article is to analyse whether there has been a paradigm shift compared to the previous legislation. The analysis focusses on three fundamental aspects. First, whether the fiduciary responsibilities of the directors have been addressed effectively drawing lessons from the prior mistake. Second, whether the stakeholder’s approach on which the 2013 Act has been enacted is appropriate to fill the lacuna. Third, whether minority shareholder’s concerns been addressed as a measure through the derivative litigation clause in the 2013 Act? The growing number of legal proceedings against independent and non-executive directors who do not take day-to-day responsibility is a major concern. Also, the emerging problem of increasing responsibility of the independent director’s position without adequate power raises concerns to be addressed by the legal framework. The role of a director during impending insolvency also needs attention.

The 2013 Act is unsatisfactory because it has failed to address inadequacies in the previous law that has led directors to resign, also because it has made things worse for directors by introducing stricter provisions pertaining to director’s liability. The normative contribution of this article stresses the need to reform the existing statutory framework for according protection to directors of a company. The article is organized as follows: Section 2 presents an overview of the current statutory framework for the director’s duties. Contrasting the 2013 Act with the 1956 Act, this section highlights the inadequacies of the current framework. Subsequently, Section 3 analyses the change in the approach of the law and also the judiciary while balancing the interests of shareholders of a company vis-à-vis the fiduciary duties of its directors. Section 4 extends attention to the impropriety of attributing inconsistent liability towards independent and non-executive directors of a company for the day-to-day functioning. Section 5 concludes with a summation of emerging concerns regarding the director’s responsibility in the Indian context to remedy the disconnect between the duties of directors and their liabilities.

India being a common law country employs common law principles while adopting new legislation or amending existing legislation.⁵ The 2013 Act has been fashioned following the United Kingdom Companies Act of 2006 (the UK Act). Section 166 of the 2013 Act that deals with the director’s responsibilities corresponds to section 172 of the UK Act.⁶ The United States, as well as the United Kingdom, has witnessed a similar transition in the corporate governance framework.⁷ Acknowledging the well-intentioned aims of the statutory reforms, there still exist inadequacies in the current regime. Indian judiciary frequently employs common law principles as the guiding beacon in adjudicating cases.⁸ More so, in the absence of a codified statute as seen in the case of Director’s duties and liabilities under the Companies Act, 1956.

While the 2013 Act attempts to incorporate statutory provisions based on ‘regulatory transplant’,⁹ it does not provide the level of clarity expected from an updated contemporary statute. Hailed as a constructive stride towards the advancement of the jurisprudence pertaining to company law, the 2013 Act strives to upgrade the Indian statute at par with its international counterparts but in this process falls short on certain parameters. The effectiveness of the Companies Act, 2013, therefore, requires critical assessment.