Functions of the Board of Directors in a Company

This article explains in detail the functions of the Board of Directors under the Companies Act, 2013 Act and how these functions are performed. The article also gives a background of the meaning and types of directors in a nutshell. Various committees formed to fulfil functions of the Board are also discsed by the author.
Estimated Reading Time: 16 minutes

Introduction – The Collective Body of Directors in a Company

Even though a company is considered to be a legal person, it does not have a physical existence and cannot be said to be a natural, living person. For a company to function and to achieve its objectives enshrined in the Memorandum of Association, it has to act through a certain medium and Board of Directors.

The directors are the officers of the company who serve as this medium. The collective body of directors, known as the Board of Directors[1], not only acts as the ‘Think Tank’ of the company but also makes decision to carry on the business of the company in accordance with the statutory requirements and the Memorandum of Association[2]. One may think that the shareholders are owners and ultimate authority of a company, then what is the role of a director. A shareholder is only the investor in the company; s/he cannot be expected to prepare business plans and ensure smooth functioning of the company. Therefore, directors are appointed to perform these tasks for the shareholders and the company.

According to Section 149(1) of the Companies Act, 2013, every company is required to have a board of directors comprising of individual directors. The Board enjoys all powers of the company including the power to use company seal. The Act provides that ‘the Board of Directors of a company shall be entitled to exercise all such powers and to do all such acts and things, as the company is authorised to exercise and do’[3]. Such carte blanche powers are vested onto the Board with the expectation that the Board will perform the task of policy making with utmost efficiency and ensure and monitor compliance of such policies.

The aim of this article is to explain in detail the functions of the Board of Directors under the Companies Act, 2013 and how these functions are performed. The article shall give a background of the meaning and types of directors in a nutshell and proceed further to delve into the matter in hand.

Meaning and Legal Position of the Directors

Etymologically, the term ‘director’ means one who directs, i.e. who is in charge of an activity. The Companies Act defines ‘director’ as ‘a director appointed to the board of a company’[4]. This definition is an exhaustive definition but does not throw any light upon the meaning of the term. There is no linkage to the governance or control of the company’s affairs in this definition. It sets out the only condition that a person must be appointed to the board of the company to be called a director. It means that mere nomination of a person as a director is not sufficient but there must be a specific act of appointment of such person as the director by the company itself (or by Board in certain circumstances).

Now, since the Companies Act and also the General Clauses Act, 1897 do not provide any specific definition to the term ‘director’, it is essential to look into external aids such as law lexicons. According to the Black’s Law Dictionary, director means ‘an individual acting as agent of the shareholders of a company[5].Aiyar’s law dictionary defines director as ‘a member of the board appointed to direct the affairs of an establishment’. According to these definitions, it can be inferred that directors are the main drivers of the company’s business, steering the wheel of growth for future.

In Tesco Stores v. Nattrass[6],the appellate court of the United Kingdom defined directors as “the directing mind and will of the company”. In Lennard’s Carrying Co. v. Asiatic Petroleum Co.[7], the court propounded the principle known as the ‘Identification Doctrine’. The court held that “a company is an abstraction. It has no mind of its own; it has to rely upon the person of somebody who can be called its agent. That person may be under the direction of the shareholders in general meeting; that person may be the Board of Directors itself”. This principle has been explained by Leigh as the ‘Alter Ego’ principle whereby, he concludes that the directors are the alter ego, i.e. a clone of the company itself[8].

Typically, the directors are responsible for the governance of the company and while exercising its powers, it may acquire different legal positions. As held in Lennard’s case[9], the Board of Directors is the agent of the company and share a principal-agent relationship whereby the principle, i.e. the company shall be liable for all acts done by its agent, i.e. the Board. Similarly, the Board acts as the Trustee of the company, holding its assets and funds in trust to be utilised for the benefit of the company. Further, the directors are the employee of the company working in their executive capacity scrutinising the day-to-day functions of the company[10].

