Liability of Managing Directors of a Company under the Companies Act

Liability for illegal acts

Where directors have used their powers to part with money of their company in a manner or for a purpose which the law forbids, it is not a defense to proceedings to make them liable for their act to plead merely that they acted in ignorance of the law. A bookshop was owned by a company. A person designated as assistant manager had day to day responsibility for running the shop. He was giving no input into policy matters like implementation of proper health and safety procedure as required by statute. He was held to be not a manager for this purpose of being prosecuted when the company was found to be guilty of breaching the statute.

Issue of duplicate shares

liability

Where with a view to combating a takeover bid the directors of the company issue duplicate share certificates in respect of original shares which to other knowledge were under a pledge and transferred them to a person and transferred them to a person who himself was not a bona fide purchaser for value, it was held that the remedy of such a transferee for recovering his price would be against the directors personally and not against the company.

Director receiving secret commission or bribe

A similar prohibition would also exist against the director obtaining any secret commission or any illegal gratification for the award of a contact with the company. A company can recover from its director any money received by him by way of a bribe in fraud of the company and the company can also sue him and the person giving the bribe for any loss sustained through entering a disadvantageous  contract or the company may rescind the contract. The director will be liable for the amount as a debt only, and the company cannot follow the profit or bribe as trust property. The traditional approach has been doubted in certain Commonwealth jurisdiction. It did allow the person receiving the bribe to keep any benefit in the accretion in value of his bribe or property in which it has been invested. It has been taken as explaining the attitude of the courts to issue such as ratification of breach of duty against a company. It is probable that the courts would take the view that it covers secret profits as well as bribes. If that is so the profit obtained by a fiduciary through insider dealing might well be considered traceable. Confidential information is a property for the purposes of the law of constructive trusts.

Director’s authority to give bribes

The managing director of a company withdraw a sum of money from the company’s account and used it to pay bribes to a contract awarding authority, and when sued by the company, contended that the company had benefited by having substantial contacts awarded to it. The court said that, as a director of the company, he had authority to use the company’s money to pay bribes and the fact that the company may have benefited from the payment of the bribes did not provide the director with any defense.

Criminal liability of managing director for misappropriation by company

Where it was alleged in a criminal complaint that the company had accepted the company sent by drafts but did not make supplies ordered and was, therefore, guilty of criminal misappropriation, the court said that the Managing Director could not be made liable unless it could be shown that he was a party to the fraud, which was not the case here.

Liability for negligence

There are no objective states of skill and care which will help in determining whether a director has been negligent. Instead, there are only general principles which may be applied depending on the facts of each case.

  • The directors are not liable for negligence if they act honestly for the benefit of the company, and within their powers with such care as is reasonably expected of them, having regard to their knowledge and experience. The directors are not bound to being any special qualifications into their office. The mere negligence to take every possible care will not amount to negligence. The court observed in this case that the director of a company “is not bound to bring any special qualifications to his office. If a director does have special knowledge about the nature of the company’s business, then he is bound to give the company the advantage of his knowledge when transacting the company’s business. The director of a property development company is not expected to be an expert in tax planning.
  • It is not negligence for directors to delegate their power to manage the company to a properly appointed Managing Director whose periodic reports and accounts they accepted, without checking, with the result that the Managing Director was able to dispose of the company’s investments for his own purposes. Though the directors as a body are responsible to the shareholders for the conduct of the company’s business, it is undoubted law that they can delegate their powers to one or more of themselves for the purpose of carrying it on more conveniently.
  • A director is not to attend all the Board meetings or devote his entire time and attention to the company’s affairs unless his service contact expressly requires him to do so. Consequently, it is not negligence for a director to fail to ascertain what business had been transacted at the Board meetings he did not attend. “A director of a company is not bound to take any definite part I the conduct of the company’s business, but so far as he does undertake he must take reasonable dispatch.”
  • Directors were held to have acted negligently when they released company funds to pay a debt and purchase assets without verifying whether the company owed the debt and whether the assets had been or were being transferred to the company.
  • Directors have been held liable for negligence when they allowed one of them to manage a part of the company’s business without a Board resolution for this purpose. Directors who participated in the company’s transactions without making enquiries to ensure that the transactions has been duly authorized by Board resolutions and were for the benefit of the company were held to be negligent.

