Vicarious Liability of Directors in Corporate Laws - Analysis and Synthesis

The Board of Directors (BOD) occupies a pivotal position in the hierarchy of a corporate structure, with larger expectations of the stakeholders expecting them to act as trustees, fiduciary agents, and key financial decision-makers of their investment in the company. The provisions of the Companies Act, 2013, relating to the director\'s roles and responsibilities are somewhat diversified and not crystal clear. Court rulings under various corporate laws have established certain tests to determine whether directors are responsible and accountable. The classification of directors under various designations under the Companies Act, 2013, also adds different dimensions to the practicality of the problems. The appointment of Independent Directors to the Board composition raises several questions relating to their position and liability. The notion that Independent Directors not only seem to be independent but are also seen to be independent, is put under test from time to time. The issues that take us further are: Whether the Board is \'collective responsibility\' or \'individual responsibility\' of the director? Is the role and responsibility of directors being well defined?

Vicarious liability A legal concept where one person is held responsible for the actions of another applies to directors primarily because of their position and status as directors within a company. The directorship coupled with vicariousness makes their position as \'titanic ship\' at times of turbulence while managing the affairs of the company, safeguarding assets and driving the company in the larger interest of stakeholders, and also being socially responsible. Though a director is appointed through a process and procedure at the general meetings of the company, the important point is that the \'consent\' to act as a director necessarily be given and filed by the director concerned with the Registrar of Companies. The consent sent conveys the message that it is voluntary and not by mere abstraction or manifestation of the law. The disqualifications of directors contained in Section 164(2) of the Companies Act, 2013, brings the concept of vicarious liability and further disqualifications.

1. The Companies Act, 2013

Section 2(60) (vi) - Who is an \'Officer\' in default?

For the purpose of any provision in this Act, an \"officer who is in default\" includes, among others, every director who is aware of a contravention of any provision of this Act, either by virtue of the receipt of any proceedings of the Board or participation in such proceedings without objecting to the same, or where such contravention had taken place with his consent or connivance. (This implies that the meetings of the company can be used as evidence to determine liability of non-executive directors in such cases).

Section 149(12) - Company to have Board of Directors

Notwithstanding anything contained in this Act

• an independent director, and
• a non-executive director who is neither a promoter nor a key managerial personnel,

shall be held liable, only in respect of such acts of omission or by a company which had occurred:

• with his knowledge, attributable through Board processes,
• with his consent or connivance, or
• due to his failure to act diligently.

Although the Code of Conduct (Schedule IV to the Companies Act, 2013) prescribes Independent Director\'s roles, the scope of their duties and responsibilities has increasingly come to imply that they are expected to be aware of all actual or suspected violations or fraud.

Section 164 (Disqualifications of Directors)

Apart from other parameters stated in sub-section (1), two important parameters under sub-section (2) are:

\"No person who is or has been a director of a company which

• a) has not filed financial statements or annual returns for any continuous period of three financial years; or
• b) has failed to repay the deposits accepted by it or pay interest thereon or to redeem any debentures on the due date or pay interest due thereon or pay any dividend declared and such failure to pay or redeem continues for one year or more,

shall be eligible to be re-appointed as a director of that company or appointed in other company for a period of five years from the date on which the said company fails to do so. Provided that where a person is appointed as a director of a company which is in default of clause (a) or clause (b), he shall not incur the disqualification for a period of six months from the date of his appointment\".

The words used in the sub-section are \'not filed\' or \'failed\'. While failure to file returns is a compliance factor, the failure to repay deposits and the interest thereon is a commercial and financial matter, which the Board and its directors, as a whole, are expected to understand and address. Ignorance of law in these circumstances is non-excusable and will be met with vicarious liability where directorship will be questionable for a period of five years from the date of default, not only in the said company but also in other company.

Section 166 (Duties of Directors)

Directors \"shall not achieve or attempt to achieve any undue gain or advantage either to himself or to his relatives, partners, or associates and if such director is found guilty of making any undue gain, he shall be liable to pay an amount equal to that gain to the company\" and \"shall not assign his office\", such that no one as a delegatee can further delegate.

