DR.

RAM MANOHAR LOHIYA NATIONAL

LAW UNIVERSITY, LUCKNOW
2021-2022

FINAL DRAFT: Corporate Law

Topic: “DIRECTORS DUTY OF CARE AND LIABILITY FOR LAPSES IN
CORPORATE DISCLOSURE OBLIGATIONS”

SUBMITTED BY: SUBMITTED TO:

SIDHANT KAMPANI Dr. Visalakshi Vegesna

ROLL NO. 190101146 (SECTION B, 2024) ASSOCIATE PROFESSOR (LAW)

B.A. LLB (HONS.), SEMESTER VI Dr. RMLNLU, LUCKNOW

 Acknowledgement

On the very outset of this project, I would like to extend my sincere and heartfelt obligations
towards all people that have helped me in this endeavour. I am forever indebted to Dr. Visalakshi
Vegesna for her continuous guidance and for being such a great mentor to me.

I am extremely thankful to the Librarian and the faculty present at the library who have enabled
me to pursue my research efficiently.

I also acknowledge with a great sense of reverence my gratitude towards my parents who have
supported me both morally as well as economically.

And last but not the least, my gratitude goes to all my friends and seniors who have directly or
indirectly contributed in helping me finish this project.

I also thank God Almighty without whom this project would never have achieved fulfilment.
 INTRODUCTION

There are several roles which directors play as “gatekeepers” of companies in the context
of good corporate governance. The first is to enhance the value of the company for the
benefit of its shareholders (having regard to the interests of other stakeholders). The
second, which may be seen as corollary to the first, is to prevent or minimise the
destruction of value in the company. A third role, which applies to directors of companies
which are publicly listed, is to ensure proper corporate disclosure of information so as to
enable investors to make informed decisions relating to the issued securities.

This article provides the author’s observations and comments on several issues of
concern faced by directors in relation to two key aspects of directorial liability for lapses
in governance – the directors’ duty of care and the liability for lapses in corporate
disclosure obligations.
 DIRECTORS’ DUTY OF CARE – RISING STANDARDS, RISING COSTS
.
Directors owe a duty under both common law 1 and statute2 to the company of which they are

directors to act with reasonable care3 in the discharge of their duties. The common law duty is

often traced to Re City Equitable Fire Insurance Co Ltd 4 in which the court held that directors
owed a duty to act with “reasonable” care. In determining the reasonableness of a director’s
actions, regard is to be given to the level of the specific director’s knowledge and experience,
thus suggesting a subjective approach to establishing liability. This has since evolved,

incorporating a more objective standard by which a director’s actions are to be measured.5 This
modern approach has been adopted in Countries like Singapore. In Lim Weng Kee v Public
Prosecutor6(“Lim Weng Kee”), it was held that the tests for determining the standard of care and
diligence is the same for both civil and criminal actions against directors.7

In pegging the test to that of a “reasonable director found in his position”, the standard of
care expected of directors will continue to evolve over time as expectations of what is
reasonable behavior will progress as businesses get more sophisticated and complicated and
directors more educated. The court is expected to “apply a standard of care that reflects

contemporary community expectations”.8 The evolution of these expectations over time will
cause the standard to drift higher and higher. The promulgation of various regulatory
responses and codes of corporate governance and best practice which followed the collapse
of huge corporations and corporate conglomerates in the developed world has also played a
significant role in raising community expectations of standards that directors should be

1
Re City Equitable Fire Insurance Co Ltd [1925] Ch 501.
2
Companies Act (Cap 50, 2006 Rev Ed) s 157.
3
Section 157 of the Companies Act (Cap 50, 2006 Rev Ed) does not make reference to the duty of care but uses the
word “diligence”. However, courts do not appear to have distinguished between “care” and “diligence”, and it has
been generally accepted to also encompass such a duty: see Lim Weng Kee v Public Prosecutor [2002] 2 SLR(R)
848. This sub-issue and the correctness of such an approach are addressed at paras 6–15 below.
4
[1925] Ch 501
5
See Daniels v Anderson (1995) 16 ACSR 607.
6
Lim Weng Kee v Public Prosecutor [2002] 2 SLR(R) 848 at [34].
7
Lim Weng Kee v Public Prosecutor [2002] 2 SLR(R) 848 at [34].
8
Australian Securities & Investments Commission v Rich (2003) 44 ACSR 341.
held up to.9 While the decision in the landmark Australian case of AWA Ltd v Daniels10

