Legal Position of Directors

Indian Legal System > Civil Laws > Company Law > Legal Position of Directors

In this article, we are going to study the legal position of the directors as agents, trustees, and organs of the company and their corresponding duties.

The supreme executive authority controlling the management and affairs of a company vests in the team of directors of the company, collectively known as its Board of Directors. At the core of corporate governance, practice is the Board of Directors which oversees how the management serves and protects the long term interests of all the stakeholders of the Company. Directors are regarded as being the Key Managerial Persons of a company, with special importance to the listed companies. They can hold multiple high and responsible positions in the companies, such as the Managing Director, Manager, Whole Time Director, or an Independent Director.  The institution of the board of directors was based on the premise that a group of trustworthy and respectable people should look after the interests of a large number of shareholders who are not directly involved in the management of the company.

Board of Directors:

A company, though a legal entity in the eyes of law, is an artificial person, existing only in contemplation of law. It has no physical existence. It has neither soul nor body of its own. As such, it cannot act in its own person. It can do so only through some human agency. The persons who are in charge of the management of the affairs of a company are termed as directors. They are collectively known as Board of Directors or the Board.

The new Companies Act, 2013 makes a laudable contribution towards stipulation and elucidation of the duties and responsibilities of the directors of a company. The provisions by Companies Act, 2013 regarding the duties and responsibilities of the directors, including the independent directors, not only provide greater certainty to the directors regarding their conducts and responsibilities, and thus, ensuring better and impeccable corporate management and governance; but also enable and empower the beneficiaries, regulators, and the courts, to judge, regulate, and control the activities and obligations of the directors more objectively and effectively. The Companies Act, 2013 does not contain an exhaustive definition of the term “director”.  As per Section 2(34) of Companies Act, 2013 Director means a director appointed to the Board of a Company. 

Legal Position of Directors:

In Judhah v. Rampada Gupta, In Judhah v. Rampada Gupta, AIR 1959 Cal 715 case, the Court held that the directors of a company registered under the Companies Act are persons duly appointed by the company to direct and manage the business of the company. A director is sometimes described as agents, trustees, managing partners, etc. But each of these expressions is used not as exhaustive of their powers and responsibilities, but as indicating useful points of view from which they may for the moment and for the particular purpose be considered.

In Imperial Hydropathic Hotel Co. v. Hampson, (1882) 23 Ch. D. 1 case the Court Observed: “directors are described sometimes as agents, sometimes as trustees and sometimes as managing partners. But each of these expressions is used, not an exhaustive of their powers and responsibilities, but as indicating useful points of view from which they may be considered.”

In Re. Forest Dean Coal Mining Co., (1878) 10 Ch. D. 450 Case, the Court observed: “Directors have sometimes been called trustees or commercial trustees and sometimes they have been called managing partners. It does not matter what you call them, so long as you understand what their true position is- which is that they are really commercial men managing a trading concern for the benefit of themselves and of all shareholders”

The legal position of directors is discussed below:

Directors as Agent:

A company, though a legal entity in the eyes of law, is an artificial person, existing only in contemplation of law. It has no physical existence. It has neither soul nor body of its own. As such, it cannot act in its own person. It can do so only through some human agency.  It acts through directors who are elected representatives of the shareholders and who execute decision making for the benefit of shareholders. An agent is a person who always acts on behalf of the principal; therefore the third party can hold the only principal liable and not the agent. Thus directors act as agents of a company. They are acting on behalf of the company. So the directors cannot be held personally liable for any default of the company.

In Ferguson v. Wilson, (1886) 2 Ch. App. 77 case, the court clearly recognized that directors are in the eyes of law, agents of the company. It was held that the company has no person; it can act only through directors and the case is, as regards those directors, merely the ordinary case of a principal and agent. When the directors (agent of a company) contract in the name, and on behalf of the company, it is the company which is liable for it and not the directors.

In Elkington & Co. v. Hurter, (1892) 2 Ch. D. 452 case, where the plaintiff supplied certain goods to a company through its chairman, who promised to issue him a debenture for the price, but never did so and company went into liquidation, the chairman (as agent of a company) was held not liable to the plaintiff.

