Functions of the Board of Directors in a Company

Introduction – The Collective Body of Directors in a Company

Even though a company is considered to be a legal person, it does not have a physical existence and cannot be said to be a natural, living person. For a company to function and to achieve its objectives enshrined in the Memorandum of Association, it has to act through a certain medium and Board of Directors.

The directors are the officers of the company whoserve as this medium. The collective body of directors, known as the Board ofDirectors[1],not only acts as the ‘Think Tank’ ofthe company but also makes decision to carry on the business of the company inaccordance with the statutory requirements and the Memorandum of Association[2].One may think that the shareholders are owners and ultimate authority of acompany, then what is the role of a director. A shareholder is only theinvestor in the company; s/he cannot be expected to prepare business plans andensure smooth functioning of the company. Therefore, directors are appointed toperform these tasks for the shareholders and the company.

According to Section 149(1) of the Companies Act, 2013, every company is required to have a board of directors comprising of individual directors. The Board enjoys all powers of the company including the power to use company seal. The Act provides that ‘the Board of Directors of a company shall be entitled to exercise all such powers and to do all such acts and things, as the company is authorised to exercise and do’[3]. Such carte blanche powers are vested onto the Board with the expectation that the Board will perform the task of policy making with utmost efficiency and ensure and monitor compliance of such policies.

The aim of this article is to explain in detail thefunctions of the Board of Directors under the Companies Act, 2013 and how thesefunctions are performed. The article shall give a background of the meaning andtypes of directors in a nutshell and proceed further to delve into the matterin hand.

Meaning and Legal Position of the Directors

Etymologically, the term ‘director’ means one whodirects, i.e. who is in charge of an activity. The Companies Act defines‘director’ as ‘a director appointed to the board of a company’[4].This definition is an exhaustive definition but does not throw any light uponthe meaning of the term. There is no linkage to the governance or control ofthe company’s affairs in this definition. It sets out the only condition that aperson must be appointed to the board of the company to be called a director.It means that mere nomination of a person as a director is not sufficient butthere must be a specific act of appointment of such person as the director bythe company itself (or by Board in certain circumstances).

Now, since the Companies Act and also the GeneralClauses Act, 1897 do not provide any specific definition to the term‘director’, it is essential to look into external aids such as law lexicons.According to the Black’s Law Dictionary, director means ‘an individual actingas agent of the shareholders of a company’[5].Aiyar’s law dictionary definesdirector as ‘a member of the board appointed to direct the affairs of anestablishment’. According to these definitions, it can be inferred that directorsare the main drivers of the company’s business, steering the wheel of growthfor future.

In Tesco Storesv. Nattrass[6],the appellate court of the UnitedKingdom defined directors as “the directing mind and will of the company”. In Lennard’s Carrying Co. v. Asiatic PetroleumCo.[7],the court propounded the principle known as the ‘Identification Doctrine’. Thecourt held that “a company is anabstraction. It has no mind of its own; it has to rely upon the person ofsomebody who can be called its agent. That person may be under the direction ofthe shareholders in general meeting; that person may be the Board of Directorsitself”. This principle has been explained by Leigh as the ‘Alter Ego’principle whereby, he concludes that the directors are the alter ego, i.e. aclone of the company itself[8].

Typically, the directors are responsible for thegovernance of the company and while exercising its powers, it may acquiredifferent legal positions. As held in Lennard’scase[9],the Board of Directors is the agent of the company and share a principal-agentrelationship whereby the principle, i.e. the company shall be liable for allacts done by its agent, i.e. the Board. Similarly, the Board acts as theTrustee of the company, holding its assets and funds in trust to be utilisedfor the benefit of the company. Further, the directors are the employee of thecompany working in their executive capacity scrutinising the day-to-dayfunctions of the company[10].

