Showing posts with label Companies Act 1956. Show all posts
Showing posts with label Companies Act 1956. Show all posts

Wednesday, August 22, 2012

LAW AND PROCEDURE OF REMOVAL OF AUDITOR(S) BEFORE EXPIRY OF HIS TERM


Law and Procedure of removal of auditor(s) before expiry of his term under Companies Act 1956


Appointment, duration and removal of the auditors are governed by Section 224 of the (Indian) Companies Act, 1956 (the “Act”).

      Section 224(1) provides that every company is required to appoint an auditor or auditors at each annual general meeting (“AGM”) who shall hold office till the conclusion of the next AGM. Section 224(1) of the Act reads as under:

     “Every company shall, at each annual general meeting, appoint an auditor or auditors to hold office from the conclusion of that meeting until the conclusion of the next annual general meeting and shall, within seven days of the appointment, give intimation thereof to every auditor so appointed

        Provided that before any appointment or re-appointment of auditor or auditors is made by any company at any annual general meeting, a written certificate shall be obtained by the company from the auditor or auditors proposed to be so appointed to the effect that the appointment or re- appointment, if made, will be in accordance with the limits specified in sub- section (1B).”


      In terms of Section 224(7) of the Act, an auditor appointed in an AGM may be removed from the office before the expiry of his term by the company only in general meeting after obtaining the previous approval of the Central Government in this behalf except as provided in proviso to section 224(5).

Section 224(7) of the Act reads as under:

       “Except as provided in the proviso to sub- section (5), any auditor appointed under this section may be removed from office before the expiry of his term only by the company in general meeting, after obtaining the previous approval of the Central Government in that behalf.”

Section 224(5) of the Act reads as under:

      “The first auditor or auditors of a company shall be appointed by the Board of directors within one month of the date of registration of the company; and the auditor or auditors so appointed shall hold office until the conclusion of the first annual general meeting: Provided that-

(a)     the company may, at a general meeting, remove any such auditor or all or any of such auditors and appoint in his or their places any other person or persons who have been nominated for appointment by any member of the company and of whose nomination notice has been given to the members of the company not less than fourteen days before the date of the meeting; and

(b)    if the Board falls to exercise its powers under this sub- section, the company in   general meeting may appoint the first auditor or auditors.”


      In the light of the aforesaid, an auditor(s) may be removed before the expiry of his/their term i.e. before the conclusion of the next AGM who has been appointed in the preceding AGM by the members/shareholders;

(i)     only in the general meeting of the company; and

(ii)   after obtaining the previous approval from the Central Government.

        Further, Section 225 of the Act provides that a special notice shall be required for a resolution at an extra ordinary general meeting (“EGM”) and/or AGM appointing as auditor a person other than a retiring auditor, or providing expressly that a retiring auditor shall not be re-appointed.

Section 225 of the Act reads as under:

“(1)  Special notice shall be required for a resolution at an annual general meeting appointing as auditor a person other than a retiring auditor, or providing expressly that a retiring auditor shall not be re-appointed.

(2)     On receipt of notice of such a resolution, the company shall forthwith send a copy thereof to the retiring auditor.

(3)    Where notice is given of such a resolution and the retiring auditor makes with respect thereto representations in writing to the company (not exceeding a reasonable length) and requests their notification to members of the company, the company shall, unless the representations are received by it too late for it to do so,—

(a)    in any notice of the resolution given to members of the company, state the fact of the representations having been made; and

(b)    send a copy of the representations to every member of the company to whom notice of the meeting is sent, whether before or after the receipt of the representations by the company,

      and if a copy of the representations is not sent as aforesaid because they were received too late or because of the company's default the auditor may (without prejudice to his right to be heard orally) require that the representations shall be read out at the meeting

    Provided that copies of the representations need not be sent out and the representations need not be read out at the meeting if, on the application either of the company or of any other person who claims to be aggrieved, the Central Government is satisfied that the rights conferred by this sub-section are being abused to secure needless publicity for defamatory matter; and the Central Government may order the company's costs on such an application to be paid it in whole or in art by the auditor, notwithstanding that he is not a party to the application.

(4)    Sub-sections (2) and (3) shall apply to a resolution to remove the first auditors or any of them under sub-section (5) of section 224 or to the removal of any auditor or auditors under sub-section (7) of that section, as they apply in relation to a resolution that a retiring auditor shall not be re-appointed.”

