Liability of Directors

Under the Companies Act, 1956, the liabilities of company directors are numerous. The directors have always to be on guard least they should incur any liability for any default or violation of any provision. Their civil and criminal liabilities may be grouped under certain heads for convenience of consideration and discussion. They are:

1. Liability to outsiders;
2. Liability to the company;
3. Liability to the shareholders;
4. Liability for statutory defaults and violations.

Liability of outsiders

Directors of a company may personally become liable to outside parties in the following cases:

When they enter into contracts on behalf of the company;

• If the contracts are ultra vires the company;
• If they act outside the scope of their own authority;
• If they act in their own name and not for and on behalf of the company;

Directors will be personally liable firstly if they contract in their own names without disclosing that they are acting on behalf of the company. Where a contract was being entered into by the company and not by the director himself, the director should clearly state so that he is doing so only as an agent or else the contract would be personal one and the directors would be personally liable. But where all the contracts for services were made in the name of the companies trading under their trade names and the director should to be made liable merely appended his name to authenticate the contracts on behalf of the companies, he could not be held personally liable. Further to make signatory director liable there should have been a clear intention on the part of the parties that the director should be a party to the contracts. In a particular case there was no such indication. The company which he represented was insolvent and, therefore, he was personally liable for breach of contract. Secondly, if the directors act beyond their powers, they will be personally liable for damages, say, if the negotiates a loan which exceeds the limits of the borrowing powers as laid down by the Memorandum of Association or misrepresent to the bank that a resolution was passed authorizing him to sign cheque where in fact, he was not so authenticated.

When they issue a prospectus,

• In violation of the provisions of the Companies Act, 1956 and the SEBI (Disclosure and Investor Protection) Guidelines;
• Which contains mis-statements;

When they are found guilty of fraud. When they allot shares in an irregular manner. When their liability has been made unlimited under sections 322 and 323 of the Act. Section 322 provides that the memorandum of a company may make the liability of any or all directors, or manager unlimited. In such cases, the directors, manager and the member who propose person for appointment to the office of director or manager, shall add to that proposal a statement that the liability of the person holding that office will be unlimited, and before the person accepts the office or acts therein, notice in writing that his liability will be unlimited, shall be given to him by the following or one of the following persons, namely, the promoters of the company, its directors, manager, if any, and its officers. A limited company may, if so authorized by its articles, by special resolution, alter its memorandum so as to render unlimited the liability of its directors or of any director. However, if the concerned director(s) is already holding office on the date of alteration, the alteration making his liability unlimited shall not have any effect till his term expires unless he accords his consent thereto. When the court orders that the directors are personally liable for all or any of the debts or liabilities of the company for fraudulent trading on the part of the company.

Liability to the company

The directors are liable to the company in the following cases:

• When they are negligent in the performance of their duty as directors and the company suffers loss, etc. There are no set standards of skills and care but only general principles which may be applied to determine whether a director has been negligent depending on the facts of each case. It is not possible or practical to take every possible care. It is not negligence for a director to fail to attend the Board meetings and thereafter not to ascertain the proceeding thereof. Where in one cases the directors delegated their power to manage the company to a properly appointed managing director who was able to dispose of the company’s investments for his own requirements, it did not amount to negligence.
• When they commit an act which is ultra virus their powers or ultra vires the company.
• When any illegal act or breach of trust is committed by them.

Liability under guarantee for company’s debts

Where a director guaranteed his company’s debts and his company became liable as a guarantor of its subsidiary company’s debts, it was held that the director’s guarantee would cover that debt also. The terms of the guarantee also covered the contingent liability of the holding company for the debts of its subsidiary as these liabilities crystallized. Where certain directors who had guaranteed the company’s debts retired and new directors were appointed in their place who also signed the guarantee bond and there was no agreement to show that the earlier guarantee had ceased to be operative it was held that all the directors including retired directors were liable jointly and severally under guarantee. A bank granted a temporary overdraft accommodation to a company for the purpose of meeting its working capital requirements. The advance was granted on the strength of a specific undertaking or promise made by the respondents, who were the managing director and a director to liquidate within one month, the entire outstanding in the account including costs and expenses. A decree passed against the director and the managing director personally was held to be justified. They could not get an order that recovery should not be out of personal assets.