Types of Directors in a Board of Directors

The Companies Act, 2013 provides for several types to directors to remain in the Board of the company either mandatorily or in certain circumstances. The various categories of directors are[11]:

1. Alternate Director: Section 161 (2) of the CompaniesAct provide for the appointment of an alternate director by the Board tosubstitute an existing director during his absence from India for a period notless than three months.
2. Executive and Non-ExecutiveDirector:According to the Companies (Specification of Definitions Details) Rules, 2014,an Executive Director is a “whole-time director” involved in the day-to-daymanagement of the company; for instance, the Managing Director. On the otherhand, a non-executive director is one who is not involved in the day-to-daymanagement of the company but gives independent opinion on any sensitive issueto the committee or group of which he is a part.
3. Independent Director: The concept of independent directorhas been introduced in the Companies Act for the first time in 2013. It means aperson who possesses integrity, relevant expertise and experience as a directorand who does not have any personal or pecuniary relationship with the promotersand management of the company[12].
4. Nominee Director: The board of a company, if authorisedby the Articles of Association, can appoint any person nominated by ashareholder or creditor or any stakeholder in a company to be a nomineedirector[13].The nominee director represents the interests of its nominator and ensures thesmooth functioning of the company.
5. Woman Director: As a step to women empowerment andenabling women to be part of policy making in companies, the 2013 Act mandatesappointment of one woman as a director on board of all listed companies andspecific public companies with paid-up share capital of Rs. 100 crores orturnover of Rs. 300 crores.
6. Shadow Director: The term is used for a person whois not on the Board of the company but exercises powers of a director. TheCompanies Act, on several occasions uses the phrase in accordance with whose advice, directions or instructionsthe Board of Directors of the company is accustomed to act[14].The person referred to in this context is usually the promoter who undersection 2(69) ‘also has control over the affairs of the company, directly orindirectly whether as a shareholder, director or otherwise’. Such persons whoare not on board of the company but can exercise such powers are called shadowdirectors or deemed directors.

Functions of the Board of Directors

For the first time, general functions of the directorsof a company are enshrined in statutory form in Indian company law[15]after the recommendations of the J.J. Irani Committee. The purpose ofcodification, as explained by Lord Goldsmith, Attorney-General for England andWales, is “to make what is expected of directors clearer and to make the lawmore accessible to them and to others”[16].It does not mean that directors did not have any duties or function to performbefore 2013. Prior to the new Act, the duties of the directors were decided byjudicial pronouncements more like in common law countries (e.g. law of tort).

In general, the functions of the Board can be dividedinto two categories, i.e. fiduciary functions and statutory functions. Beforethe Act of 2013, all the duties owed by the directors were fiduciary in nature.Now, before proceeding it is necessary to first determine what a fiduciary is.According to Millet LJ, a fiduciary is ‘someonewho has undertaken to act for or on behalf of another in a particular matter incircumstances which give rise to a relationship of trust and confidence’[17].Thus, a fiduciary function is one which is performed on the basis of trust andfaith on one another. Several duties have been evolved by the English as wellas Indian courts on the basis of the fiduciary relationship between the companyand its directors.

After the 2013 Act, the legislature has tried tocodify all these duties and has come up with Section166 which deals with‘duties of directors’. These duties are identified as:

1. Dutyto act in accordance with the Articles of Association of the company[18].
2. Dutyto act in good faith and best interest[19].
3. Dutyto exercise reasonable care, skill, diligence and independent judgment[20].
4. Dutyto avoid conflict of interest[21].
5. Dutynot to make undue gain or advantage[22].
6. Dutynot to assign his position[23].

These are the six essential functions of the Board asa whole and are dealt in detail hereunder.

Duty to Act in Accordance with the Articles of Association of the Company

Section 166 (1) of the Companies Act 2013, states adirector’s overriding duty of obedience to the articles of the company. Thearticles of a company consist of provisions related to payment of dividends,decision-making process for quorum, voting or holding of general meetings.These articles are drafted such that the restrictions placed on the powers ofdirectors are relatively limited[24]and thus, it is able to perform its functions while remaining within the scopeof the articles.

According to Section 10 of the Act, the Articles ofAssociation form a contractual agreement that binds the relationship of themembers of the company inter se andthe relationship between the company and its members. As the court observed in NareshSanyal v. Calcutta Stock Exchange[25],the provisions of AoA are to regulate the internal management of the companyand hence, are binding on its members. In Minmar(1929) Ltd. v. Khalastchi[26],the appointment of the administrator was held invalid as the decision was nottaken in a valid general meeting as required by the AoA of the company.