Types of Directors in a Board of Directors

The Companies Act, 2013 provides for several types to directors to remain in the Board of the company either mandatorily or in certain circumstances. The various categories of directors are[11]:

  1. Alternate Director: Section 161 (2) of the Companies Act provide for the appointment of an alternate director by the Board to substitute an existing director during his absence from India for a period not less than three months.
  2. Executive and Non-Executive Director: According to the Companies (Specification of Definitions Details) Rules, 2014, an Executive Director is a “whole-time director” involved in the day-to-day management of the company; for instance, the Managing Director. On the other hand, a non-executive director is one who is not involved in the day-to-day management of the company but gives independent opinion on any sensitive issue to the committee or group of which he is a part.
  3. Independent Director: The concept of independent director has been introduced in the Companies Act for the first time in 2013. It means a person who possesses integrity, relevant expertise and experience as a director and who does not have any personal or pecuniary relationship with the promoters and management of the company[12].
  4. Nominee Director: The board of a company, if authorised by the Articles of Association, can appoint any person nominated by a shareholder or creditor or any stakeholder in a company to be a nominee director[13]. The nominee director represents the interests of its nominator and ensures the smooth functioning of the company.
  5. Woman Director: As a step to women empowerment and enabling women to be part of policy making in companies, the 2013 Act mandates appointment of one woman as a director on board of all listed companies and specific public companies with paid-up share capital of Rs. 100 crores or turnover of Rs. 300 crores.
  6. Shadow Director: The term is used for a person who is not on the Board of the company but exercises powers of a director. The Companies Act, on several occasions uses the phrase in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act[14]. The person referred to in this context is usually the promoter who under section 2(69) ‘also has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise’. Such persons who are not on board of the company but can exercise such powers are called shadow directors or deemed directors.

Functions of the Board of Directors

For the first time, general functions of the directors of a company are enshrined in statutory form in Indian company law[15] after the recommendations of the J.J. Irani Committee. The purpose of codification, as explained by Lord Goldsmith, Attorney-General for England and Wales, is “to make what is expected of directors clearer and to make the law more accessible to them and to others”[16]. It does not mean that directors did not have any duties or function to perform before 2013. Prior to the new Act, the duties of the directors were decided by judicial pronouncements more like in common law countries (e.g. law of tort).

In general, the functions of the Board can be divided into two categories, i.e. fiduciary functions and statutory functions. Before the Act of 2013, all the duties owed by the directors were fiduciary in nature. Now, before proceeding it is necessary to first determine what a fiduciary is. According to Millet LJ, a fiduciary is ‘someone who has undertaken to act for or on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence[17]. Thus, a fiduciary function is one which is performed on the basis of trust and faith on one another. Several duties have been evolved by the English as well as Indian courts on the basis of the fiduciary relationship between the company and its directors.

After the 2013 Act, the legislature has tried to codify all these duties and has come up with Section166 which deals with ‘duties of directors’. These duties are identified as:

  1. Duty to act in accordance with the Articles of Association of the company[18].
  2. Duty to act in good faith and best interest[19].
  3. Duty to exercise reasonable care, skill, diligence and independent judgment[20].
  4. Duty to avoid conflict of interest[21].
  5. Duty not to make undue gain or advantage[22].
  6. Duty not to assign his position[23].

These are the six essential functions of the Board as a whole and are dealt in detail hereunder.

Duty to Act in Accordance with the Articles of Association of the Company

Section 166 (1) of the Companies Act 2013, states a director’s overriding duty of obedience to the articles of the company. The articles of a company consist of provisions related to payment of dividends, decision-making process for quorum, voting or holding of general meetings. These articles are drafted such that the restrictions placed on the powers of directors are relatively limited[24] and thus, it is able to perform its functions while remaining within the scope of the articles.

According to Section 10 of the Act, the Articles of Association form a contractual agreement that binds the relationship of the members of the company inter se and the relationship between the company and its members. As the court observed in NareshSanyal v. Calcutta Stock Exchange[25], the provisions of AoA are to regulate the internal management of the company and hence, are binding on its members. In Minmar (1929) Ltd. v. Khalastchi[26], the appointment of the administrator was held invalid as the decision was not taken in a valid general meeting as required by the AoA of the company.

The two known exceptions to this function are (a) entrenched provisions and (b) shareholders’ agreement[27]. In case of an entrenched provision, for e.g. Section 5(3), it is allowed to pass a special resolution to override the provisions of AoA provided such power is provided for in the articles. Moreover, if the shareholders enter into any private agreement which is inconsistent with the provisions of the articles, such agreement can be valid if it is not inconsistent with the Act[28].

Duty to Act in Good Faith and in Best Interest

The Act codifies the duty of the directors to act in a way that he considers, in good faith, would be most likely to promote the success of the company and for the benefit of its members as a whole. The decision as to what is in the best interest of the company is one for the director’s good faith judgment. This reflects the position at English common law where Lord Greene observed that ‘the directors must exercise their discretion bona fide in what they consider is in the interests of the company’[29].

