What a director is personally exposed to under the Companies Act

Section 166 has seven sub-sections and each one is a rule that can be tested against a fact. Section 166(1) requires a director to act in accordance with the articles of the company. Section 166(2) requires a director to act in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of environment. Section 166(3) requires the duties to be exercised with due and reasonable care, skill and diligence and with independent judgment. The direction to the members as a whole in sub-section (2) is the answer to the argument that a director owes the family that appointed him.

Sections 166(4) to 166(6) close the three doors that directors most often walk through. A director shall not involve in a situation in which he may have a direct or indirect interest that conflicts, or possibly may conflict, with the interest of the company. A director shall not achieve or attempt to achieve any undue gain or advantage either to himself or to his relatives, partners or associates, and if he is found guilty of making any undue gain he is liable to pay an amount equal to that gain to the company. A director shall not assign his office, and any assignment so made is void. Section 166(7) makes a contravention punishable with fine which shall not be less than one lakh rupees but which may extend to five lakh rupees.

Two points of law come from the cases rather than from the section. The first is the position of a nominee director. Once appointed, the loyalty of a nominee director is to the company and not solely to the body that nominated him, and the Supreme Court said so in Tata Consultancy Services Ltd. v. Cyrus Investments Pvt. Ltd. (2021) 9 SCC 449 when it dealt with the nominee directors of a trust. The second is the duty of care. The principles determining the liability of a managing director and the board in misfeasance proceedings were set out in Official Liquidator, Supreme Bank Ltd. v. P. A. Tendolkar (Dead) by L. Rs. and Ors. (1973) 1 SCC 602, a decision on the Banking Companies Act, 1949 and section 235 of the Companies Act, 1913, which remains the reference on care, diligence and supervision and on how far a director may rely on the officials of the company.

Section 165 sits alongside section 166 and is a limit on how much a person can take on. A person may not hold office as a director, including an alternate directorship, in more than twenty companies at the same time, and the maximum number of public companies in which a person can be appointed as a director shall not exceed ten. For the limit of twenty companies, the directorship in a dormant company is not counted.

Section 164(1) lists the personal grounds of disqualification. A person is not eligible for appointment as a director if he is of unsound mind and stands so declared by a competent court, is an undischarged insolvent, has applied to be adjudicated as an insolvent and the application is pending, or has been convicted of an offence and sentenced to imprisonment for not less than six months and a period of five years has not elapsed from the date of expiry of the sentence. Where the sentence was seven years or more, the person is not eligible to be appointed as a director in any company. The section also covers a disqualification order passed by a court or the Tribunal which is in force, the failure to pay calls on shares for six months from the last day fixed for payment, a conviction for the offence of dealing in related party transactions under section 188 at any time during the last preceding five years, and the failure to comply with section 152(3) on the director identification number.

Section 164(2) is the disqualification that catches a director by accident. No person who is or has been a director of a company which has not filed financial statements or annual returns for any continuous period of three financial years, or which has failed to repay deposits accepted by it, or pay interest on them, or redeem debentures, or pay a declared dividend, and where the failure continues for one year or more, is eligible to be re-appointed as a director of that company or appointed in any other company for a period of five years from the date on which the company fails to do so. Where a person is appointed as a director of a company in default, the disqualification runs for six months from the date of the appointment. Section 164(3) lets a private company add its own disqualifications by its articles.

M. K. Rajagopalan v. Dr. Periasamy Palani Gounder & Anr. (2024) 1 SCC 42 shows how the section bites in practice. A resolution applicant who was a director of a company that had collected share application money pending allotment and had not refunded it was held to be disqualified under section 164(2)(b), because the unrefunded amount was to be treated as a deposit, and the consequence was that the person stood disqualified from acting as a director in any company for five years. The Court also observed that a disqualification of that kind is essentially a matter for the consideration of the Registrar of Companies unless a categorical finding is recorded by the Adjudicating Authority, which is why the finding has to be specific.