The two known exceptions to this function are (a)entrenched provisions and (b) shareholders’ agreement[27].In case of an entrenched provision, for e.g. Section 5(3), it is allowed topass a special resolution to override the provisions of AoA provided such poweris provided for in the articles. Moreover, if the shareholders enter into anyprivate agreement which is inconsistent with the provisions of the articles,such agreement can be valid if it is not inconsistent with the Act[28].

Duty to Act in Good Faith and in Best Interest

The Act codifies the duty of the directors to act in away that he considers, in good faith, would be most likely to promote thesuccess of the company and for the benefit of its members as a whole. Thedecision as to what is in the best interest of the company is one for thedirector’s good faith judgment. This reflects the position at English commonlaw where Lord Greene observed that ‘the directors must exercise theirdiscretion bona fide in what they consider is in the interests of the company’[29].

The test to determine the function of director to actin good faith was laid down recently in Regentcrestplc v. Cohen[30]. The court observed that the functionof the director to act bona fide in the interests of the company is a“subjective one”. Thus, the question that should be asked is ‘whether thedirector honestly believed that his act or omission was in the interests of thecompany’. However, when it can be demonstrated that the director’s belief wasnot well founded and based on unreasonable circumstances, he shall be liablefor the breach of his duty[31].

Duty to Exercise Reasonable Care, Skill, Diligence and Independent Judgment

In HiddenHarbour Estates v. Norman[32], it was held that ‘the actions of theboard of directors must meet the test of reasonableness. The test of reasonablecare is ‘expected care to be taken by an ordinary man in similar circumstanceson his own behalf’[33].Section 174 (2) of the UK Companies Act, 2006 defines ‘reasonable care, skilland diligence’ as the “care, skill and diligencethat would be exercised by a reasonably diligent person with – (a)the generalknowledge, skill and experience that may reasonably be expected of a personcarrying out the functions carried out by the director in relation to thecompany, and(b) the general knowledge, skill and experience that the directorhas. Therefore, in a case where the director acted negligently towards thecompany, he was held liable for breach of duty to take reasonable care andexercise diligence[34].

Independentjudgment is the function of the directors exercise their discretion and powerimpartially without any biasness or influence. In Scottish Co-operative Wholesale Society Ltd. v. Meyer[35], theappellant company incorporated a subsidiary company and made the tworespondents as managing directors transferring them certain amount of shares inthe subsidiary company. Later, the shareholders decided to take the shares awayfrom the respondents and when they denied, resolution was passed in boardmeeting to transfer the subsidiary company into a department within the parentcompany thereby reducing the value of the shares[36].The court held that there was nominee director in the board meeting whoaffirmed the decision under the influence of the majority shareholders and heldthem liable.

Duty to Avoid Conflict of Interest

A director should avoid any conflict of interest inany situation where he has or can have a direct or indirect interest thatconflicts or has the potential to conflict with the interests of thecompany.  This function is based on thecommon law rule of equity that any person owing fiduciary duties must not puthimself into a position in which he has or can have conflicting interests[37]. Therule was laid down in Aberden RailwayCompany v. Blaikie Bros.[38]by Lord Cranworth and was most recently applied in Bhullar v. Bhullar[39]where the directors were held liable for delaying decision in order to preventthe prices of shares of the company from falling and thereby incurring loss tothem.

This section also includes a situation where thedirector is on the board of two or more companies which are competing with eachother and he prefers or potentially prefer his interest in their competition.The function to avoid conflict applies in particular to the exploitation of anyproperty, information or opportunity. In CMSDolphin Ltd. v. Simonet[40], thecourt held that “misappropriation, diversion or exploitation of the company’sproperty by a director for his personal gains will amount to breach of the dutyto avoid conflict of interest” under Section 166 (4).

Duty Not to Make Undue Gain or Advantage

The duty under Section 166 (5) provides that “a director of a company shall not achieve or attempt toachieve any undue gain or advantage either to himself or to his relatives,partners, or associates and if such director is found guilty of making anyundue gain, he shall be liable to pay an amount equal to that gain to thecompany”. The section has two parts: the firstpart creates an obligation on the director not to have any undue gain oradvantage directly or indirectly using the name of the company and the secondpart foists a liability if the director does gain any undue advantage[41].