Liability for breach of warranty of authority

A director is not personally liable for his company’s failure to perform a contract which he has made on its behalf, but he is liable in damages to person with who he purports to make a contract which is not binding on his company at all. When a director presenting a company negotiates a contract he impliedly provides to the other contracting party that he has authority to bind the company as its own agent. If he lacks his authority, he is guilty of a breach of warranty of authority, and is liable for the loss which the other party suffers as a result of entering into the contract. A director is personally liable to the other party for breach of warranty of authority when the contract is ultra vires the company, is beyond the powers of the directors, wherein the Board’s acquiescence exonerated the director from liability. In order to make the director liable, the representation must be one of fact, and not of law. A director was held liable where he negotiated a loan to his company which resulted in it exceeding the limits of its borrowing powers fixed by its memorandum, the effect of the transaction being that director impliedly represented to the lender as a matter of fact that the company was not exceeding its borrowing powers by borrowing from him.  Directors are liable if they induce the company’s bank to honor cheques signed by one of them when no resolution has been passed by the Board authorizing the signatory to issue cheques. The directors impliedly represent to the Bank that such a resolution has been passed. It would seem that a representation as to the contents of the company’s memorandum and the articles is a representation of fact. The memorandum and articles contain a private contract between the members of a company. They are not an enactment by Parliament. The fact that the contract is given statutory effect by registration under the Act would not appear to raise the status of those documents to that of an Act of Parliament. Consequently, if directors misrepresent the powers of their company or of its Board of Directors to a person who deals with the company, they will be liable for breach of warranty of authority. The Directors were held personally liable for accepting a bill of exchange in the company’s name when the company itself has no power to do so by its memorandum. The measure of damages in either case will be the value of which the contract would have had if it had been binding on the company. The director liable may generally reduce the damages by tendering performance of the contract himself. Where a director had taken an active part in an illegal investment and had assented to it, he could not escape personal liable on the ground that they have exceeded their authority.

Vicarious liability

To hold a director vicariously responsible for offences under a statute, the prosecuting agency should not only make a specific allegation that the person charged was a director but also to indicate as to how and in what  manner the director had been in charge of the affairs of the company. In the absence of such allegations, the director’s application under section 482 of Code of Criminal Procedure, 1973 for quashing the complaint that he was responsible for the company evading payment of Exercise Duty has to be allowed.

Liability in respect of contracts

Apart from liability for illegal acts, it is necessary to bear in mind that, as regards contracts and other transactions the directors will be personally liable if they contract in their own names without disclosing that they are acting on behalf of the company. Also, if the directors’ act beyond their powers, they will be personally liable in damages, where their acts do not bind or are not ratified by the company. Directors are liable to a third person for breach of warranty of authority if they contract with him outside their powers. A director is liable if he liable negotiates a loan to his company which results in it exceeding the limits of its borrowing powers as fixed by memorandum of association. Likewise, directors are liable if they induce company’s bank to honor cheques signed by one or the other director where no resolution has been passed by the Board to authorize him to issue cheques, for the directors impliedly represent to the bank that such a resolution has been passed. Where the directors of the company acting on its behalf enter into an agreement contrary to the provisions of law, the agreement is unlawful and on proof of the director’s knowledge of such facts as constitute illegality, they and all other parties to the agreement and transaction made pursuant to it are liable to the company in conspiracy. In such a case the company is a victim of the conspiracy to which the directors acting on its behalf are parties. The company is, therefore, not a co-conspirator and may claim damages against the directors in conspiracy. Directors are not personally liable under a contract which is lawful and which they have made in the proper exercise of their authority. Directors purchased goods for their company and agreed with the supplier to allot him debentures for the price. Before the debentures could be issued, the company went into liquidation. The supplier was held not entitled to make the directors personally liable under the contract. Where an accountant was appointed for the company by its director cum majority shareholder and he subsequently acting as a director removed the accountant. He was held not liable to compensate the accountant because he had acted only as an officer of the company but he has held liable for the accountant’s costs and expenses of litigation because the litigation was solely due to his conduct in acting in a high handed manner.