        In addition to the aforesaid, a special notice is required to be given in terms of Section 190 of the Act, which reads as under:

“(1)  Where, by any provision contained in this Act or in the articles, special notice is required of any resolution, notice of the intention to move the resolution shall be given to the company not less than fourteen days before the meeting at which it is to be moved, exclusive of the day on which the notice is served or deemed to be served and the day of the meeting.

(2)    The company shall immediately after the notice of the intention to move any such resolution has been received by it, give its members notice of the resolution in the same manner as it gives notice of the meeting, or if that is not practicable, shall give them notice thereof, either by advertisement in a newspaper having an appropriate circulation or in any other mode allowed by the articles, not less than seven days before the meeting.”

         In the light of the above discussions, the procedure to remove the Auditor before the expiration of its term can be summarized as hereunder:

(i)      a special notice under Section 190 is required to be given to the Company by a member/shareholder;

(ii)           an extra ordinary general meeting of the members/shareholders (“EGM”) is required to be held in which the resolutions related to the removal of the Auditor will be passed by the members of the company; and

(iii)     an application is to be made to the Central Government (in the present case, the Regional Director) with concrete reasons explaining the facts and circumstances of seeking the removal of the Auditor before expiration of the term of its office.  

        Once the Central Government approval is obtained, the present auditor is deemed to have been removed from the office.

The brief step plan for removal of an auditor before the expiry of his term is as follows:


Step I:

      A special notice of not less than 14 days is to be given by a shareholder to the Company for removal of the Auditor and appointment of new auditor subsequent to the removal of Auditor

Step II

        Obtaining a certificate in writing from the new auditor to the effect of his eligibility to act as auditor, if appointed;

Step III

Holding a board meeting of the Company to pass the necessary resolutions to:


(i)             consider the special notice for removal of Auditor given by the shareholder and to decide the day, time and place[1] for calling the EGM;

(ii)               to approve the draft notice of EGM and explanatory statement thereof and to authorize the company secretary or director of the Company to issue the notice;

(iii)             to authorise the director or manager of the Company to make an  application to the Central Government under Section 224(7) for removal of the Auditor; and

(iv)          to authorise the company secretary or director of the Company ndia to inform the Auditor of the decision of the board of his removal.


Step IV

         Intimate the Auditor of his removal in writing along with a copy of the special notice as given by the Shareholder.

Step V

Holding of EGM to pass the necessary resolutions to:

(i)                 approve removal of the Auditor from the office of statutory auditors of the Company;

(ii)               appointment of new auditors subject to approval of regional director to hold office until the conclusion of next AGM;

(iii)             to authorise the director, company secretary or manager of the Company to intimate the new auditor of his appointment; and

(iv)             to authorise the director or manager of the Company to make an application to the Central Government (Regional Director) under Section 224(7) of the Act for removal of the Auditor.

Step VI

     Making application to the Regional Director (Central Government) in whose jurisdiction the registered office of the Company ndia falls in e-Form No. 24A along with the following documents:

-           Copy of ordinary resolution;
-           Copy of special notice under section 224(7) of the Act;
-           Copy of the representation, if any, made by the Auditor. and
-           Grounds of making application for removal of Auditor.

Step VII

      Upon receipt of approval from regional director intimate the new auditor of his appointment as an auditor of the Company to hold the office until the conclusion of next Annual General Meeting.

Tuesday, October 18, 2011

Transactions under Section 297 of the Companies Act, 1956: A Brief Analysis


Transactions under Section 297 of the Companies Act, 1956: A Brief Analysis

By this article I attempted to elaborate and interpretation Section 297 of the Companies Act, 1956, which deals with ‘Board’s sanction to be required for certain contracts in which particular directors are interested’.

What section 297 says (bare act):

(1)   Except with the consent of the Board of directors of a company, a director of the company or his relative, a firm in which such a director or relative is a partner, any other partner in such a firm, or a private company of which the director is a member or director, shall not enter into any contract with the company-

(a)    for the sale, purchase or supply of any goods, material or services; or

(b)    after the commencement of this Act, for underwriting the subscription of any shares in, or debentures of, the company:

[Provided that in the case of a company having a paid-up share capital of not less than rupees one crore, no such contract shall be entered into except with the previous approval of the Central Government.]