Liability in respect of company’s debts

There is no provision in the Companies Act making the managing director of a company personally liable for the company’s debts. For ascertaining such liability, the principles of agency shall apply to the transaction in question.

Where directors deliberately dispose of their company’s assets so as to make them unavailable to pay the company’s debts, the creditors affected cannot recover damages fram them (i.e. the value of the assets made unavailable) by suing them for the tort of conspiracy, because the director’s purpose is to benefit the company by preserving the assets for its benefit.

The managing director of a company who executed the documents for obtaining cash credit facility from a bank on behalf of the company would not incur any personal liability for the loan obtained by the company. He is also not a necessary party to suit by the bank against the company. Directors are liable for any misapplication of money to any ultra vires purpose. A shareholder can maintain an action against the directors to compel them to restore funds of the company employed in ultra vires transactions, without making the company a party to it.

Where certain directors who had guaranteed the company’s debts retired and new directors were appointed in their place who also signed the guarantee bond and there was no agreement to show that the earlier guarantee had ceased to be operative, it was held that all directors including retired directors were liable jointly and severally under the guarantee.

Directors are personally liable if they act beyond the powers delegated to them even though the acts are not ultra vires the company. In case of service contracts, directors are liable for damages if they breach the express or implied terms of these contracts. The company can then recover the entire amount of compensation for the loss suffered.

Liability to the Shareholders

The position of the directors in respect of the company’s properties and the rights conferred upon them to be exercised as directors is that of a trustee. If they commit any breach of trust or indulge in wrongful uses of their rights and the company suffers loss, they have to make good the loss. Similarly, if shareholders suffer loss due to the negligence of the directors they are personally liable for the loss.

Right of shareholders to take action

When directors have acted mala fide or beyond their powers, the majority of the shareholders must in such a case be held entitled to take steps to redress the wrong. Even a single shareholder can proceed in such a case.

Liability for Statutory Defaults and Violations

Under the Companies Act, 1956, the directors are required to ensure compliance with the several provisions of the Act and penalties have been prescribed for defaults and/or non-compliance. The directors are liable for consequences in the following situations:

a) If, they issue a prospectus in contravention of Section 57 or 58 of the Companies Act. 1956, they are liable to be punished with fine, which may extend to fifty thousand rupees (Section 59).

b) Pursuant to the provisions of Section 69 (5) of the Act. Directors of a company shall be jointly and severally liable to repay share application money with interest at the rate of six per cent per annum from the expiry of one hundred and thirtieth day after the first issue of the prospectus, if the minimum subscription as stated in the prospectus has not been received by the company.

c) The directors of a company, according to Section 71 (3) of the Act, who knowingly contravene, or willfully authorize or permit the contravention of any of the provisions of Section 69 or 70 of the Act with respect to the allotment of shares or debentures, shall be liable to compensate the company and the allottee respectively for any loss, damage or costs which the company or the allottee may have sustained or incurred thereby.

d) Section 73 (2) and (2A) of the Act lays down that the directors of a company shall be jointly and severally liable to repay the share application money with interest at the rate of 15% presently prescribed, from the expiry of the eighth day from the day the company becomes liable to repay it. The directors are liable under Section 207 of the Act to be punished with simple imprisonment for a term which may extend to three years and shall be liable to a fine of one thousand rupees for every day, if they fail to distribute dividend within thirty days of its declaration by the shareholders. Directors knowingly contravening the provisions of Section 300 of the Act by participating and/or voting in Board proceedings relating to any contract or arrangement in which they are interested or concerned, shall be liable for punishment which may extend to fifty thousand rupees as per Sub-section (4) of the said Section.

g) Sub-section (4) of Section 299 declares that every director who fails to comply with the provisions of Sub-section (1) or (2) of Section 299 with regard to disclosure of their interest at Board meetings, shall be liable to punishment which may extend to fifty thousand rupees and also he vacates the office of director automatically under Section 283(1)(I).

h) The directors of a company, who are knowingly party to any contravention of the provisions of Sub-section (1) or (3) of Section 295 of the Act, which deal with loan to directors without the previous approval of the Central Government, shall be liable to punishment either with fine which may extend to fifty thousand rupees or with simple imprisonment for a term which may extend to six months. There are numerous other provisions in the Companies Act, for default or violation whereof the directors are liable to varying degrees of punishments and fines or both.