Section 167 then turns the disqualification into a vacancy. The office of a director becomes vacant where he incurs any of the disqualifications specified in section 164, where he absents himself from all the meetings of the board held during a period of twelve months with or without seeking leave, where he acts in contravention of section 184 or fails to disclose his interest in contravention of section 184, where he is disqualified by an order of a court or the Tribunal, where he is convicted of an offence involving moral turpitude or otherwise and sentenced to imprisonment for not less than six months, where he is removed in pursuance of the Act, or where he was appointed by virtue of holding an office or employment in the holding, subsidiary or associate company and ceases to hold that office. Section 167(2) makes it an offence to go on functioning as a director when the office has already become vacant.

Section 173 sets the rhythm. Every company shall hold the first meeting of the board within thirty days of the date of its incorporation and thereafter hold a minimum number of four meetings a year in such a manner that not more than one hundred and twenty days shall intervene between two consecutive meetings of the board. Participation may be in person or through video conferencing or other audio visual means. A director who cannot attend has to build the record, which is why the disclosure rules matter as much as the attendance rules.

Section 184(1) requires a director to disclose his concern or interest in any company or body corporate, firm or other association of individuals, including the shareholding, at the first meeting of the board in which he participates as a director, thereafter at the first meeting of the board in every financial year, and whenever there is any change in the disclosures already made, then at the first board meeting held after the change. Section 184(2) covers the contract itself. A director who is concerned or interested in a contract or arrangement with a body corporate in which he holds more than two per cent shareholding or is a promoter, manager or Chief Executive Officer, or with a firm or other entity in which he is a partner, owner or member, must disclose the nature of his concern at the meeting of the board in which the contract is discussed and must not participate in that meeting.

The consequence of a miss is set out in section 184(3). A contract or arrangement entered into by the company without disclosure under sub-section (2), or with the participation of a director who is concerned or interested in it, is voidable at the option of the company. Section 184(4) puts a penalty of one lakh rupees on a director who contravenes sub-section (1) or sub-section (2). Section 189 then gives the record: every company shall keep one or more registers giving separately the particulars of all contracts or arrangements to which section 184(2) or section 188 applies, and after entering the particulars the register is placed before the next meeting of the board and signed by all the directors present at that meeting. A director or key managerial personnel must disclose to the company the particulars relating to his concern or interest in other associations within a period of thirty days of his appointment or of relinquishing his office.

Section 190 carries the same discipline into the employment contract. Every company shall keep at its registered office a copy of a written contract of service with a managing or whole-time director, or a written memorandum of its terms where the contract is not in writing, and those copies are open to inspection by any member of the company without payment of fee. A default makes the company liable to a penalty of twenty-five thousand rupees and every officer of the company who is in default liable to a penalty of five thousand rupees for each default. The section does not apply to a private company.

Personal liability comes in three shapes. The first is a penalty or punishment that the Act names against a director personally. Section 166(7) puts fine on a director who contravenes the duties section. Section 167(2) puts fine on a person who functions as a director when the office has become vacant. Section 447 puts a director and any other person who is found to be guilty of fraud involving an amount of at least ten lakh rupees or one per cent of the turnover of the company, whichever is lower, to imprisonment for a term which shall not be less than six months but which may extend to ten years, and to a fine which shall not be less than the amount involved in the fraud but which may extend to three times the amount involved. Where the fraud involves public interest, the term of imprisonment shall not be less than three years.

The second is the liability that a court fixes in a misfeasance proceeding. Official Liquidator, Supreme Bank Ltd. v. P. A. Tendolkar (Dead) by L. Rs. and Ors. (1973) 1 SCC 602 is the reference on what that liability consists of and on how it is apportioned. The Court determined the total remaining liabilities of the managing director and the directors, specified individual and joint and several liabilities, and set out the procedure for recovery. It also settled where a director has died: the court cannot make a compulsive order against the heirs of a deceased director under section 235 of the Companies Act, 1913, because the liability does not survive the person, though other remedies remain available against the estate. The same decision considered the period of limitation for proceedings against directors and officers.

The third is the liability that follows a winding up, and it is where section 339 and section 340 do their work. Section 339 deals with liability for fraudulent conduct of business, and section 340 with the power of the Tribunal to assess damages against delinquent directors. Section 266 gives the Tribunal the corresponding power where a company is wound up. Section 286 puts the obligation on directors and managers to cooperate with the liquidator, and section 450 provides for punishment where no specific penalty or punishment is provided for a contravention.