No personal liability under contracts signed for company

Where all the contracts for services were made in the name of the companies trading under their trade names and the director sought to be made liable merely appended his name to authenticate the contacts on behalf of the companies, he could not be held personally liable. For the signatory liable director to be created liable there should have been an intention on the part of the parties that he should be a party to the several types of contracts. On the factors no such indication was available. The companies which he represented were insolvent and, therefore, the action was filed against him for breach of various contracts. This will be so even if there is a clause in the contract imposing personal liability on the director. Such a clause will not bind him unless his attention was drawn by the other party to the contract to such an onerous and unusual clause. To make directors personally liable for recovery of damages alleging breach of contract by the company would be a negation of the concept of limited liability.

Liability under guarantee for company’s debts

In the context of a loan transaction of the company, it was held that the directors who had not given any personal guarantee for the loan could not be made liable merely because they were directors. Where a director guaranteed his company’s debts and his company 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 holders company for the debts of its subsidiary as these liabilities crystallized. The guaranteeing directors cannot say that the creditor should first proceed against the borrowing company. The borrower and guarantor are equally liable by virtue of the provisions in sections 126 and 128 of the Contract Act, 1872. A brand 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 their personal assets.

Limitations against liability of directors as guarantors

Realizations from the sale of the company’s assets were not sufficient to discharge the whole liability of the company under a loan and, therefore, directors were sought to be made liable as guarantors. The court said that the limitation period for proceedings against directors was three years and not twelve years. A guarantee was executed in favor of the state Financial Corporation on a stamp paper. The guarantors were promoters and directors of the company. The guarantees were found to be valid. The court allowed invocation. The company was in industrial sickness. Twelve year period was allowable from the date of invocation. Petition for enforcement of guarantees was, therefore, maintainable.

Liability in respect of torts

A director is not automatically liable for torts of the company irrespective of the size of the `company or of the degree of his control over its affairs. In determining his liability it is necessary to examine carefully the role he played in regard to the alleged tortious acts. There is no general requirement that a director would be liable for torts committed by a company only if he has acted recklessly or with the knowledge that the acts are tortious. The director’s state of mind might be relevant where this is a necessary ingredient in proving the commission of the particular wrong, but different considerations would apply where the state of mind of the tortfeasor is not relevant, as for example, copyright. In matter of this kind, there was an infringement of the copyright in a computer program committed by a company.  The governing act provided that directors would be liable if they were guilty of willful and knowing pursuit of a course of conduct that was likely to constitute an infringement or reflected an indifference to risk of it. The evidence established that certain directors had authorized and certain others had engaged in activities which constituted the infringement.

Director’s liability for wrongful restraint

Allegations were made against a company regarding restraining the movement on read in connection with the development of property. The directors were not personally at the site. No allegation of common intention was made in the compliant. It was held that they could not be made liable under section 34 of the Indian Penal Code, 1860.

Liability for fraud

The Court of Appeal held that in an action for deceit against a company officer, it is necessary to show that the officer in question made the statements and the plaintiff relied upon them. There must also be an assumption of responsibility so as to create a special relationship between the plaintiff and the defendant director. The simple point at issue here was the personal liability of a director for fraudulent misrepresentations made by him in obtaining, on his company’s behalf, payment under a letter of credit. By employing the concept, which treats both director and company as a single legal unit, the court found that the director was not liable for the deceits, only the company was. A company contracted to purchase a consignment of tea from a company. The company brought action against the seller, a shareholder director of company, alleging loss as a result of the director’s false representation. It was submitted that the director has demanded full payment of the purchase price of the consignment, despite her knowledge that her own supplier has no intention of fulfilling the order. It was held that (1) given that the cause of action was unrelated to its deception of the third party, and that buyer’s own part to play in the deceit was not so severe that to grant relief to him would offend public conscience, the defense of ex turpi causa failed, and (2) in accordance with long established principle, the director was liable in deceit as a joint tortfeasor for false representations that she had made on behalf of the company as she had authorized, directed and procured the deceit and there was nothing to indicate that anyone else within the company was responsible for it.