Section 179 (Powers of Board)

The Board of Directors can exercise all such powers for which the company is authorised and can take actions within the company\'s authority. Except the powers mentioned in sub-section (3) of section 179—such as the power to borrow money, power to invest the funds of the company and power to grant loans or provide guarantee or security for loans, no other powers can be further delegated to any sub-committee of directors. The Board, as a whole, and each director as an individual, hold vicarious responsibility for understanding the sensibilities of its powers which are not omnibus.

Tests for Vicarious Liability

Factual: When he is in charge?
Legal: When he is responsible to Principal?

A case of vicarious criminal liability cannot succeed unless the prosecution satisfies both the principles of vicarious liability.

The Supreme Court in K.K. Ahuja v. V.K. Arora, 10 SCC 48, 2009, analysed the two terms often used in vicarious liability provisions, i.e., \'in charge of\' and \'responsible to\'. It was held that the \'in charge of\' principle presents a factual test and the \'responsible to\' principle presents a legal test. A person would be considered \'in charge of\' the company\'s business if the person is in overall control of its day-to-day operations. A case of vicarious criminal liability cannot succeed unless the prosecution satisfies both the principles of vicarious liability.

Supreme Court\'s Observations on Liability of Directors:

• Whether Vicarious liability can be automatically imputed on the directors in the absence of a statutory provision to the effect? A constitution bench of five Judges in Standard Chartered Bank and Others v. Directorate of Enforcement, (2005) 4 SCC 530 had held that a company could be prosecuted and convicted for an offence that requires a minimum sentence of imprisonment. However, the constitution bench categorically clarified that it is not expressing any opinion on the question of whether a corporation could be attributed with requisite mens rea to prove the guilt. The Supreme Court categorically laid down that, \"When the company is the offendor, vicarious liability of the directors cannot be imputed automatically, in the absence of any statutory provision to that effect.\" It is a cardinal principle of criminal jurisprudence that there is no vicarious liability unless the statute specifically provides for it.
• Whether a Corporate Body can be prosecuted for committing an offence under the Indian Penal Code? The question of punishing a corporation was deliberated in a criminal case filed by Iridium India Telecom Ltd. against Motorola Inc., SC Criminal Appeal No.688 of 2005. A division bench of the Supreme Court had laid down that the criminal intent of the \"alter ego\" (an alternate self-distinct from the original personality) of the company, referring to the group of individuals guiding the company\'s business, would be imputed to the company. The SC held that a corporation can no longer claim immunity from criminal prosecution on grounds that it lacks mind or mens rea.
• On whom does liability depends upon? \"Liability depends on the role one plays in the affairs of a company and not on designation or status.\" In the S.M.S. Pharmaceuticals Limited v. Neeta Bhalla, 8 SCC 89 (2005), the Supreme Court held that liability arises from being \'in charge\' of and \'responsible\' for the conduct of the business of the company at the relevant time when the offence was committed and not on the basis of merely holding a designation or office in a company. Conversely, a person not holding any office or designation in a company may be liable if he satisfies the main requirement of being in-charge of and responsible for the conduct of business of a company at the relevant time.

Company or Directors - Who shall be responsible?

The Supreme Court in Sunil Bharti Mittal v. Central Bureau of Investigation and Others, AIR 2015 SC 923 or (2015) 4 SCC 609, was faced with the issue of when can a director/person in charge of the affairs of the company be prosecuted for an offence committed by the company. Given the artificial nature of companies and corporations, it is the employees and executives that act as its agents. Executives are the ones who make the major decisions on behalf of the company. They can easily control the acts and omissions of the company on a short-term and long-term basis. It is vital to have laws, regulations, and principles governing the actions of these executives so that they do not violate the law without fear of repercussions and do not evade punishment. The Court relying upon the decision in Iridium India Telecom Ltd. against Motorola Inc. (Iridium) stated that the principal of attribution is applied to impute criminal intention to the company on account of criminal intention of its alter ego and cannot be applied in a reverse scenario to make the directors liable for offences committed by the company.

When can Individual directors be made liable?

The Supreme Court in Shiv Kumar Jatia v. State of NCT of Delhi, CA. No. 1263 of 2019, quashed the criminal proceedings that were initiated only on the ground that the accused was the managing director of the company and that he was the only non-independent executive director of the company. The Court in this case reaffirmed its views set forth in the case of Sunil Bharti Mittal v. Central Bureau of Investigation, holding that, in the absence of any vicarious liability provision, individual directors can be accused only if there is sufficient evidence to prove their active role coupled with criminal intent.

