Legal Position of Directors in a Company

The legal position of directors in a company is a complex and pivotal one, intertwining various legal identities. Directors are not easily defined as either agents, trustees, managing partners, or employees. Their functions are influenced by the overarching framework of corporate law and the specific governing documents of a company.

They represent the interests of shareholders, wield significant decision-making authority, and owe a fiduciary duty to the company. This intricate blend of roles underscores the legal intricacies of a director’s position.

This article explores the legal position of directors, shedding light on their diverse responsibilities and legal obligations.

Who is a Director of a Company?

A director is a person chosen or designated to oversee a company’s business and operations. A company’s director isn’t an employee or servant of the company. Instead, they are professionals hired by the company to guide its activities. The group of directors within a company is collectively called its Board of Directors, which holds the highest executive authority in managing and running the company.

Describing the role of a director in a corporate enterprise can be challenging. They don’t have a servant-master relationship with the company because they have control over the company’s activities. As Bowen L.J. once pointed out, directors are sometimes described as agents, sometimes as trustees, and sometimes as managing partners. However, these descriptions don’t fully encompass their powers and responsibilities. They are used to offer different perspectives on how directors can be viewed depending on the specific context and purpose.

Legal Position of Directors

Describing the precise legal role of directors in a company can be quite challenging. Judges have used various terms to define directors, such as agents, trustees, and managing partners. Directors are individuals who have been duly appointed by the company to direct and manage its affairs. However, these terms, like agents and trustees, do not cover all of their powers and responsibilities comprehensively.

In the case of Ram Chand & Sons Sugar Mills Pvt. Ltd. v. Kanhayalal Bhargava (1966), it was acknowledged that it’s indeed difficult to provide an exact legal position of a director in a company. Judges have described it as a multi-dimensional role, which can be viewed as that of an agent, trustee, or manager, even though these terms may not have the same legal implications in a strict legal sense.

Directors as Agents

A company cannot independently take action in its own capacity and requires a representative. This representative role is fulfilled by the directors, establishing a principal-agent relationship.

In this relationship, directors possess the authority to act and make decisions on the company’s behalf. Any contracts or transactions made on behalf of the company render the company responsible, while the directors remain free from personal liability. Directors merely sign and execute contracts on behalf of the company.

In the case of Ferguson v. Wilson (1904), it was legally recognized the legal position of directors as agents of the company. This acknowledgement stems from the legal principle that a company, as an artificial entity, cannot function independently; it necessitates an agent to act on its behalf.

Additionally, in the case of Ray Cylinders & Containers v. Hindustan General Industries Limited (1998), it was clarified that directors act as agents of the company, not of its individual members unless special circumstances dictate otherwise. A company is legally distinct from its shareholders.

In the case of Kirlampudi Sugar Mills Ltd. v. G. Venkata Rao (2003), it was observed that when a company’s CEO executes a promissory note and borrows money for the company, the liability does not fall on the CEO personally. Even if the company fails to repay the borrowed amount, the agent (CEO) does not incur personal liability.

However, in the case of H.P. State Electricity Board v. Shivalik Casting (P.) Ltd. (2003), it was established that if a director provides surety in their personal capacity, and not on behalf of the company, the company cannot be held responsible for the surety amount.

Certain circumstances were outlined in the case of Vineet Kumar Mathur v. Union of India (1996) in which directors can become personally liable:

• When directors enter into contracts in their own names, rather than on behalf of the company.
• When directors omit or incorrectly use the company’s name in agreements.
• When directors sign contracts or agreements in a manner that is unclear whether the company (as the principal) or the director (as the agent) is signing and who will be liable for future obligations.
• When directors exceed the approved limits and borrow in excess of authorized funds.

Unauthorized actions can sometimes be ratified. In Bhajekar v. Shinkar (1933), it was noted that if a transaction made by a director exceeds their authority but falls within the company’s overall powers, it can be validated through a company resolution.