(2)   Nothing contained in clause (a) of sub-section (1) shall affect-

(a)    the purchase of goods and materials from the company, or the sale of goods and materials to the company, by any director, relative, firm, partner or private company as aforesaid for cash at prevailing market prices; or

(b)    any contract or contracts between the company on one side and any such director, relative, firm, partner or private company on the other for sale, purchase or -supply of any goods, materials and services in which either the company or the director, relative, firm, partner or private company, as the case may be, regularly trades or does business.

Provided that such contract or contracts do not relate to goods and materials the value of which, or services the cost of which, exceeds five thousand rupees in the aggregate in any year comprised in the period of the contract or contracts; or

(c)    in the case of a banking or insurance company any transaction in the ordinary course of business of such company with any director, relative, firm, partner or private company as aforesaid.

(3)   Notwithstanding anything contained in sub-sections (1) and (2) a director, relative, firm, partner or private company as aforesaid may, in circumstances of urgent necessity, enter, without obtaining the consent of the Board, into any contract with the company for the sale, purchase or supply of any goods, materials or services even if the value of such goods or cost of such services exceeds five thousand rupees in the aggregate in any year comprised in the period of the contract; but in such a case, the consent of the Board shall be obtained at a meeting within three months of the date on which the contract was entered into.

(4)   Every consent of the Board required under this section shall be accorded by a resolution passed at a meeting of the Board and not otherwise; and the consent of the Board required under sub-section (1) shall not be deemed to have been given within the meaning of that sub-section unless the consent is accorded before the contract is entered into or within three months of the date on which it was entered into.

(5)   If consent is not accorded to any contract under this section, anything done in pursuance of the contract shall be voidable at the option of the Board.

(6)   Nothing in this section shall apply to any case where the consent has been accorded to the contract before the commencement of the Companies (Amendment) Act, 1960.

Sub-Section wise Analysis:

Sub-Section
Deals with
     297 (1)

Charging / Fixing responsibility to obtain consent of board for entering into contract
     297 (2)

Exemptions / Gateways
     297 (3) & (4)


Modus operandi for obtaining consent
     297 (5)

Consequences of not obtaining consent

It is now clear that Section 297 states about obtaining consent of the board of directors, for entering into certain contracts in which particular directors are interested. Thus, not every contract requires consent of the board, only those contracts in which directors are interested require the consent of board. It is to be noted that usually a contract is entered into with the approval of the board, or even with the authority of the Managing Director/CEO/VP, or with the sanction of the Management Committee. But, here the only way of getting sanction for the contracts (in which directors are interested) is board’s sanction.

Section 297 (1):

Board’s sanction is required if:
        i.            a director;

      ii.            or his relative;

    iii.            a firm in which such a director or relative is a partner;

    iv.            any other partner in such a firm ( ie; a firm as stated in (iii) above);

      v.            a private company of which the director is a member or director;

enters into a contract with the company (a) for the sale, purchase or supply of any goods, materials or services; or (b) for underwriting the subscription of any shares in, or debentures of the company.

Further, the board’s sanction to be supported by the PREVIOUS approval of the Central Government, if the company’s paid-up capital is not less than Rs.1 Crore.

Section 297 (2):

Exemption to board’s sanction - to the  contract for the sale, purchase or supply of goods, materials or services, ie: Section 297 (1) (a) doest not apply, to the following:

§  purchase / sale for cash at prevailing market prices; or

§  regular trade / business between the company and party (director etc.), up to Rs.5,000/- per annum for the contract period;

§  any transaction in the ordinary course of business (exemption only for banking / insurance company)

Section 297 (3) & (4):

The board should accord its sanction only through a resolution passed at a board meeting (ie; it should not be a circular resolution) before the contract is entered into or within three months of the date on which the contract was entered into (three months allowed only in the case of urgent necessity – sub-section (3)

If the board’s sanction is not obtained, either before the contract date or within three months (in urgent cases), it will be deemed that the board’s sanction is not obtained, under Section 297.

Section 297 (5):

This sub-section states the consequence of not obtaining board’ sanction, as stipulated under section 297. As per 297 (5), if the consent is not accorded to any contract, anything done in pursuance of the contract shall be VOIDABLE AT THE OPTION OF THE BOARD.