In Kuriakos v. PVK Group Industries, (2002) 111 Comp Cas 826 Ker case, the Court held that a director was not liable to be personally not liable in a suit against a private chit fund company. Attachment of the property of the director was held to be not permissible.

The rule that a notice given to an agent in course of his agency amounts to a notice given to his principal. The same rule applies in the case of directors. Notice given to a director is notice to the company. As an agent of the company the duty of the director to communicate it to the company.

In Re. Hampshire Land Co. Ltd. (1896) 2 Ch. D. 743 case, the Court held that where one person is a director of two companies his personal knowledge is not necessarily the knowledge of both the companies. The knowledge which he has acquired as a director of one company will not be imputed to the other company unless he has some duty imposed on him to communicate his knowledge to the company sought to be affected by the notice, and some duty imposed on him by that company to receive the notice; and if the common director has been guilty of fraud, or even irregularity, the Court will not draw the inference that he has fulfilled these duties.

The rule that agents have to disclose their personal interests with the principal. The same rule applies in the case of directors. Directors have to disclose their personal interests, if any, in any transaction of the company.

In Ray Cylinders & Containers v. Hindustan General Industries Ltd, (2001) 103 Comp Case 161 Del case, the Court held that the directors are the agents of the institution and not of its individual members, except when that relationship arises due to the special facts of the case. Also granted permission to file a suit against a company was not allowed to be treated as permission against directors as well.

In Sarathi Leasing Finance Ltd v. B Narayana Shetty, (2000) 131 Co. Cases 798 case, the articles of association empowered the managing director to represent the company in legal proceedings. It was held that a further authorization was not necessary to enable him to file a complaint for dishonour of cheque under Sec. 138 of Negotiable Instrument Act.

In Bhajekar v. Shanker, (1934) 4 C. cases, 433 case, the Court held that just as a principal can ratify an unauthorized act of his agent, so also can a company ratify an act of directors which is beyond their powers, but which lies within the power of the company.

In the following cases, a director can incur personal liability:

• When a director enters into a contract in his own name instead of doing so in the name of the company;
• When the contract is entered into in such a manner that it is not clear as to whether it is signed by the director on behalf of the company or by the director in his personal capacity;
• When a director incorrectly uses the company’s name, as for instance by omitting the word “Ltd.”;
• When the directors exceed their authority, as for instance, when they borrow money in excess of their limits.

Director as trustees:

A trustee is a person who is vested with the legal ownership of certain property, which he has to administer for the benefits of others. Director is treated as trustees of the company, money, and property: and of the powers entrusted to and vested in them only as trustee and they have to use these powers for the benefit of the company.

A director of a company enjoys several powers where discretion is to be exercised, s for instance, the power to allot shares, to make calls, to declare a dividend, to forfeit shares, to allow or disallow a transfer of shares, etc. All these powers are to be exercised by the directors in the best interest of the company and not in their own personal interest.

Section 197 of the Companies Act, expressly regards the director as a trustee in certain circumstances. It lays down that if a director receives remuneration in excess of that permitted by the Act, he must refund the excess amount to the company, and until he does so, he holds it in trust for the company.

In Smith v. Anderson, (1880) 15 Ch D 247 at p 275 case, the Court observed that in the real sense the directors are not trustees. A trustee is the legal owner of the trust property and contracts in his own name. On the other hand, the director is a paid agent or officer of the company and contracts for the company.

In Percival v. Wright, (1902) 2 Ch. D. 421 case, the court held that directors have no duty towards individual shareholders. Thus, the directors are trustees to the company and not of individual shareholders.

In Allen v. Hyatt, (1914) 30 TLR 444 case, the Court held that the directors are trustees of the profit for the benefit of the shareholders. They cannot always act under the impression that they owe no duty to the individual shareholders. But it is of no doubt that the primary duty of the director is to the company.

In Peskin v. Anderson, [2000] 2 BCLC 1 case, the Court held that the directors are not agents or trustees of members or shareholders and owe no fiduciary duties to them. They are agents and trustees to the company.