However, if the company has been deregistered and dissolved by the registrar, it cannot ratify actions because a non-existent entity cannot initiate legal actions. Hence, it can be stated that the legal position of director in a company is similar to an agent.

Director as a Trustee

Within a company, the legal position of director is also as a trustee. This trustee role implies that directors manage the company’s assets and work in the best interests of the company.

A trustee is someone who can be entrusted with the company’s resources and acts to achieve the company’s objectives rather than for personal gain. Furthermore, a trustee is granted certain powers, such as share allocation, issuing calls, accepting or declining transfers, etc., which are referred to as powers in trust.

In the case of Dale & Carrington Investment (P.) Ltd. v. P.K. Prathapan (2004), it was emphasized that directors must act in a fiduciary capacity. This means they have a duty to act on behalf of the company with the utmost care, skill, good faith, and due diligence, primarily in the best interests of the company they represent.

As highlighted by the Madras High Court in the landmark case of V.S. Ramaswami Iyer v. Brahmayya and Co. (1966), directors can be held liable as trustees in terms of their authority to manage the company’s funds. Directors may potentially misuse these funds. Consequently, if legal action is taken against a director for such offences, the cause of action persists even after the director’s death and can be pursued against their legal representative.

However, it’s crucial to note that, as affirmed in the cases of Percival v. Wright (1902) and Peskin v. Anderson (2001), directors owe their duty to the company as a whole and are not trustees for individual shareholders. They do not owe a fiduciary duty to shareholders solely by virtue of their positions. Additionally, they can purchase company shares without disclosing ongoing negotiations for the sale of the company’s business.

Hence, the legal position of director can be considered as a trustee.

Director as a Managing Partner

Directors of a company act as representatives of the shareholders, carrying out their will and objectives. They work on behalf of the shareholders and their interests, which grants them significant powers and the ability to perform functions that are essentially proprietary in nature.

The company’s Memorandum of Association (MOA) and Articles of Association (AOA) establish the board of directors as the highest authority for policy-making and decision-making.

Director as an Employee/Officer

Shareholders elect directors in a general meeting convened by the company. Once a director is elected, they have rights and powers granted to them by the law. These powers and rights cannot be revoked by the shareholders, and shareholders cannot interfere in the decision-making processes of the directors.

Because directors possess these substantial powers and rights, they cannot be classified as employees of the company. Employees typically have limited authority and work under the direction of the employer without the ability to interfere in decision-making. Hence, the legal position of director can be considered as an employee.

In the case of Lee Behrens & Co., Re (1932), it was established that shareholders elect representatives who then direct the company’s affairs on their behalf, akin to acting in the capacity of agents. This ruling also clarified that directors are not employees or servants of the company.

However, the Madras High Court, in the case of R.R. Kothandaraman v. CIT (1957), held that in the absence of specific legal constraints, directors can choose to enter into special contracts with the company to be considered employees.

Directors are also regarded as officers in certain aspects of a company. They can be held accountable for penalties if they fail to comply with the law. To summarize the legal position of directors in a company, the statement of Jessel M.R. from Forest of Dean Coal Mining Co., Re (1878) can be quoted: “Directors have sometimes been called trustees or commercial trustees, and sometimes they have been called managing partners.

It does not matter much what you call them as long as you understand the legal position of director in a company, which is that they are essentially businesspeople managing a trading entity for their own benefit and for the benefit of all the shareholders. They hold a fiduciary position with respect to the company, given their control over powers and capital.”

Conclusion

The legal position of directors in a company is multifaceted and includes roles as agents, trustees, managing partners, and officers. Directors act as representatives of shareholders, wielding substantial powers and making key decisions. They operate under the company’s governing documents as the supreme authority.

While they are not employees in the traditional sense, they can enter into special contracts to hold an employee status. Directors also bear a fiduciary duty toward the company, ensuring they act with care, good faith, and diligence in its best interests. This intricate role underscores the pivotal position directors hold in guiding and safeguarding a company’s affairs.