A separate point is remuneration. Section 199 lets a company recover from a past or present managing director, whole-time director, manager or Chief Executive Officer the remuneration, including any stock option, received in excess of what would have been payable on the restatement of the financial statements, where the company is required to restate its financial statements because of fraud or non-compliance with any requirement under the Act or the rules made under it. Section 202 governs compensation for loss of office of a managing or whole-time director or manager, and section 194 prohibits forward dealings in securities of the company by a director or key managerial personnel.

Section 185(1) draws a hard line. No company shall, directly or indirectly, advance any loan, including a loan represented by a book debt, to, or give any guarantee or provide any security in connection with any loan taken by, a director of the company or of a company which is its holding company, or any partner or relative of any such director, or a firm in which any such director or relative is a partner. The prohibition covers the company that gives the money and the company that receives it, and it covers a guarantee and a security as well as a loan.

Section 185(2) allows a loan, guarantee or security to a person in whom a director of the company is interested, on two conditions: a special resolution must be passed by the company in general meeting, and the loans must be utilised by the borrowing company for its principal business activities. The explanatory statement to the notice for the general meeting must disclose the full particulars of the loans, guarantee or security, the purpose for which it is proposed to be used and any other relevant fact. The Explanation to section 185(2) defines the class of persons: a private company of which the director is a director or member, a body corporate at a general meeting of which not less than twenty-five per cent of the total voting power may be exercised or controlled by the director or by two or more such directors together, and a body corporate whose board of directors, managing director or manager is accustomed to act in accordance with the directions or instructions of the board or directors of the lending company.

Section 185(3) opens the exceptions. Nothing in sub-sections (1) and (2) applies to the giving of a loan to a managing or whole-time director as part of the conditions of service extended by the company to all its employees, or pursuant to any scheme approved by the members by special resolution. It also does not apply to a company which in the ordinary course of its business provides loans or gives guarantees or securities for the due repayment of any loan and in respect of which an interest is charged at a rate not less than the rate of the prevailing yield of the one year, three years, five years or ten years Government security closest to the tenor of the loan.

Section 186 carries the same structure for loans and investments by the company, and section 187 requires the investments of the company to be held in its own name. Where a company lends to a body corporate in which a director is interested, the transaction is also a related party transaction under section 188 and has to run through the approval route in that section.

Section 188(1) requires the consent of the board of directors, given by a resolution at a meeting of the board and subject to such conditions as may be prescribed, before a company enters into a contract or arrangement with a related party in respect of the sale, purchase or supply of any goods or materials, the selling or otherwise disposing of or buying of property of any kind, the leasing of property of any kind, the availing or rendering of any services, the appointment of any agent for purchase or sale of goods, materials, services or property, the related party's appointment to any office or place of profit in the company, its subsidiary company or associate company, and the underwriting of the subscription of any securities or derivatives of the company.

Two arms decide most of these transactions. A contract that is in the ordinary course of the company's business and is on arm's length terms is taken out of the section by the proviso to section 188(1), and the company has to be able to produce the evidence of both when it is asked. Section 189 is where the record is kept: one or more registers giving separately the particulars of all contracts or arrangements to which section 184(2) or section 188 applies, placed before the next meeting of the board and signed by all the directors present. A director who has an interest in a contract that goes into the register has to disclose it, and a contract entered into without disclosure is voidable at the option of the company.

The approval route for the transactions that are not taken out by the proviso runs through section 177. The board of every listed public company, and such other classes of companies as may be prescribed, shall constitute an audit committee, which shall consist of a minimum of three directors with independent directors forming a majority, and the majority of the members including the chairperson must be persons with the ability to read and understand the financial statement. The committee acts on terms of reference specified in writing by the board, and those terms have to cover the related party transactions it is to approve.

