Directors’ Liability in India

The duties of a director are provided under corporate law as well as the laws related to taxation, cross-border trade, and environmental protection, among others. While a company typically bears the liability for its actions, its directors can also be held personally liable under certain circumstances. Such liability to directors may arise from a failure to fulfil their duties, or if they engage in unfair or illegal practices, or abuse or exceed their authority.

Directors act as representatives of the company and custodians of the company’s funds and assets. They must manage the affairs of the company with skill and reasonable care. They must act in the best interests of the company, its shareholders and employees, above their own.

Directors can thus be held liable for their fraudulent or self-serving actions, as well as actions that contribute or result in an offence being committed by the company. Offences for which a director might be held liable range from serious crimes like capital market manipulation and investment fraud to less severe ones such as failure to meet corporate compliances by the company on time. They can also be held liable, if upon becoming aware of an offence by the company, they have failed to act, or if their actions are negligent in nature.

A director may be held liable even after their resignation for the offences committed by them or the company during their tenure.

Companies and their directors bear responsibility to their creditors, shareholders, and third-party associates as per the nature of their arrangements, and are also beholden to government authorities and regulators to strictly adhere to the law, both in letter and spirit.

An investor who has relied upon misleading information when making an investment, and has suffered a loss as a result, may bring a suit against the company’s directors who were serving at the time such information was provided. A lender may also sue the directors if the company has borrowed funds with the intent to defraud the lender, and fails to make interest payments or return the principal amount as per the agreed terms.

Directors of a company that is undergoing liquidation, who have been found not to have taken adequate measures to minimize any protentional losses to the company’s creditors, could be directed by the insolvency court to contribute to the repayment of the company’s unpaid debts.

Government authorities may initiate proceedings against managing directors for the offences committed by a company, or even non-executive directors who have conspired and assisted with the commission of a crime.

Tax authorities may initiate proceedings against directors if they are unable to recover the company’s tax liability due to insufficient funds or liquidatable assets. This would also apply if the company is liquidated and dissolved prior to recovery of deficit taxes due from the company, rendering it impossible for tax authorities to recover such dues.

A company may itself sue directors that have been involved in embezzlement, fraud, or have abused or exceeded their authority causing loss or harm to the company.

A director may be criminally liable for their illegal acts, and in some cases the wrongful acts of the company or other directors. Punishment for an offence may include payment of a fine or imprisonment, or both. In case of any loss suffered by a victim of an offence, the offender and /or the offending company may be directed to pay compensation to the victim to make good any losses suffered by them, as well as additional compensation for the hardship and distress caused to them.

A director committing fraud may be fined as much as thrice the amount involved, and may be punished with imprisonment with a term of up to ten years based on the severity of the offence. Directors may also be fined for failing to meet reasonable standards of service or for other breaches of their ethical responsibilities.

Criminal proceedings are typically initiated in one of two ways. A victim may approach the police to submit his/her complaint, and if the police feel that the complaint is genuine and a crime has been committed, they may start criminal prosecution with an investigation. For relatively less severe classes of offences, a person may be required to approach a magistrate. Here the magistrate would consider the veracity of the complaint and direct the police to start an investigation. Government authorities tasked with monitoring and regulating certain activities may directly initiate investigation and prosecution of a company and its directors.

In more recent years, director’s insurance has become a common practice in India. It is most frequently seen in large enterprises especially when multiple unaffiliated domestic or foreign investors each have their own board representation, or when a foreign investor has appointed a director to the board, or when a director is appointed for his/her professional or technical knowledge and plays no active part in the company’s affairs. Such insurance would help to reduce the monetary loss that directors might otherwise bear while defending a suit brought against them, regardless of the outcome of the proceedings. The director’s actions must be within his/her authority, in line with his/her duties, and permitted and valid under law.

Corporate laws attempt to hold accountable managing or executive directors and senior management that control the company’s conduct and day to day affairs. Such directors and managers face the highest risk of civil and criminal liability. When a company does not have such management roles, all directors, whether executive or non-executive, run the risk of liability. With his or her consent, the board may designate one director to take on the full burden of such risk of liability. In doing so all other directors would be shielded from liability. In any case, any director who has received knowledge of a violation and has failed to act, or has conspired or contributed to the occurrence of a violation would be considered guilty and can be prosecuted. Other laws also have similar mechanisms in place for lifting the corporate veil and holding the company’s directors and managers accountable for the company’s wrongs. Directors may also be required to prove that the wrong cannot be attributed to any gross neglect, improper management, or breach of duty on their part.

Directors who do not have an executive role are not expected to know the day-to-day operations of a company. They are thus not presumed guilty without sufficient evidence to cast reasonable doubt upon them. A plea of innocence by a non-executive director claiming lack of knowledge would not be considered valid if the director has cast an affirmative vote at a board meeting, which has contributed to the commission of an offence. An expression of dissent recorded in the minutes of the meeting would go far in corroborating such plea of innocence.

Shareholders are the owners of the company and are not expected to know its day-to-day workings. Their liability is limited to the amount remaining unpaid on their shares, or to the extent of any guarantee provided by them. The office of director accompanies with it certain duties and responsibilities laid on the shoulders of the individual holding such office, and a shareholder cannot be held liable for the wrongful actions or inaction of the company, or a director. Such protection would not extend to fraudulent or illegal activity, and courts have in such cases been seen to lift the corporate veil and hold accountable all persons who are complicit in the commission of an offence.