may have been “well received by the business community”11 at the time, the more recent

decision of Australian Securities & Investments Commission v Healey12 raised levels of

anxiety for directors significantly. In the latter case, non-executive directors were held
liable for failing to note errors in the reported financial statements of a company relating to
the categorization of certain short-term debts and guarantees. The implication of that
decision is that directors are now expected to be familiar with the relevant accounting
standards applicable to the categorization of certain transactions and to have a working
knowledge of how these are to apply. A similar expectation has recently been voiced in
Singapore. It has been explicitly stated by the Accounting and Corporate Regulatory
Authority (“ACRA”) that directors are expected to “have sufficient and up-to-date
knowledge of the accounting principles and practices to perform an effective high-level
review of the financial statements” in the context of financial reporting and review of their

company’s financial statements.13 It is unlikely that this would have been a community
expectation of directors a decade or so ago.

There are several practical implications which flow from these rising standards. First, the
rising expectations of, and hence standards imposed on, directors will no doubt make
directors pay closer attention to corporate affairs and their governance responsibilities.
While this is no doubt a good thing, there is also a downside. First, there will be a direct
increase in expenses (such as increases in premiums for directors’ and officers’ liability
insurance, directors’ fees, and advisory fees incurred as more and more directors seek
professional advice for their decisions etc). Secondly, there are also likely to be indirect
9
In this regard, industry standards and codes have been held to be relevant in determining the appropriate
standard of care to be expected in cases involving negligence generally. See Jurong Primewide Pte Ltd v Moh Seng
Cranes Pte Ltd [2014] 2 SLR 360 and Hotel Royal @ Queens Pte Ltd v J M Pang & Seah (Pte) Ltd [2014] 3 SLR 967.
10
(1992) 10 ACLC 933; Daniels v Anderson (1995) 13 ACLC 614.
11
See John Farrar, “Directors’ Duties of Care – Issues of Classification, Solvency and Business Judgment and the
Dangers of Legal Transplants” (2011) 23 SAcLJ 745 at 752. It was the first instance decision of Rogers J in AWA Ltd v
Daniels (1992) 10 ACLC 933 that appeared to be well received by the business community at the time it was
delivered.
12
[2011] FCA 717.
13
See the Accounting and Corporate Regulatory Authority, Practice Direction 2 of 2014, “Directors’ Duties in
Relation to Financial Reporting and Review and Sanction Process of the Financial Reporting Surveillance
Programme Administered by the Accounting and Corporate Regulatory Authority” Annex A at para 3.
 opportunity costs associated with directors spending an inordinate amount of time
focusing on compliance and accountability issues, and insufficient time on issues that can
enhance corporate performance at board meetings. Related to this is the possibility that
directors (in particular non-executive directors) will be less inclined to take risks or may
insist on checks which either limit or restrain the ability of the company to move forward
quickly when opportunities present themselves. Finally, there is the question of whether
these rising standards may dissuade candidates from taking up the role of non-executive
directors. The fact that there may be criminal liability imposed on directors for breach of
their duty of care only adds to these potential challenges. It is to this issue that the author
next turns his attention.

Liability for Breach of Duty of Diligence by The Directors Imposed Under

the Companies Act, 2013

Section 166 of the Companies Act, 201314, mentions about the fiduciary duties of the directors
which inter-alia includes that the director shall exercise his duties with due and reasonable care,
skill and diligence and should not attempt to achieve or attempt to achieve any undue advantage
either to himself or to any of his relative. If the director takes the undue advantage, then, it shall
be held liable to pay an amount equal to that gain to the company and he shall be liable to pay
fine which may extend to Rs. 5,00,000/-.15

Liability of Director under the Companies Act, 2013

The Companies Act, 2013 contain a set of liabilities for the directors and key managerial
persons. The Companies Act also criminalizes various kinds of activities in the course of the
economic life of the company, chief among them being fraudulent activities committed by the
company through its employees.

