Liability of Directors in Company

The responsibilities of a Director are multifaceted, encompassing several duties, statutory obligations, and a commitment to act in the company's best interests.

Types of Liability

1. Civil Liability

Directors are entrusted with fiduciary duties, requiring them to act in good faith, with due diligence, and in the best interests of the company. A breach of these duties can result in civil liability. In Official Liquidator, Supreme Bank Ltd. v. P.A. Tendolkar[1], the Hon’ble Supreme Court held that directors could be held liable for losses resulting from their negligence or misconduct. The Hon’ble Supreme Court emphasized that directors must exercise their powers with caution and not act beyond their authorized capacity. The Hon’ble Apex Court had examined the question whether a Director, alleged to be liable for misfeasance had acted reasonably as well as honestly and with due diligence so that he could not be held liable for fraud and misappropriation which takes place. A director who has been closely and extensively involved in the management of a company may be held liable for fraud in its operations even if no direct act of dishonesty is attributed to him. The Hon’ble Apex Court went on to observe that a director cannot shut his eyes to what must be obvious to anyone who would be examining the affairs of the Company even superficially. It is enough if his negligence is such as to enable frauds to be committed and losses thereby incurred by the Company. In the aforesaid case, Court held that Directors could not have been ignorant of the fact that the Account Books of the company contained fictitious entries which showed payments for shares by them when they had not actually paid for them. Nor could the Directors be so innocent as to not know of the presentation of false balance sheets so as to conceal the true state of affairs from the depositors for years. It went on to observe that any Director who is conscious of his managerial responsibilities, who had cared to examine the affairs of the Bank, could not have failed to find out what was really happening in the Bank. The fact that these practices were tolerated for such a long period without any check by the Board of Directors goes to show that the Directors must be participants in the benefits of widespread misappropriation even though they may have not left any traces of such misappropriation in the records of the Bank.

2. Criminal Liability - Vicarious Liability under Statutory Provisions

Certain statutes impose criminal liability on Directors for offenses committed by the company. Section 141 of the Negotiable Instruments Act, 1881 (NI Act) is an example where Managing directors and directors of a company are held vicariously liable for offenses related to cheque dishonour.

However, the Hon’ble Supreme Court in S.M.S. Pharmaceuticals Ltd. v. Neeta Bhalla[2] has clarified that mere designation as a director is insufficient for imposition of liability. It emphasized that specific allegations are necessary to demonstrate a director's active role and responsibility in the company's operations in order to establish vicarious liability.

It is necessary to specifically aver in a complaint under Section 141 that at the time the offence was committed, the Director who has been accused was in charge of, and responsible for the conduct of business of the company. Without this averment being made in a complaint, the requirements of Section 141 cannot be said to be satisfied. It also held that merely being a director of a company is not sufficient to make the him liable under Section 141 of the Act. A director in a company cannot be deemed to be in charge of and responsible to the company for the conduct of its business.

The requirement of Section 141 is that the person sought to be made liable should be in charge of and responsible for the conduct of the business of the company at the relevant time. There is no deemed liability of a director in such cases. It also went on to observe that by virtue of the office that a managing director or joint managing director hold, they are persons in charge of and responsible for the conduct of business of the company. Therefore, they get covered under Section 141. It also observed that so far as the signatory of a dishonoured cheque is concerned, he is clearly responsible for the incriminating act and will be covered under subsection (2) of Section 141.

[1] (1973) 1 SCC 602.

[2] (2007) 4 SCC 70.

Author: Yashvi Aswani, Senior Associate