The Conflict between interests and Duties of a Director

Introduction

Every company has a board of directors in charge of managing the company’s business, making the strategic and operational decisions and meets the company’s statutory obligations.A director has the duty to pursue the best interests of the stake holders in good faith while promoting the objects of the company. He is bound to utilize independent and unbiased judgement to perform his duties with due care.Avoiding conflict of interest is of primary concern to a director.

The case deals with Section 91-Bof the Indian Companies Act[1]which states that no director can vote on any contract or arrangement where he is either directly or indirectly concerned. Additionally, his presence will not be counted for forming a quorum at the time of any such vote and if he proceeds to vote, his vote will not be counted. The only exception is that the directors may vote on any contract of indemnity against any loss which they may suffer by reason of becoming or being sureties or surety for the money. The penalty for the contravention of this section is a fine of Rs. 1000.[2]The subject-matter deals with definingthe term ‘personal interest’ in relation to the duties of a director.

Factual Background

Oakley Bowden and Co. Ltd. is a public company registered under the Indian Companies Act. It is managed by a Board of three directors. The Board acts either at meetings or by resolutions passed through circulations. On 2nd June1953, the Board passed a resolution stating that the Chartered Bank of India, the Imperial Bank of India, the National Bank of India Ltd., the Indian Bank Ltd., and the Eastern Bank Ltd.will be empoweredto honour cheques, bills of exchange, and promissory notes; drawn, accepted or made on behalf ofOakley Bowden and Co. Ltd.; by T. P. Khaitan and Krishnaswami and to act on any instructions and accept any receipts or other documents relating to the transactions or affairs, of the company, if signed on behalf of the company, whether the account is in credit or overdrawn.[3]

However, the resolution was cancelled in order to appoint A. M. Khaitan to act on behalf of the company and its managing agents to operate on its accounts. Subsequently, through the resolution signed by T. P. Khaitan and V. S. Krishnaswami and passed through circulation on 22nd February 1954, V. S. Krishnaswami was instructed to communicate A. M. Khaitan’s appointment to the aforementioned banks.[4]Following this, the Registrar of Joint-StockCompanies filed C. C. Nos. 11913 to 11915 of 1955 stating that the three resolutions violated Section 91-B(1) of the Act. In C. C. No. 11913 as well as 11915, the accused are T. P. Khaitan and Krishnaswami whereas the sole accused in C. C. No. 11914 is Krishnaswami.[5]The basis of the prosecution was that the accused as directors voted on a contract in which they were either directly or indirectly concerned or interested and thereby contravened the provisions of Section 91-B(1), attracting the penalty under subsection (2).

Issues

1. Whether the directors had any personal interest in the contracts entered into?[6]
2. Whether the actions that were undertaken by the directors were part of their duties?[7]

Summary of the decision and judgement

The object of Section 91-A was to ensure that there shall be no conflict between personal interests and duties of directors towards their company.[8]In the event of such a conflict, this section provides for the disclosure of such an interest which prevents any biased decisions. Moreover, such personal interests are to be entered in a register to bring it to the notice of the shareholders under subsection (3) of 91-A.[9] The underlying rule of law is that directors should not make profits out of any contract or arrangement without the knowledge of other directors and shareholders. Section 91-B deals with voting on such contracts.[10]

One of the fundamental principles of company law is that directors constitute the body entrusted with the operations of the business.Undoubtedly, they have the right to delegate their powers and duties. Had the directors not passed the resolutions, the only result would have been that the bank account would not be opened, which comes within their interests as directors of the company.[11] Therefore, the Court concluded that the actions taken by the directors were part of their duties. It is pertinent to bear in mind the intention behind the provision which ultimately intends to avoid conflicts between personal interests and duties. Delegation of power does not attract the penal consequence under Section 91-B.[12] Hence, the accused were acquitted and the appeals were dismissed.[13]