2. The Negotiable Instruments Act, 1881

Is prosecution of a company a condition precedent? The Supreme Court in Aneeta Hada v. Godfather Travels and Tours (P) Ltd., (2012) 5 SCC 661, while adjudicating a dispute under the Negotiable Instruments Act, 1881, ruled that the prosecution of a company is a condition precedent if its officer-in-charge is responsible for the conduct of its business to be prosecuted.

Are directors criminally liable if they were not involved in the day-to-day affairs of the company? An example of the vicarious liability provision can be seen under Section 141 of the Negotiable Instruments Act, 1881, which provides that \"every person who, at the time the offence was committed, was in charge of, and was responsible to the company for the conduct of the business of the company, as well as the company, shall be deemed to be guilty of the offence and shall be liable to be proceeded against and punished accordingly.\" According to a Supreme Court judgment, liability under section 138/141 of the Negotiable Instruments Act only arises if the directors were involved in the day-to-day functioning of the enterprise.

3. The Competition Act, 2002

Whether a director can simultaneously proceed along with that of the company or a conviction on the company is a condition precedent to proceed against the director? The Competition Commission of India (CCI) in Monsanto (Monsanto Holdings Pvt Ltd and Others Vs. CCI & Others (W.P. (C) 1776/2016 & 3556/2017) observed that:

• a) Under the Indian law, numerous statutes impose vicarious liability for the acts of the company upon its directors and other officers in key managerial positions.
• b) Such provisions generally contain an exception stating that the director shall not be held vicariously liable for the acts of the company if he is able to prove that the alleged act was committed without his knowledge and negligence and he has exercised all due diligence to prevent the offence.
• c) Vicarious liability is attached on the officer-in-charge responsible for the conduct of business of the company by fiction of law in spite of the fact that such person may or may not have been directly responsible for the commission of such offence by the company.
• d) A person vicariously liable for acts of the company may be prosecuted simultaneously with the company.
• e) The Competition Commission of India is not required to first record a conviction against the company to proceed against the directors.

4. The Foreign Exchange Management Act, 1999

Section 42 of the Foreign Exchange Management Act, 1999, provides that \"where a person committing a contravention of any of the provisions of this Act or of any rule, direction or order made thereunder is a company, every person who, at the time the contravention was committed, was in charge of, and was responsible to, the company for the conduct of the business of the company as well as the company, shall be deemed to be guilty of the contravention and shall be liable to be proceeded against and punished accordingly.\" In both instances, there is no distinction between the Executive Director and the Non-Executive Director in imposing the liability.

5. The Insolvency and Bankruptcy Code, 2016

The Latest SC Ruling on Director of a Company in IBC, 2016: Merely because a person is a director of a company does not imply that he is aware of its day-to-day functioning. There is no universal rule that a director of a company is in charge of its everyday affairs. (Susela Padmavathy Amma Vs. Bharati Airtel Ltd. SC, March 19, 2024)

To Conclude: Is Vicarious A Precarious?

The list of statutes furthering vicarious liability in the Law of Torts is unending. The Concept of Vicarious Liability on the part of the company and its directors is fraught with many complexities. The Law on Liability of Directors is not clear, not to say it is not correct. Summons and Notices have become the Order of the Ordeal.

The principles reiterated by Lord Denning in Bolton (H.L.) (Engg) Co. Ltd. v T.J. Graham & Sons Ltd. are no doubt worth pondering:

\"A company may in many ways be likened to have a human body. They have a brain and never centre which controls what they do. They also have hands which hold the tools and act in accordance with directions from the centre. Some of the people in the company are mere servants and agents who are nothing more than hands to do the work and cannot be said to represent the mind and will of the company and control what they do. The state of mind of these managers is the state of mind of the company and is treated by law as such. So, you will find in these cases where the law requires personal fault of the manager will be fault of the company. That is made clear in Lord Haldane\'s speech in Lennard\'s Carrying Co. Ltd. v. Asiatic Petroleum Co. Ltd. (AC at pp 713, 714). So also, in criminal cases where the law requires a guilty of mind of the directors or managers will render the company themselves guilty\".

In short, but not so sweet to conclude, \'Vicarious is Precarious\'.