CRITICAL INTERPRETATION:

Now, we will go into few critical interpretation of Section 297.

Aspect
Interpretation
Consent of Board


Consent of board means ‘a consent throughresolution at a duly convened board meeting, and not by mere circular resolution.
Contract between a company and director / interested director / relative / firm / private company.


The, the section does not apply to a contract between two public limited companies, because the word used is ‘private company’. If the word used is ‘company’, then it may be interpreted as any type of company (public / private). Thus, the two parties of the contract must be 1st party -  any type of company, and 2nd party -  director / relatives / firm / private company. 
Any other partner in such a firm.


Section is attracted to the contract entered into by the company and any other partners, of the firm of in that the director / his relative are a partner.
Sale or purchase of any goods, materials or services.


Section does not apply to a contract of immovable property (eg: purchase of land, building etc.), because the terms used is goods, materials or services – all are movables.  Thus contract for movables only get attracted by the section, immovable properties contracts are excluded.
Exemptions under sub-section (2)


Exemptions are independent provisions, because the words “or” is used to separate the provisions.
Exemption to transactions in the ordinary course of business.


Exemption applies only to banking and insurance companies, and not for all companies.
Rs.5000/- Exemption limit.


Calculated on Annual Basis, only for the period of contract.
Effect on not obtaining consent of board.


Contract voidable at the option of the board, and not void (invalid). The contract is voidable ie; can be ratified by the board.

Monday, June 13, 2011

VARIOUS LIABILITIES, RELIEFS, DEFENCES AND PROTECTIONS TO THE DIRECTORS UNDER INDIAN LAWS


VARIOUS LIABILITIES, RELIEFS, DEFENCES AND PROTECTIONS TO THE DIRECTORS UNDER INDIAN LAWS
A company is legally separate and distinct from its members. It is ultimately an artificial creation and it acts through its servants or agents. The decisions of a majority of its members in general meetings are regarded as the acts of the corporation. The majority acts through the Board of Directors. Board of Directors, as a whole, is generally delegated all powers of the management and it may sub-delegate any of these powers to individuals directors or other servants and managers. There is a relationship akin to agency between the corporation and its board as well as the servants or agents that are delegated with specific responsibilities. These Corporate executives are assigned with immense power which must be regulated not only for public good but also for the protection of those whose investments are involved. A director must however exercise his expert skill and knowledge for the company. He should exercise skill and care in carrying out their managerial functions. In addition to fiduciary duties there are some statutory duties also that have been provided under the Companies Act, 1956. A director has to perform his functions with reasonable care. If the directors unable to perform their duties they can be held to be liable under the provisions of this Act. At the time of winding up of a company the liquidator has a vital role to play. But since the directors are the key officers of the company they are also having some liabilities which are as under:

LIABILITY TO THE COMPANY:

Directors owed the following liability to the company:                          

Duties of Skill and Care: Unless the Articles of the Company provide otherwise, the directors are responsible for the management of the company. They should exercise skill and care in carrying out their managerial functions. However, a mere error of judgment will not amount to a breach of the duty of care which a director owes to a company. A professionally qualified or expert person who is a director must however exercise his expert skill and knowledge for the company.

Liability for negligence: A director has to perform his functions with reasonable care. He has to attend with due diligence and caution the work assigned to him. Directors may not know the nature of the company’s trade, because all that the law expects from them is that if they know they must use the knowledge for the benefit of the company. Accordingly the directors were held guilty of negligence when they participated in a transaction without trying to know whether the transaction was really for the purposes of the company or they were authorized by the Board in that respect, and it was no defence for any director to show that he believed that he was bound to sign because the other directors wanted it or that he joined under protest or that even without his joining, the other directors were determined to carry out the transaction. Directors were also held liable where they released the company’s funds for paying the debt without trying to know whether anything was really due and for purchasing the assets without knowing whether there was any real transfer of those assets. Liability for negligence also followed where without any board resolution being properly passed a single member was allowed to manage a part of the company’s business and he misconducted himself.  S.201 renders void any provision in the company’s articles or in any agreement which excludes liability for negligence, default, and misfeasance, breach of duty or breach of trust. Directors would decidedly be liable for omitting to do what they could have done in the circumstances. Where the president of an investment company improvidently invested in companies in which he was interested and caused loss, his fellow directors were held liable because they had left the investment of the company’s funds to the president’s unfettered discretion and exercised no supervision over him.

