India: Safeguarding The Interests Of Non-Executive Directors Nominated By PE Investors / VC Funds

Last Updated: 26 April 2018
Article by Iqbal Tahir Syed, Karan Ajitsaria and Gaurav Kapur


Being designated as a director in a company has a cascading effect with respect to exposure to liabilities under various legislations (including tax legislations like the Central Goods and Services Tax Act, 2017 (GST Act)). This issue becomes significant in view of the recent media reports on notices being served on some non-executive nominee directors, of private equity investors (PE), from the income tax department in connection with tax claims of investee companies.

Many PEs, by virtue of rights that they enjoy, under contractual arrangements with the promoters and investee companies, have a considerable say in the running of such companies. As a consequence, directors nominated by such PE investors (PE Directors), despite generally being non-executive directors, find it more difficult to absolve themselves when an investee company is in non-compliance of law, or is questioned by the tax office. The intention of this article is to briefly highlight the provisions under the GST Act that focus on the liabilities of directors of private limited companies; and what measures that PE Directors should generally adopt in order to safeguard their interests and avoid any undue liability.


Section 89 of the GST Act addresses the issue of liability of directors of a private limited company. It may be pertinent to note that this section overrides the Companies Act, 2013. The referred section states that if a private limited company does not pay its dues in relation to any supply of goods or services or both, for any period whatsoever, then, in such an event, the directors of such a company shall be jointly and severally liable for the dues of the company. It does not clearly classify which category of directors would be liable, and hence does not make any distinction so as to exclude any non-executive directors. While there are divergent views on this issue, the prevailing view is that there is no-carve out for non-executive directors (including PE Directors), as they also play a role in the running of companies. However, it is also important to note that only the directors who were holding office during such period when the tax was due will be held accountable and shall be made liable. Additionally, no liability will be triggered for any director (including the PE Director), if such director can prove that the non-payment by the company was due to reasons other than any negligence or breach of duty on his/ her part. It may be noted that Section 89 of the GST Act only applies in relation to unpaid dues of the company, and not for any personal penalty imposed on the directors under the GST Act. The particular director(s) will be responsible for their personal dues.


In order to avoid/ mitigate any liability on the PE Directors, arising out of a non – compliance/ breach by the investee company under the GST Act, or any other legislation in force, it is recommended that the following measures be adopted by PEs in relation to their PE Directors:

1. Indemnification Provisions

Statutory Relief to Directors from Liabilities: Section 463(1) of the Companies Act, 2013 states that in proceedings brought against directors (including non-executive directors) for negligence; default; breach of duty; misfeasance or breach of trust, the court may relieve the directors from liability, either wholly or partly, depending on the circumstances of the case, and if such director has acted honestly and reasonably.

Indemnification under Companies Act, 2013: While Section 201 of the erstwhile Companies Act, 1956 had restricted a company from indemnifying the directors of the company, the Companies Act, 2013 does not have any such restriction and therefore, directors can now be indemnified by companies against liabilities.

Statutory Limitation on Indemnification: Indemnification can also be provided for in the company's articles of association (Companies Act, 2013 - Schedule I - Table-F - Clause 91). However, the indemnity will be enforceable only if it is against any liability incurred by a director in proceedings that have any of the following outcomes, namely: (a) judgment is given in the director's favour; or (b) the director is acquitted or discharged; or (c) it is determined that, although liable, the director acted honestly and reasonably and should be excused. As per the proviso to Section 463(1) of the Companies Act, 2013, a director cannot be indemnified against liability in civil or criminal proceedings for which he or she is found guilty.

In light of the above, it is advisable for PE Directors to be comprehensively indemnified (especially against contingent liabilities arising from tax related issues) jointly and severally by the investee company and its promoters, under the shareholder's agreement/ employment agreement, and also under the articles of association of the investee company.

2. Directors and Officers Liability (D&OL) Insurance

Overview: D&OL Insurance safeguards past, present and future directors from any claim for damages arising from alleged/ actual wrongful acts of such directors. The coverage includes: (a) right to defend; (b) coverage for retired directors; (c) regulatory crisis response coverage; (d) special excess security for non-executive directors; (e) damage to reputation cover; etc.

Statutory Limitation on Insurance: It may be noted that as per Section 197(13) of the Companies Act, 2013, where any insurance is taken by a company on behalf of its managing director, whole-time director, etc. for indemnifying them against any liability in respect of any negligence, default, breach of duty/ trust, the premium paid on such insurance shall not be treated as part of the remuneration payable to any such personnel, provided, however, that if such person is proved to be guilty, the premium paid on such insurance shall be treated as part of their managerial remuneration.

Despite the statutory limitation on insurance provisions under the Companies Act, 2013, it may be noted that the D&OL Insurance is generally considered by PE investors as a pre-requisite for investing funds in the investee company. It is advisable for the PE investors to review the investee company's policies to ensure that the policies are adequate to protect their nominee/ non – executive directors. These insurance issues become particularly critical if the investee company does not have liquidity, in which case investee company would not be able to satisfy its indemnity obligations, and the investee company's insurance becomes critical.

3. Attending Board Meetings Regularly; Recording Dissenting Views

Overview: Under the provisions of Section 173(1) of the Companies Act, 2013, every company is required to hold a minimum of 4 (Four) board meetings in a year. Most of the business decisions made at a board meeting have a direct impact on the company, its board and its employees. Some decisions have an indirect effect, such as decisions regarding rules, regulations and financial operations. If a director is not regular in attending board meetings, then it is highly likely that such director is not observing and participating in the company's decision-making process, which may lead to neglect his/her duties to the company and exposure to undue liabilities.

In addition to attending board meetings regularly, for the reasons stated above, it is important for a PE Director to record his/ her dissenting views in the minutes of the board meetings on any agenda item discussed or any resolution passed. Such director must act honestly and with reasonable justifications. This will serve as an additional safeguard to such non-executive director in the event of any dispute, in relation to such agenda item/ resolution passed by the board of directors, arising in the future. Section 118(4)(b) of the Companies Act, 2013 also requires recording of names of the directors in the minutes book to specifically ascertain who dissented or not concurred with the resolutions passed by the board of directors. Also, it is advisable to peruse the agenda of the board meeting carefully and seek additional information, in writing, wherever necessary and report concerns about unethical behaviour, actual or suspected fraud or violation of the investee company's code of conduct.

4. Independent Audit

Overview: Under Section 143(2) of the Companies Act, 2013, auditors of a company are required to prepare an audit report on the basis of accounts examined by them.

Though, under the provisions of the Companies (Audit and Auditors) Rules, 2014, an auditor is required to report any fraud committed by a company to the Central Government/ Audit Committee, as the case may be, as a matter of abundant precaution, it is advisable for the PE Directors to have an independent audit right on the investee company. Such right, including its scope and duration, can be negotiated by the PE investor at the time of negotiating the shareholders agreement with the promoters and the investee company. The independent audit, in addition to the statutory audit requirements, will keep an additional check on the investee company on its financial transactions and/ or compliances. Needless to mention, such independent audit will be supported by way of a detail report setting out the irregularities of the investee company, if any, and suggested measures to rectify them.

5. Seeking Professional / Legal Advice

Seeking professional/ legal advice from reputed/ experienced lawyers/ independent auditors relating to issues pertaining to, inter alia, related party transactions, office of profit, loans to directors, appointment/ removal of directors and disclosure of interests by directors will significantly help the PE Directors to mitigate their liability and help them to reach a conclusive answer to their queries / concerns. In particular, in respect of related party transactions, it is strictly advisable for the nominee directors to exclude themselves from participation in transactions where there is a conflict of interest.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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