In Ramaswamy Iyer v. Brahmayya & Co. Ltd. (1966) 1 Co. Law Journal, 107 case, the Court observed: “The directors of the company are trustees for the company, and with reference to their power, they can be rendered liable as trustees.”

In York & North Midland Rly Co. v. Hudson, (1853) 61 Beav. 485 case, the Court observed that: “directors are persons selected to manage the affair of the company for the benefit of the shareholders. It is an office of trust, which if they undertake, it is their duty to perform fully and entirely.”

In Shantidevi Gaekwad v. S. P. Gaekwad, (2002) 37 SCL 339 case, the Court held that the powers conferred on the directors to issue shares is a fiduciary power to be exercised by them bona fide and in the interest of the company. They cannot use this power for maintaining their own control over the company or for the purpose of diminishing the majority shareholding of a group of shareholders.

In Dale & Carrington Investment Co. Pvt. Ltd. v. P.K. Prathapan, (2004) 54 SCL 60 1 case, the Court held that the fiduciary duty imposed upon directors enjoins them to act with utmost good faith, care, skill, and due diligence and in the best interests of the company they represent.

Directors as Organs of a Company:

A company, though a legal entity in the eyes of law, is an artificial person, existing only in contemplation of law. It has no physical existence. It has neither soul nor body of its own. As such, it cannot act in its own person. It can do so only through some human agency. It acts through the directors of the company. The Directors are more than mere agents or trustees of the company and recognized to be a primary organ of the company. Directors and managers represent the directing mind or will of the company and control what it does. The state of mind of these managers is the state of mind of the company. Thus the directors’ personal fault in the business of the company becomes the “fault of the company.

In Bath v. Standard land Co., (1910) 2 Ch. D. 408 case, the Court observed: “the board of directors is the brain and only brain, of the company which is the body, and the company can and does not act only through them.”

In H. L. Bolton (Engg) Co. Ltd. v. T. J. Graham & Sons, (1956) 3 WLR 804 case, the Court observed: “A company may, in many ways, be likened to a human body. It has a brain and a nerve centre which controls what it does. It has also hands which hold the tools and act in accordance with the directions from the centre. Some of the people in the company are mere servants and agents who are nothing more than hands to do the work and cannot be said to represent the mind or will. Others are directors and managers who represent the directing mind or will of the company and control what it does. The state of mind of these managers is the state of mind of the company and treated by the law as such.”

In State Trading Corp. of India v. CTO, AIR 1963 SC 1811 case, the Court observed: “Where the brain functions, the corporation is said to function.”

In Gopal Khaitan v. State, AIR 1969 Cal 132, 138 case, the Court observed that the organic theory of corporate life treats certain officials as organs of the company, for whose action the company is held liable just as a natural person is for the action of his limbs

Directors as employees (Servants):

In Re. Lee Behrens & Co. Ltd., (1932) 2 Co. Cases 588 case, the Court held that directors are elected representatives of the shareholders, engaging in directing the affairs of the company on their behalf. As such they are agents of the company but not its employees or servants.

Being a director does not, of itself, make that person an employee of the company. A directorship is an office, not necessarily an employment. If, however, the company enters into a service contract with the director, the terms of which make the director an employee under the usual common law test, then the director becomes an employee. Law does not prevent the company to appoint the director as an employee. When the director is appointed as a whole-time employee of the company then that particular directors shall be considered an employee director or a whole-time director.

Directors as Managing Partners:

Some authors consider a company to be a large partnership firm. In a company, the management is in the hands of many directors. So, the directors are managing partners (the term partner used in the sense of the Partnership Act) and the shareholders as dormant partners. Even though substantial powers may be entrusted upon directors or to an outsider, such a person has to act under the superintendence, control, and direction of the board of Directors. Hence, unlike in a partnership firm, no power can be delegated to a single director as a managing partner. The principle that power once delegated cannot be further delegated, is applicable to company management.

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Indian Legal System > Civil Laws > Company Law > Legal Position of Directors