14
Companies Act 2013, s 166.
15
Companies Act 2013, s 166.
Statutory Liabilities

This kind of liabilities are statutory in nature like any governmental authority can initiate legal
proceedings against directors or company. For e.g.: Non filing of statutory documents, RoC can
impose penalty on directors and company. This kind of liabilities are specifically set forth in the
Companies Act, 2013. These could either be a civil liability requiring directors to make
payments of fine / penalty or criminal liability resulting in fines or imprisonment. Criminal
liability arise in case of fraud. As per Section 447 of the Companies Act, 2013, fraud means as
any act or abuse of position committed with an intent to deceive, to gain undue advantage from,
or to injure the interests of a person, company, shareholders or creditors whether or not there is
wrongful gain or loss then the person shall be liable for imprisonment upto 10 years.16

Non-statutory Liabilities
The kind of liabilities could arise from claims made against the directors either by the company
or the shareholders for breach of directors’ duties. Section 245 of the Companies Act, 2013
allows a group of shareholders constituting a minimum of 100 shareholders or those holding
10% shares in the company to bring an action on behalf of all affected parties, which includes
claims for compensation from directors for any fraudulent, unlawful or wrongful act or omission
or misconduct on their part which are commonly called as “Class action suit”. 17

Vicarious Liability of the Company and Directors

Generally, a person is liable for his own wrongful acts or omissions. However, in Vicarious
Liability, person is responsible for the acts or omissions of another person. The concept of
vicarious liability have been evolving since the evolution of law of torts starting from the
liability of the employers for the tort committed by its employee subject to the act done within
the course of his employment.

16
Companies Act 2013, s 447.
17
Companies Act 2013, s 245.
Vicarious Liability for Indian Companies (Corporate Criminal Liability)
Corporate criminal liability can be defined as a crime which has been committed by individual or
association of individuals who for pursuing a common purpose or make business gain in course
of their occupation commit such acts or omission which is forbidden by law and with guilty mind
where it is for the benefit of the corporation or any individual out of the association of
individuals. Earlier corporation was not held liable for any criminal act as it is an artificial legal
person, so it could not be imprisoned, and corporation not being natural person there was
absence of mens rea. The debate on vicarious liability in India has been dominated by the debate
on whether a company can be held criminally liable for the actions of its employees where the
law is silent on this question. 18 The Supreme Court in “Iridium India Telecom Ltd. v Motorola
Inc.”19 case considered the issue of a company being criminally responsible for the actions of its
employees. Motorola Inc. sold a technology product to Iridium that was accompanied by
assertions and promises by Motorola that allegedly turned out to be false. Iridium brought a case
of cheating against Motorola. The case was brought not against Motorola’s employees but
against Motorola itself. Under the provisions of the Indian Penal Code, cheating requires an
intention to deceive. Motorola argued that a corporate body, being an artificial person, is not
capable of a mental state and therefore cannot be held criminally liable for offences such as
cheating. Motorola’s arguments were rejected by the Supreme Court after it considered the
modern approach to the problem of corporate criminal liability in the English courts. The
company held vicariously liable for the acts committed by its employees if it is done in the
course of its employment.

Vicarious Liability of Directors and Officers of Company

The action and the mental states of the companies’ directors are deemed to be the actions and the
mental states of the companies. Can the reverse be true? Suppose a company through its
employees commits actions that have criminal consequences. Can the directors of the company
be attributed these actions such that they can be held responsible for the criminal consequences?
In the context of company law, the vicarious liability provisions have a standard language
providing that the “person-in-charge of” and “responsible for” the conduct of the business of the

18
Dhaval Gusani, Directors and Officers liability in India (Tax Guru, 26 Nov 2020)< https://taxguru.in/company-
law/directors-officers-liability-india.html> last accessed 27th March 2022.
19
Iridium India Telecom Ltd. v Motorola Inc Criminal Appeal No. 35 of 2015.
company at the time of the commission of the offence, as well as other officers are liable for that
offence. The Supreme

Court in the case of “Sunil Bharti Mittal v. Central Bureau of Investigation” 20 had clarified
that the principle of alter ego can only be applied to make a company liable for acts of a person
or a group of persons who exercise significant and pervasive control over the affairs of the
company and could not be applied in the reverse.

Facts of the case

The central government issued telecommunication licences to a number of companies. The
license process came under scrutiny for certain irregularities as a result of which a criminal
investigation was launched against various companies including their directors. One of these
companies was Bharti Cellular Ltd. (BCL). The special court investigating the licensing
irregularities decided to attribute the actions of Bharti Cellular Ltd. to Sunil Bharti Mittal, its
Chairman cum Managing Director, and made him an accused in the proceedings. The special
court’s directions to make the director of BCL the accused was challenged in the Supreme Court
as a mistake of law. 21

Supreme Court Verdict

The Supreme Court held that without statutory backing, the persons in charge of a company
cannot be held criminally liable for the actions of a company. The Supreme Court further noted
that directors of the company can be held responsible for the wrong done by the company only
where there is sufficient evidence to prove that such persons played an active role and they had a
criminal intent or otherwise, the relevant statute has specifically imposed liability on them, such
as labour and environmental law statutes. Vicarious liability cannot be imposed on any director
in the absence of legislative mandate.

