A director of a company is prohibited from being involved in a situation where he may have a direct or indirect interest that conflicts, or possibly may conflict, with the interest of the company. Identifying and addressing conflict situations may require assistance from corporate legal advisors.
Introduction
Company directorship is a position of responsibility. The question is the extent of such responsibility and the manner of discharge of such responsibility. In a company structure, ownership is distinct from management. The owners of a company, i.e., its shareholders, wield ultimate authority in relation to the company as they can determine the engagement, terms of engagement of the director and extent of powers and authority of the board of directors.
The vision and goals of the controlling shareholders ultimately determine management's values. Of course, there are examples of directors who have stood firm against the spoken or unspoken dictate of the controlling shareholders or appropriately recused themselves from participating in decision-making where warranted.
This article examines a director's statutory duty towards the company regarding situations of conflict of interest.
Director – situation of conflict of interest
Section 166 of the Companies Act, 2013 (‘Companies Act') lays out the duties of directors.
Sub-section 4 of said section 166 states as under:
(4) A director of a company 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.
It seems like an obvious position that a director's paramount duty is towards the company and should not engage in any transaction which may conflict with the interest of the company. However, the single-sentence sub-section raises questions. The following issues arise for consideration:
- This duty applies to all kinds of directors. A director is defined under section 2(34)of the Companies Act as a director appointed to the board of a company. Companies Act envisages various kinds of directors, including non-executive directors, independent directors, and alternate directors.
A non-executive director is one who is not employed by the company and who is not involved in its day-to-day functions or activities.
An independent director is a director other than a managing director, a whole-time director or a nominee director who, in the opinion of the board, is a person of integrity and possesses relevant expertise and experience; is or was not a promoter of the company or its holding, subsidiary or associate company; is not related to promoters or directors in the company, its holding, subsidiary or associate company; has or had no pecuniary relationship with the company, its holding, subsidiary or associate company, or their promoters, or directors, during the two immediately preceding financial years or the current financial year.
An alternate director may be appointed by the board if authorized by the articles or by a resolution passed by the company in a general meeting to act for a director who is absent from India for a minimum period of three months for whatever reason.
An independent director, non-executive director or an alternate director is likely to find themselves on the board of other companies operating in the same space. Arguably, following the strict mandate of said sub-section (4), a person should refrain from holding directorship in companies operating in the same space because ‘possible conflict' cannot be ruled out.
- The director is prohibited from involving in any situation, not just transactions that conflict.
Involvement in a ‘situation' connotes a set of things happening, a circumstance, or certain conditions prevailing at a given time. The question that arises for consideration is whether the expression ‘situation' has to be understood in the context of ‘a general state of affairs' or a ‘specific transaction' in question. There is no easy answer.
For example, a director may be wearing two hats- the person may be a managing director and a nominee director of a particular shareholder group. This situation presents a conflict because, as a managing director, it is the task of the person to handle the affairs of the company effectively. However, by its very definition, a nominee director is tasked with taking care of the shareholder group that has nominated such a director.
- The director is not allowed to be involved in any situation in which he may have conflicting direct or indirect interests.
A ‘direct' interest conflict could arise when the person is also a director on the board of a competing company or companies.
An ‘indirect' interest that conflicts may arise if a relative or someone with whom such a person enjoys a personal relationship is a director on the board of a competing company or companies. In such a scenario, conflict may arise not just due to financial involvement but also due to personal relationships. The question is whether directors should avoid involving themselves in situations where there may not be an actual conflict of interest but rather a perceived conflict.
- The director is not allowed to be involved in any situation that possibly may conflict.
The preceding situation does present a possibility of conflict, which sub-section (4) prohibits.
- The conflict is with respect to the interests of the company (not necessarily legitimate business interests).
Interestingly, the duty cast under section 166 is independent of other corporate governance provisions of the Companies Act, such as section 184 (disclosure of interest by director) and section 188 (related party transactions).
Case law
The issue of the role and conduct of nominee directors and whether such directors' acts and conduct breached their fiduciary duties was discussed in AES OPGC Holding (Mauritius) v. Orissa Power Generation Corporation Limited [2005] 125 COMPCAS 299(CLB).
In this case, it was alleged that the nominee directors of a certain shareholder group were in breach of their fiduciary duties and committed acts of omission to protect the interests of the shareholder group and the company in which they held 100% shares.
The Company Law Board observed that since a director is a trustee and also an agent, he cannot do anything which would be against the interests of the company, nor could he profit at the expense of the company. A conflict of interest would arise when a person owes allegiance to two or more entities/persons and is placed in a situation to take a decision which would affect the interest of all those to which/whom he owes allegiance.
The Company Law Board held that if a director of a company is placed in such a situation, either he should recuse himself or is duty-bound to make the decision that would be in the interest of the company, failing which he would be in breach of his fiduciary duties. This is more so in the case of nominee directors when there is a clash of interests between the company and their nominators.
Viewpoint
Clarity may be perceived as a double-edged sword because while it provides clear direction, it does not necessarily offer the much-needed flexibility.
Said Section 166 lays down the duties of a director, which also forms the bedrock for Corporate Governance. The fundamental duty to act in the best interests of the company has been underscored in this provision, and becomes critical when it comes to dealing with subsidiaries and joint ventures, where the potential for a conflict may be very high. A properly structured policy for such conflict of interests would arguably be a strategic imperative for a company.
Text of said Section 166 is reproduced below to explain the context of the foregoing thought process:
166. Duties of directors.—
(1) Subject to the provisions of this Act, a director of a company shall act in accordance with the articles of the company.
(2) A director of a company shall 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.
(3) A director of a company shall exercise his duties with due and reasonable care, skill and diligence and shall exercise independent judgment.
(4) A director of a company 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.
(5) A director of a company shall not achieve or attempt to achieve any undue gain or advantage either to himself or to his relatives, partners, or associates and if such director is found guilty of making any undue gain, he shall be liable to pay an amount equal to that gain to the company.
(6) A director of a company shall not assign his office and any assignment so made shall be void.
(7) If a director of the company contravenes the provisions of this section such director shall be punishable with fine which shall not be less than one lakh rupees but which may extend to five lakh rupees.
The said subsection seeks to ensure that directors do not find themselves in situations of conflict of interest and are able to focus on the interests of the company. The big question that arises is – ‘what is the interest of the company'? The law as it stands today casts onerous responsibility on the directors, and, among other things, a director of a company is prohibited from involving 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. Accordingly, to give effect to Section 166, particularly subsection 4, it will be useful to have in place a policy document to serve as a guide for the directors and the company. It is essential to define the parameters of what constitutes a ‘conflict of interest' to lend certainty and clarity in implementing the presently widely worded ‘conflict of interest' provision.
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.