The provision,basically, codifies the rule prohibiting the exploitation of the position ofdirector for personal benefits. As Lord Goldsmith stated during the GrandCommittee meeting of the House of Lords, ‘this is a long-standing rule thatprohibits benefits only if their acceptance is likely to give rise to aconflict of interest’[42].This means that any benefit given by the company or any associated company tothe director shall not amount to undue gain or advantage.

In Shri Kishore Kundan v. Samrat Shipping Co.Pvt. Ltd.[43],the managing director who was operating an agency of the company, createdanother company and shifted himself to that company to run the agency andbrought diversion of business. The Company Law Board held him liable for anygain by him in this transactions. In Croninv. Grierson[44],the court expanded the meaning of the term undue benefit or gain and held that‘benefit means financial or non-financial benefit and may include any gift orhospitality’.

Duty Not to Assign His Position

The last statutory duty makes it categorical that theoffice of the director cannot be assigned or transferred to someone else. Thisis based on the premise that the shareholders of the company, while reposingtheir faith in the director, have appointed him and they expect the same directorto act and not someone else. A director is appointed after due consideration ofhis skill, experience and competence. Hence, it is imperative that theappointed director must act on his own and should not assign his office as adirector to someone else[45]. Theduty also implies that the director is supposed to attend the Board meetingsand he cannot substitute himself with someone else for this function. In New Fleming Spinning and Weaving Co. v.KessowjeNaik[46],the court held that instead of performing their duties and showing reasonablediligence, if the directors delegate all control to the agents, the directorshall be liable for breach of the duty not to assign his position to someone else.

Other Functions of the Board

The Board of Directors, besides the statutory dutiesunder Section 166, also perform several other functions tomanage, represent and supervise the operations of the company so as to ensurethat the Company fulfils its corporate objectives, while seeking to protect theCompany’s general interests and create value for the benefit of all theshareholders. These functions are usually performed by several committeesformed by the Board itself[47].The Act does not provide for any specific committee within the Board ofDirectors, but, however, the most common committees that fulfil functions ofthe Board are:

1. Executive Committee:The directors in the executivecommittee are the day-to-day managing directors also known as whole timedirectors. The function of the executive committee is to hold meetings of theboard as and when necessary, to prepare strategic planning, fund-raisingprograms, to look over the promotional and marketing activities of the companyand all matters which are ancillary to the running of the business of thecompany.
2. Audit and Control Committee: As the name indicates, thiscommittee of the board looks into financial and accounting aspects of thecompany. Audit is the official inspection of the accounts of a company toensure all the accounting principles are appropriately followed by the companywhile maintaining its books of accounts. This inspection is done by anindependent person called ‘the auditor’. The function of the audit committee isto submit proposals to the Board regarding the selection, appointment andsubstitution of the external auditor for the company. It serves as a channel ofcommunication between other directors of the Board and the auditor. Thecommittee also keeps an eye on the working of the auditor and controlsauditor’s affairs within the business to ensure his/her independence.
3. Nomination and RemunerationCommittee:The main function of the committee is to assess the skills, knowledge andexperience necessary in the Board of Directors. For thesepurposes, it shall define the functions and aptitudes needed of the candidatesto cover the vacancies that may arise in the board. Ensures that each genderand class of people are equitably represented in the Board. It makesrecommendations to the board for appointment of independent directors,additional directors and if required alternate directors. Besides theappointment of all key managerial persons, it submits proposals for theirremuneration including salary, bonus and pay raise.

Conclusion

Board of Directors of a company is identified by its functions and notby the descriptive titles of its individual directors. It occupies a centralposition in the structure of the company law. The board reflects three purposes[48].The first purpose is that companies are formed and managed by the directors forthe benefit of the shareholders. This is achieved through the fiduciaryobligations and functions exercising skill and diligence by the directors. Thesecond purpose is that there should be safeguard to the actual and potentialcreditors. This is achieved by the supervisory function of the executivedirectors and the capital management committee of the Board of Directors.Finally, for the benefit of the community as a whole which is achieved byaccounting disclosures and inspections by the Audit and Control Committee ofthe Board.