Defense for the directors- statutory provision [s.633]-
Section 633 gives a defense to the directors as special protection against a liability that may have been incurred in good faith. Where it appears to the court that the director sued, “has acted honestly and reasonably, and that having regard to all the circumstances of the case….he ought to fairly to be excused, the court may relieve him either wholly or partly from his liability on such terms as it may think fit. Three circumstances must be shown to exist. The position must be such that the person to be excused is shown to have acted honestly, secondly, reasonably, and thirdly, having regard to all the circumstances he ought fairly to be excused.  In a case before the Orissa High Court, where the annual general meeting of a company could not be held in time on account of the dissolution at the material time of the Company’s Board of Directors by a court order, the court granted relief against liability for default.

Duty to attend board meetings: If some persons are guilty of gross non-attendance, and leave the management entirely to others, they may be guilty by this means if breaches of trust are committed by others. The defendants were directors of a trust company whose by-laws required monthly directors' meetings. A meeting was omitted because of the absence of several directors upon vacations. Losses resulted to the trust company which would have been prevented had the directors met and exercised proper supervision over certain loans. Held, that the directors are accountable to the trust company for such losses.

Misuse of corporate information- Exploitation of unpublished and confidential information belonging to the company is a breach of duty and the company can ask the director in question to make good its loss, if any. Any knowledge or information generated by the company is the property of the company, commonly known as intellectual property. Turn over of business, profit margins, list of customers, future plans, any personal use of such knowledge is equivalent to misappropriation of property. Use of such information can be restrained by means of an injunction. Any gain made by the use of inside information has to be accounted for to the company.

FIDUCIARY AND COMMON LAW DUTIES:
Directors owe a number of fiduciary and common law duties to the company. These duties include:
  • Duty to act with honesty
  • Duty to account for any profit made
  • Duty not to exploit corporate opportunities to their own advantage.
  • Duty to ensure that the capital of the company is used only for the legitimate business.
  • Duty not to use the company’s assets for the benefit of a rival concern
  • Duty to repay the company any profit they make on shares in the company

LIABILITY FOR BREACH OF TRUST-
Good faith requires that all the endeavors of the directors must be directed to the benefit of the company so that the ultimate benefit should be gone to the legitimate shareholders of the company. Thus where a director of a company, being also the member of another company, earned business from the other company by providing some business facility  of his company, he was held liable to account for such profits, although the company had itself not lost anything and also could not have earned the bonus. But there is some situation where directors may make personal use of company’s opportunity and where the corporation is insolvent and defunct; its officers are free to act for themselves, since such condition is ascertainable and not easily feigned. Where the opportunity is outside the scope of corporate business, or where the corporation has shown no interest in the property, an officer may buy for himself. There is no breach of duty if a director competes with his company or olds some interest in the rival company or is a director in a competing company. If a company had given special training to a director, he may be restrained by the company from using those special skills for the benefit of the rival company. A director who acquires property while in office will, however, be liable to account for his profit upon resale if two elements are present. He must have acquired property only by reason of the fact that he was a director and in the course of the exercise of the office of director.

LIABILITY UNDER SEBI (INSIDER TRADING) REGULATIONS, 1992-
For prevention of use of unpublished price sensitive information for money making through stock market The Securities and Exchange Board of India has formulated SEBI (Insider Trading) Regulations, 1992. Since directors are given the shares of the company in which they are the directors of the company and they also have the right to sell the shares of the company after a lock in period. When director decide to sell their shares however acquired or to buy more shares, their trading comes to be governed by the legislation on insider trading.. “If the director has access to unpublished price sensitive information, such as information on future earnings, figures, security issues, assets disposal and purchases, etc., which if it were made public would have a significant effect on the share prices, it is illegal for them to trade on such information.

TORTIOUS LIABILITY OF DIRECTORS: -
Directors as such are not liable for the torts or civil wrongs of their company. To make a person liable for a tort, e.g. for negligence, trespass, nuisance or defamation it must be shown that he was himself the wrongdoer or that he was the employer or principal of the wrongdoer in relation to the act complained of, or that the tort was committed on his instructions.
 