Analysis

The concept of interest is complicated as it is not restricted to financial interest alone but further includes interest arising out of fiduciary duties. The interest may be direct or indirect. The nature of interest makes it difficult to decide whether a director has a personal interest in a particular contract or arrangement. An interplay between numerous factors is required to establish personal interest in a case. The Court observed in Foster v. Foster[14], the law stated that a director might contract with the company provided he is prevented from voting in respect of any contract in which he was interested. It was held that the appointment by the Directors of one of their body as chairman, or the appointment by the directors as a managing directoris merely a delegation of powers and is similar to the power which they possess to appoint committees and delegate powers to those committees.[15]

A similar dictum was followed in Nutton v. Wilson[16], which was concerned with the construction of Rule 64 under the Public Health Act[17], which laid down that a member of the local board who was in any manner concerned in any contract entered into by such board shall cease to be a member and his office shall become vacant. The Court concluded that to interpret this rule, which has no definite meaning and was purposely employed for that very reason, the objective behind the provision must be analyzed. The objectwas to prevent conflict between interest and duty that inevitably arises to disturb commercial harmony.

Mere carrying of duties does not amount to being concerned with any contract or arrangement. It does not amount to personal interest under Section 91 of the Indian Companies Act.[18] The Court held that the expression ‘interest in any contract or arrangement’ is elastic to the extent that it involves a conflict between interest and duty.

Conclusion

Section 184[19] of the Companies Act, 2013 deals with disclosure of interest by directors. The object of Section 184 is the same as Section 91[20] of the Indian Companies Actwhich is to bring to the notice of the directors the conflict of interest and duty of any of their colleagues on the Board. The provisions are founded on the principle that a director is prohibited from dealing and entering into engagements in which he has a personal interest and would conflict with the interest of those to whom he is bound by fiduciary duty to protect. It is pertinent to note that Section 184 does not prohibit such engagements or contracts or arrangements, but it requires disclosure by the directors of their interests to their co-directors.

Subsequent cases applied the sound judgement in this case as in Smt. Sandeep Kaur Ahluwalia v.Mukat Pipes Ltd. &Ors.[21], where it was held that the section cannot be applied unless there is personal interest on the part of the director. In Shailesh Harilal Shah &Ors. v.Matushree Textiles Ltd. &Ors.[22], the elasticity of this provision was discussed wherein it was established that interest and duty are separate and the section can only be applied when a conflict has arisen. A company enters into contracts and arrangements for the purpose of growing and developing their business. Such decisions are taken by the directors, who are entrusted with the fiduciary duty to do what is best for the company. To ensure protection and promotion of the interest of the company and its stakeholders, certain limitations exist to curtail the powers of the director if they possess conflicting interests. Therefore, the law places this restriction to promote commercial interests while the courts act as a watchdog by interpreting these provisions while keeping in mind the best interests of the directors, employees and stakeholders.

[1]Indian Companies Act, 1913, No. 7, Imperial Acts, 1913,Section91-B (1).

[2]Id. atSection91-B (2).

[3]Public Prosecutor v. T.P. Khaitan, 27 CompCas. 77 (Mad.), para. 3.

[4]Id.

[5]Id. at 4.

[6]Id. at 8.

[7]Id. at 11.

[8]Indian Companies Act, 1913, No. 7, Imperial Acts, 1913, Section91-A.

[9]Id. atSection91-A (3).

[10]Id. at Section 91-B.

[11]Public Prosecutor v. T.P. Khaitan, 27 CompCas. 77 (Mad.), para. 11.

[12]Id. at 15.

[13]Id. at 16.

[14] Foster v. Foster, [1916] 1 Ch 532.

[15]Public Prosecutor v. T.P. Khaitan, 27 CompCas. 77 (Mad.), para. 11.

[16]Nutton v. Wilson, [1889] 22 QBD 744.

[17]Public Health Act 1875, 38 & 39 c. 55, Rule 64 (Eng.)

[18]Indian Companies Act, 1913, Section 91.

[19]The Companies Act, 2013, No. 18, Acts of Parliament, 2013, Section 184.

[20]Indian Companies Act, 1913, Section 91.

[21]Smt. Sandeep Kaur Ahluwalia v. Mukat Pipes Ltd. &Ors., (2007) 138 CompCas 33 (CLB).

[22]Shailesh Harilal Shah &Ors. v. Matushree Textiles Ltd. &Ors., (1995) 82 CompCas 5 (Bom).