The boundary between a board decision and an oppression complaint is a live one. In Hasmukhlal Madhavlal Patel and Anr. v. Ambika Food Products Pvt. Ltd. and Ors. [2023] 8 S.C.R. 243 the question before the Tribunal was whether an increase in the paid-up capital and the allotment of shares that followed was an act of oppression, and the direction to allot shares in the impugned order was set aside while the order for conducting an audit remained undisturbed. A decision the board takes on a capital issue is not an oppression simply because a minority shareholder dislikes it, and the pleading has to show conduct that is harsh and wrongful rather than a commercial disagreement.

Section 149 fixes the shape of the board. Every company shall have a board of directors consisting of individuals as directors and shall have a minimum number of three directors in the case of a public company, two directors in the case of a private company and one director in the case of a One Person Company, and a maximum of fifteen directors, with a company permitted to appoint more than fifteen directors after passing a special resolution. Every company shall have at least one director who stays in India for a total period of not less than one hundred and eighty-two days during the financial year. Every listed public company shall have at least one-third of the total number of directors as independent directors.

Section 150 governs how independent directors are chosen and where their names are recorded. A section 177 audit committee and a section 178 nomination and remuneration committee are the two committees the Act requires, and the audit committee of a listed public company has to recommend the appointment and remuneration of the auditors and the related party transactions that section 188 requires to be approved.

Section 176 protects the company from an irregularity in the appointment. No act done by a person as a director shall be deemed to be invalid, notwithstanding that it was subsequently noticed that his appointment was invalid by reason of any defect or disqualification or had terminated by virtue of any provision contained in the Act or in the articles of the company. The proviso is the limit: nothing in the section gives validity to an act done by the director after the company has noticed that his appointment has been invalid or has terminated. The defect has to be found before the company acts on it.

One more route into the board has to be mentioned. In Sangramsinh P. Gaekwad v. Shantadevi P. Gaekwad (2005) 11 SCC 314 the Division Bench exercised the power under section 402 of the Companies Act, 1956 to appoint a director to protect the petitioner's interest and to guard a divided board, and the Supreme Court reviewed the exercise of that power. The corresponding power under the 2013 Act is the appointment of directors to report to the Tribunal under section 242(2), and it is worth knowing that the court can put a director on the board of a company whose board cannot act.

Section 169(1) lets the members remove a director by ordinary resolution, not being a director appointed by the Tribunal under section 242, before the expiry of the period of his office, after giving him a reasonable opportunity of being heard. An independent director re-appointed for a second term under section 149(10) can be removed only by a special resolution and after a reasonable opportunity of being heard. Section 169(2) requires a special notice of the resolution, and section 115 sets the threshold for that notice: such number of members holding not less than one per cent of the total voting power, or holding shares on which the prescribed aggregate sum not exceeding five lakh rupees has been paid up. Section 169(1) does not apply where the company has adopted the principle of proportional representation under section 163 with not less than two-thirds of the directors appointed that way.

Section 168 governs resignation and, more usefully, the liability that survives it. A director may resign by giving notice in writing to the company, and the board shall on receipt of the notice take note of it, the company shall intimate the Registrar in the prescribed manner within the prescribed time, and the fact of the resignation is to be placed in the report of directors laid in the immediately following general meeting. A director may also forward a copy of the resignation along with detailed reasons for it to the Registrar within thirty days of the resignation. Section 168(2) provides that the resignation takes effect from the date on which the notice is received by the company or the date, if any, specified by the director in the notice, whichever is later, and that the director who has resigned is liable even after his resignation for the offences which occurred during his tenure.

Section 168(3) covers the empty board. Where all the directors of a company resign from their offices, or vacate their offices under section 167, the promoter or, in his absence, the Central Government shall appoint the required number of directors, who hold office until the directors are appointed by the company in general meeting. That is the last-resort mechanism, and it is slow. A director who is resigning because the company is in trouble should expect the vacancy to be noticed and the books to be called for.

What an indemnity or a liability policy can do is a question of contract and of the law of the company, and the Act does not answer it. What the Act does answer is where the liability sits. Section 199 lets a company recover remuneration received in excess of what would have been payable on a restatement of the financial statements, and section 242(2) of the Companies Act lets the Tribunal remove a director and order the recovery of undue gains made during the appointment. Both are routes that run against the director personally and neither depends on the company proving a claim in a civil suit.