STATUTORY LIABILITY OF THE DIRECTORS UNDER THE COMPANIES ACT:-
Provisions of the companies act 1956 directors have burdened the directors with some statutory liabilities. These liabilities are as mentioned below:

Misleading Prospectus- If a prospectus contains some untrue statement and if on the basis of which a person has subscribed the shares of that company then the directors of the company are liable to compensate the person who has subscribed shares on the faith of the prospectus, which contained untrue statement. The Director should compensate every such subscriber for any loss or damage he may have sustained by reason of such untrue statement in an action in tort and also under section 62 of the Act to pay compensate. If the Director discovers a mistake in the prospectus, it is his duty to specifically point it out. The Director may also have to face criminal prosecution for untrue statement in the prospectus. He may be imprisoned for two years and fined Rs.5000.

Inducement to invest- The Directors are liable to criminal prosecution for inducing or attempting to induce a person by statement or even forecast which is false or misleading to enter into or to offer to enter into any agreement to buy shares of the company. They shall be punishable with imprisonment for a term which may extend to five years, or with fine which may extend to Rs.10,000, or with both.

Maintenance of proper books of accounts: -
Where directors manage a company then each director shall be responsible (if there is no managing director) that the company should maintain and keep proper books of account. Default or non-compliance will make the Director punishable with imprisonment for a term not exceeding six months or fine of Rs.100 or both. In the event of winding up, failing to keep proper accounts will make him punishable with one-year imprisonment and for falsification of book imprisonment for eight years.

Liability for Unauthorized Contracts- The directors of the company are authorized to enter into the contracts on behalf of the company subject to the articles of the company. The contract will be binding on the company. But share holder can impose some restrictions upon the powers of the directors to make contracts. But the directors may be held personally liable for any loss caused to the company as a result of the unauthorized transaction. The directors' actions can be ratified by a separate, special resolution of the shareholders, which will relieve the directors from liability.

Reduction of members’ below the minimum: If at any time the number of a company reduced, in case of a public company or, in the case of  a privatr company, below two and the company carries on the business for more than six months while the number is so reduced, every person who is a member of the company and knows of the fact  shall be severally liable for all the debts of the company contracting during that time.

Personal Liability of Directors:
A director may incur personal liability towards the company if:
  • He acquires non-cash assets of the company or the company acquires such assets from him without also obtaining the approval of the shareholders. The contract may be set aside, and the company may recover any of its loss, or his gain, from the director;
  • The company makes a payment by way of compensation to a director for loss of office without details of it being disclosed to and approved by the shareholders. The payment is unlawful, and as such can be recovered from the director;
  • A payment is made to him (by the company or some third party) on the transfer of the whole or any part of its undertaking by way of compensation for loss of office or in consideration of his retirement, again without shareholder approval. The payment is held on trust for the company and as such can be recovered from him.
The directors of a company incur a personal liability in the following circumstances:
  • Where they contract in their own names;
  • Where they use the company's name incorrectly, e.g., by omitting the word 'Limited';
  • Where the contract is signed in such a way that it is not clear whether it is the principal (the company) or the agent who is signing, and
  • Where they exceed their authority, e.g., where they borrow in excess of the limits imposed upon them

LIABILITY TO SHAREHOLDERS
While a director owes fiduciary duties to the company, he owes no such duty to the shareholders. He does, however, owe to the shareholders - collectively, not individually. They could be liable for improper use of corporate assets that exist for the benefit of all shareholders or for favoring one group of shareholders over another in a takeover battle.

Liability for Infringement of Personal Rights If the directors override the rights which the company's Articles confer upon the shareholders, by causing the company to act in a manner inconsistent with those rights, they will incur a liability, in damages, to the shareholders for procuring a breach of contract.

Statutory Liabilities A director may incur liability for losses suffered by shareholders resulting from non-compliance with legislation. For example for breach of statutory pre-emption rights, misrepresentation in the prospectus or for any dishonest disclosure to the shareholders

LIABILITY TO CREDITORS AND OUTSIDERS:

Liability on Contracts: Where the directors enter into a contract on behalf of the company, in the unlikely event of the company itself not being bound by that contract, the director may incur liability to the other party.

