Liabilities and Safeguard tools that every Director should know
Last year, a non-executive director of Modi Xerox was pulled up by the Enforcement Directorate for alleged exchange rate violations by the company. Executive directors of Bundl technologies, which operates e-commerce platform Swiggy, in turn, were threatened to be arrested by the GST officials for alleged wrongful availment of the tax credit.
Both the cases were dismissed by the upper Court – not without causing hardship to the directors concerned.
Duties and liabilities of directors are increasingly coming under focus, especially in the wake of rising corporate scams and many legal proceedings being made against them.
Liabilities of a director in a company can arise under the Companies Act, 2013 as well as under other legislation that apply to the company due to the nature of its business.
Liabilities under Companies Act
Managing directors, CEOs, whole-time directors, executive directors are usually in charge of day-to-day business activities and hence held responsible for any lapse. However, independent directors and non-executive directors can also be held liable for wrongful acts or omissions or if the activity was performed with their consent or connivance.
Director’s liabilities can be classified into the following:
- Breach of fiduciary duty – Directors hold the office of trust and fail to exercise their power in the interest of the company.
- Ultra-vires Act – Director acts beyond the powers sanctioned under the Companies Act, Memorandum and Articles of Association.
- Negligence – Failure to exercise care and caution. The error of judgment however cannot be construed as negligence.
- Mala fide acts – Liable for breach of trust if found misusing their powers.
Then, depending upon their nature of operations, directors are also liable under other legislations.
For instance, a fine might be imposed on failure to deduct TDS, while a deliberate attempt to evade taxes can be punishable with imprisonment that may extend up to 7 years under the Income Tax Act.
Similarly, labour legislations – Building and other construction workers Act, 1996 and contract labour Act, 1970 – make it mandatory to adhere to prescribed working and safety measures. Any offense where the directors are found directly responsible could attract penalties including that of imprisonment.
Then, there are liabilities under exchange control laws, Negotiable instrument Act, environmental laws and so on.
Directors can use the following safeguard measures to ensure they don’t fall on the wrong side of the law:
Director’s liability can be mitigated if it can be demonstrated that a director has exercised due diligence in ensuring compliance with requirements of applicable laws and that the offense was committed without his knowledge, consent or connivance.
Directors, therefore, need to be on top of data flow and monitoring systems related to their area of operations. While tracking their company in greater detail, they also need to keep a tab of peer performance and market trends.
Any activity or step which they feel is violative should be brought forward in the board meeting and ensure such dissent is recorded in the minutes of the meeting. Furthermore, the directors can insist on an indemnification clause in the shareholder’s agreement or in the employment agreement, which will safeguard them from any claims arising from third parties on account of their bonafide actions in the company.
They can also insist that the company obtain Directors and Officers Liability insurance. It hedges against any pecuniary liability arising out of actual or alleged breach of duty, neglect, misstatements or errors in the director’s managerial capacity.
Independent directors need to be aware beforehand of company’s legal cases that are pending in the Court. Likewise, of the legal status of the industry they operate in. For instance, there is the rising number of cases being initiated against directors in the fintech and cryptocurrency industry.
By exercising due diligence and by adhering to best practices in the areas of employment, taxation, environment and corporate governance, directors can mitigate liability-related risks.
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