Liabilities of Independent Director and Non-Executive Directors

Every director is not liable for the actions and conduct of the companies but only those directors
who is aware of such contravention by virtue of the receipt by him of any proceedings of the
20
 Sunil Bharti Mittal v. Central Bureau of Investigation (2015) 4 SCC 609
21
Sunil Bharti Mittal v. Central Bureau of Investigation (2015) 4 SCC 609
board or participation in such proceedings without objecting to the same, or where such
contravention has taken place with his consent or connivance are liable for action.

Generally, Managing Directors, Whole time Directors, Executive Directors, CEOs are in-charge
of day to day business operations and management and hence, they are responsible for any action
of the company. However, an Independent Directors and Non-Executive Director can be held
liable if following conditions are satisfied:

– Acts of omission or commission by a company which had occurred with their knowledge; and
– With their consent or connivance or where he had not acted diligently.

If the aforementioned conditions are not satisfied then, under no circumstances, the Independent
Directors and Non-Executive Directors can be held responsible. Recently, the Ministry of
Corporate Affairs (“MCA”) issued directions to the Regional Directors, Registrar of Companies
and Official Liquidators vide circular dated 2nd March, 2020, directing them not to initiate any
civil or criminal proceedings against Independent Directors and Non- Executive Directors (non-
promoters and non-KMP) unless sufficient evidence exists against them. Monitoring the day-to-
day compliances of the company is not the responsibility of the ID/ NED. Hence an ID/ NED
cannot be held liable for acts, which are beyond their control, like failure on the part of the
company to maintain and update statutory registers, minutes of meetings, filing of returns, etc.
Additionally, it was also clarified that the Registrars are required to follow a standard operating
procedure, as prescribed by MCA, while initiating proceedings against ‘officer who is in
default’.22

I. Conclusion
Directors play a key role in setting and maintaining corporate governance standards for
companies. The law plays a part in setting the tone taken by directors by, inter alia, imposing
liability where directors are at fault for the destruction of the value of the corporation.
Liability is further extended, in the case of companies whose securities are traded on a

22
Dhaval Gusani, Directors and Officers liability in India (Tax Guru, 26 Nov 2020)< https://taxguru.in/company-
law/directors-officers-liability-india.html> last accessed 27th March 2022.
 securities exchange, to situations where directors fail to ensure that their corporations comply
with disclosure requirements designed to enable investors to make an informed decision as
to the value which they may be willing to attach to the securities.23

There has been a palpable rise in recent years of community expectations of how
directors should go about fulfilling their duties to corporations. This has resulted in a rise
in the standards of care and diligence which are expected of directors in the performance
of their duties. As these standards rise, so too does the potential for being held liable for
breach of these duties. This, coupled with the call for more active enforcement of
directorial breaches by certain quarters and the fact that directors continue to face
potential criminal liability for negligence, may in turn affect the manner in which
directors go about managing the affairs of their companies. In many instances, the result is
added costs for corporations. This may also deter qualified directorial candidates from
being willing to serve on corporate boards. At the same time, the need to protect the
interests of shareholders should not be ignored. The environment for business, business
culture and community expectations continues to evolve at an ever-increasing pace. The
challenge is to continually evaluate the corporate governance framework and to respond
appropriately to these changes. What is required is to have a robust governance
framework which facilitates accountability and appropriately penalizes non-compliance
while balancing the need not to unduly affect efficiency and efficacy in board
responsibility for corporate performance.

23
Victor YEO Chung Seng ‘DIRECTORS’ DUTY OF CARE AND LIABILITY FOR LAPSES IN CORPORATE DISCLOSURE
OBLIGATIONS’ (2016) SAclJ < https://journalsonline.academypublishing.org.sg/Journals/Singapore-Academy-of-
Law-Journal/e-Archive/ctl/eFirstSALPDFJournalView/mid/495/ArticleId/1162/Citation/JournalsOnlinePDF> last
accessed on 27th March, 2022.