References:

[1]Companies Act, No. 18, Act ofParliament, §2 (10), 2013 (India).

[2]Ashish Makhija, Corporate Directors 23 (1st ed. 2016).

[3]Companies Act, No. 18, Act ofParliament, §179 (1), 2013 (India).

[4]Companies Act, No. 18, Act ofParliament, §2 (34), 2013 (India).

[5]Bryan A. Garner, Black’s Law Dictionary 1065 (10th ed. 2014).

[6]Tesco Stores v. Nattrass, 1972 AC153.

[7]Lennard’s Carrying Co. v. AsiaticPetroleum Co., 1915 AC 705.

[8]L.H. Leigh, The Alter Egoof a Company28 M.L.R. 584 at 585 (1965).

[9]Supra note 7.

[10]2 A. Ramaiya, Guide to Companies Act 2273 (16th ed. 2004).

[11]Kamal Garg, Directors and KeyManagerial Persons 03 – 05 (1st ed. 2016).

[12]Companies Act, No. 18, Act ofParliament, §§ 2 (47) and 149, 2013 (India).

[13]Companies Act, No. 18, Act ofParliament, §149, 2013 (India).

[14]Companies Act, No. 18, Act of Parliament,§2(69), 2013 (India).

[15]Companies Act, No. 18, Act ofParliament, §166, 2013 (India).

[16]Lords Grand Committee, 6 February2006, column 254.

[17]Bristol and West Building Society v. Mothew [1998] Ch1, 16D, CA.

[18]Companies Act, No. 18, Act ofParliament, §166 (1), 2013 (India).

[19]Companies Act, No. 18, Act ofParliament, §166 (2), 2013 (India).

[20]Companies Act, No. 18, Act ofParliament, §166 (3), 2013 (India).

[21]Companies Act, No. 18, Act ofParliament, §166 (4), 2013 (India).

[22]Companies Act, No. 18, Act ofParliament, §166 (5), 2013 (India).

[23]Companies Act, No. 18, Act ofParliament, §166 (6), 2013 (India).

[24]Simon Mortimore QC, CompanyDirectors: Duties, Liabilities and Remedies 241 (1st ed. 2009).

[25]NareshSanyal v. Calcutta StockExchange, AIR 1971 SC 422.

[26]Minmar (1929) Ltd. v. Khalastchi,(2011) BCC 485.

[27]Makhija, supra note 2 at 165 – 66.

[28]Ibid at 167.

[29]In Re: Smith and Fawcett Ltd. (1942)ChD 304, CA.

[30]Regentcrest plc v. Cohen, (2001) 2BCLC 80.

[31]Mortimore, supra note 24 at 255 – 56.

[32]Hidden Harbour Estates v. Norman,309 So.2d 180 (1975).

[33]Ramaiah, supra note 10 at 2311.

[34]In Re: City Equitable Fire InsuranceCo. ltd., (1925) 1 Ch 407 (CA).

[35]Scottish Co-operative Wholesale Society Ltd. v. Meyer, (1959) AC 324.

[36]Mortimore, supra note 24 at 280.

[37]Ibid at 305– 306.

[38]Aberden Railway Company v. BlaikieBros., (1854) 1 Macq 461, HL.

[39]Bhullar v. Bhullar, (2003) 2 BCLC241.

[40]CMS Dolphin Ltd. v. Simonet, (2002)2

[41]Makhija, supra note 2 at 181-82.

[42]Mortimore,supra note 24 at 315.

[43]Shri Kishore Kundan v. Samrat Shipping Co. Pvt. Ltd., (2004) 58 CLA 298 (CLB).

[44]Cronin v. Grierson, (1968) AC 895.

[45]Ramaiah, supra note 10 at 2371.

[46]New Fleming Spinning and Weaving Co.v. KessowjeNaik, (1885) ILR 9 Bom 373.

[47]Garg, supra note 11 at 71 – 72.

[48]Mortimore, supra note 24 at 26.