Liability for using prohibited names

A director was involved in the management of the company using a prohibited name. The court explained in Revenue and customs Commissions versus Walsh the type of liability that such a director would incur. In deciding whether a company name is so similar to a prohibited name as to suggest an association with the prohibited name the test to be applied is whether the similarity between the two names is such that it is probable that members of the public, comparing the names in the relevant context, would associate the two companies with each other. Whether there would probably be an association between the two names is to be assessed by the likely impact of the names on a reasonable person in the relevant commercial field, having regard to the way the titles of the companies are likely to be used, the sort of customers who would use the companies and the context in which they would do to so and the types of businesses in relation to which customers would use the companies. Although the location of the registered offices of both companies at the same address, the employment of the defendant’s wife as secretary of both companies and use of the same letter heads  were matters of little or no significance, the facts that the companies were both building and civil engineering companies which carried on similar businesses, that the defendant was involved in, and the part of the face of both companies and that they had used the same trading address, telephone and fax numbers were likely to cause a customer of the new company to think that the two companies were closely associated. The defendant was liable under section 217 for the debts of the insolvent company.

Liability for negligence information, advice or opinion

A company represented to its potential franchisees that the company’s franchise would establish for them a viable business. Financial projections were given on the basis that the company had expertise and experience to provide properly reasoned advice to its franchise holders. It was stated that the Managing Director of the company had that essential expertise and experience. On reliance of the representation the plaintiff entered into an agreement with the company to purchase its projections turned out to be substantially overstated and the company was not able to give any explanation for the short fall. The plaintiff sued the company and the Managing Director for his loss. It was held that the relationship of the company with the plaintiff was such in which the advice on the financial viability of the proposed franchise was a vital part of the service which the company offered and it knew that the plaintiff would act on the advice. The company had held itself out as having special expertise and this gave rise to a duty of reasonable care to see that the financial projections were correct or at least properly and reasonably prepared. The Managing Director was under a personal duty to assure the accuracy the accuracy by using his personal knowledge and experience with reasonable care and skill.

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. Such liability will turn upon the application of agency principles to the transaction in question. It was held that where a decree was obtained against the Managing Director and the company, the Managing Director was not to be proceeded against unless there was proof of that he was to be personally liable under the circumstances relating to the debt. In this case, the liability to discharge the decretal amount (arrears of rent) was that of the company and not of its Managing Director. The Liability of a Chit Fund Company was not allowed to be enforced against the company’s director. The attachment of his property for this purpose was held to be not permissible.

Liability of directors, shareholders and auditors for improper dividend

A director who authorizes the payment of an unlawful dividend in breach of his duty as a quasi-trustee would be held liable to repay such dividends if he knew that the distribution was unlawful, whether or not that actual knowledge amounted to fraud; or if he knew the facts that established the impropriety of the payments, even though he was unaware that such impropriety rendered the payment unlawful; or if he must be taken in all the circumstances to have known all the facts which rendered the payments unlawful; or if he must be taken in all the circumstances to have known all the facts which rendered the payments unlawful; or if he ought to have known, as a reasonably competent and diligent director, that the payments were unlawful. In this case, dividends were paid without there being adequate profits for the year or sufficient distributable reserves. The distribution was, therefore, unlawful and ultra vires.

Liability for misappropriation of company’s funds

Certain payments were made by a company to its subsidiaries. The holding company was taken over by another company which questioned the payments and sought to recover to recover the sums from the directors on the grounds of breach of fiduciary duty, dishonest assistance, etc. The court said that the company had demonstrated on the facts that payments had been made by means of misappropriation of funds and that the defendant directors had not shown that payments had been made for proper purposes. Those who participated without knowledge of the true nature of the transactions were not party to the conspiracy. Expert evidence demonstrated that such matters would have been actionable under the tort of conspiracy in Spain.

Liability under pollution laws

The Managing Director and the members of the Board of Directors can be prosecuted under the Water (Prevention and Control of Pollution) Act, 1974 and it is not necessary that the company should also be prosecuted along with them. But the Chairman and the Vice Chairman have been held to be not directly in charge of and responsible for the conduct of the company’s business so as to bring them within the liability for prosecution under section 40 of the Air (Prevention and Control of Pollution) Act, 1981. The non-joinder of the company was at the most a technical flaw and, being curable, could not be used to shield the guilty officers.

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