Potential Liability of Directors for the Breach of Fiduciary Duty to Creditors: Officers and directors of an insolvent company owe fiduciary duties to creditors, and are under a heightened duty to maximize value in connection with the inevitable break up of the company. After determination of the insolvency of the company, officers and directors are charged with a fiduciary responsibility of protecting the interests of creditors based on an "informed business judgment" standard of care.

The Liability of Directors on Corporate Insolvency
When a company goes into insolvent liquidation a director of the company may be exposed to a risk of personal liability. The liquidator of the company has the right to investigate the affairs of the company, including the actions of the directors. If there has been any breach of statutory duty or there have been unlawful payments such as loans or compensation, the liquidator will claim against the director. Specifically, there are a number of provisions in the Insolvency Act 1986 which provide for the potential liability of directors, both in the period leading up to liquidation and during the liquidation itself. These include the following matters.
(a) Fraud, etc in anticipation of winding-up. It is a criminal offence to conceal or destroy the company's property, books, records and the like within 12 months before insolvent liquidation (or up to 5 years if done with intent to defraud the creditors). The court may also order repayment, restitution or the payment of compensation by the directors;
(b) Concealment from, and failure to co-operate with, the liquidator. It is a criminal offence not to hand over property, books, etc to the liquidator, or deliberately to make a false Statement of Affairs;
(c) Fraudulent trading. If a liquidator proves that a company carried on its business with the intent to defraud creditors, the court may order the directors responsible to contribute to the assets of the company. This is also a criminal offence.

LIABILITY FOR THE ACTS OF OTHER DIRECTORS:
Generally IN the absence of negligence, a director is not liable for the breach of duty by other directors of which he was ignorant. However, where a director is under a duty of care, imposed by his contract or by the general law, to supervise the activities of another director and he fails to do so, or where he knowingly participates to some degree in or sanctions conduct which constitutes a breach of duty, he will be just as liable for those wrongful acts as the other director.

RELIEF TO THE DIRECTORS FROM LIABILITY:
There are a number of ways in which a director may be relieved from liability which would otherwise be incurred for breach of duty.
  • Some breaches may be remedied through the director's conduct being disclosed to a general meeting and being ratified by the shareholders passing an Ordinary Resolution except the following:
    • Any breach involving a failure of honesty on the director's part;
    • Any breach of duty which results in the company performing an act which it cannot lawfully do e.g by reason of some prohibition imposed by statute or the general law
    • Any breach of duty which results in the company performing an act not in adherence with the company's articles;
    • A breach of duty bearing directly upon the personal rights of the individual shareholders;
    • A breach of duty involving "fraud on the minority"
  • If shareholders of the company unanimously approve the relieve of the directors of the company from their liability for any breach of duty the directors can be relieved from such duty.
  • Any contract between the directors and the company, or any similar provision in the Articles which attempts to exempt the directors from liability for negligence, default or breach of trust towards the company is void. However, directors may exclude their liability to third parties by means of an express contractual provision or a disclaimer.
  • The court has power to relieve a director from some civil or criminal liabilities for negligence, default or breach of trust if it is satisfied that the director has acted honestly and reasonably and in all the circumstances he ought fairly to be excused.

PROTECTION TO THE DIRECTORS FROM LIABILITY:
The following protections available to the directors of the company:
  • The company can, in the following circumstances, indemnify a director in respect of his legal costs. This indemnity may be ex gratia, or it may be contained in the director's service contract or in the Articles The power to indemnify is limited to the two cases namely costs incurred by the director in successfully applying for judicial relief re non-payment for shares by a nominee of the company and costs incurred by the director in successfully applying for judicial relief.
  • For an independent director, the best way out before landing in a legal mess, of course, is to be a whistle-blower. To point out the minutest of irregularities and make sure they are recorded in the minutes of the meetings.
  • A director can obtain insurance to cover certain of his personal liabilities, including the costs of litigation in which he becomes involved in or arising out of his office. A company is permitted to pay the director's premiums on this type of policy.
  • The directors have been protected by the business judgment that is applied for the mistakes in the mistakes in judgment by the directors. As long as the director or officers has acted according to the duties of loyalty, obedience and diligence, then the director or officer may be protected by the Business Judgment Rule.