The test to determine the function of director to act in good faith was laid down recently in Regentcrest plc v. Cohen[30]. The court observed that the function of the director to act bona fide in the interests of the company is a “subjective one”. Thus, the question that should be asked is ‘whether the director honestly believed that his act or omission was in the interests of the company’. However, when it can be demonstrated that the director’s belief was not well founded and based on unreasonable circumstances, he shall be liable for the breach of his duty[31].

Duty to Exercise Reasonable Care, Skill, Diligence and Independent Judgment

In Hidden Harbour Estates v. Norman[32], it was held that ‘the actions of the board of directors must meet the test of reasonableness. The test of reasonable care is ‘expected care to be taken by an ordinary man in similar circumstances on his own behalf’[33]. Section 174 (2) of the UK Companies Act, 2006 defines ‘reasonable care, skill and diligence’ as the “care, skill and diligence that would be exercised by a reasonably diligent person with – (a)the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and(b) the general knowledge, skill and experience that the director has. Therefore, in a case where the director acted negligently towards the company, he was held liable for breach of duty to take reasonable care and exercise diligence[34].

Independent judgment is the function of the directors exercise their discretion and power impartially without any biasness or influence. In Scottish Co-operative Wholesale Society Ltd. v. Meyer[35], the appellant company incorporated a subsidiary company and made the two respondents as managing directors transferring them certain amount of shares in the subsidiary company. Later, the shareholders decided to take the shares away from the respondents and when they denied, resolution was passed in board meeting to transfer the subsidiary company into a department within the parent company thereby reducing the value of the shares[36]. The court held that there was nominee director in the board meeting who affirmed the decision under the influence of the majority shareholders and held them liable.

Duty to Avoid Conflict of Interest

A director should avoid any conflict of interest in any situation where he has or can have a direct or indirect interest that conflicts or has the potential to conflict with the interests of the company.  This function is based on the common law rule of equity that any person owing fiduciary duties must not put himself into a position in which he has or can have conflicting interests[37]. The rule was laid down in Aberden Railway Company v. Blaikie Bros.[38] by Lord Cranworth and was most recently applied in Bhullar v. Bhullar[39] where the directors were held liable for delaying decision in order to prevent the prices of shares of the company from falling and thereby incurring loss to them.

This section also includes a situation where the director is on the board of two or more companies which are competing with each other and he prefers or potentially prefer his interest in their competition. The function to avoid conflict applies in particular to the exploitation of any property, information or opportunity. In CMS Dolphin Ltd. v. Simonet[40], the court held that “misappropriation, diversion or exploitation of the company’s property by a director for his personal gains will amount to breach of the duty to avoid conflict of interest” under Section 166 (4).

Duty Not to Make Undue Gain or Advantage

The duty under Section 166 (5) provides that “a director of a company 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”. The section has two parts: the first part creates an obligation on the director not to have any undue gain or advantage directly or indirectly using the name of the company and the second part foists a liability if the director does gain any undue advantage[41].

The provision, basically, codifies the rule prohibiting the exploitation of the position of director for personal benefits. As Lord Goldsmith stated during the Grand Committee meeting of the House of Lords, ‘this is a long-standing rule that prohibits benefits only if their acceptance is likely to give rise to a conflict of interest’[42]. This means that any benefit given by the company or any associated company to the director shall not amount to undue gain or advantage.

In Shri Kishore Kundan v. Samrat Shipping Co. Pvt. Ltd.[43], the managing director who was operating an agency of the company, created another company and shifted himself to that company to run the agency and brought diversion of business. The Company Law Board held him liable for any gain by him in this transactions. In Cronin v. Grierson[44], the court expanded the meaning of the term undue benefit or gain and held that ‘benefit means financial or non-financial benefit and may include any gift or hospitality’.

Duty Not to Assign His Position

The last statutory duty makes it categorical that the office of the director cannot be assigned or transferred to someone else. This is based on the premise that the shareholders of the company, while reposing their faith in the director, have appointed him and they expect the same director to act and not someone else. A director is appointed after due consideration of his skill, experience and competence. Hence, it is imperative that the appointed director must act on his own and should not assign his office as a director to someone else[45]. The duty also implies that the director is supposed to attend the Board meetings and he cannot substitute himself with someone else for this function. In New Fleming Spinning and Weaving Co. v. KessowjeNaik[46], the court held that instead of performing their duties and showing reasonable diligence, if the directors delegate all control to the agents, the director shall be liable for breach of the duty not to assign his position to someone else.

Other Functions of the Board

The Board of Directors, besides the statutory duties under Section 166, also perform several other functions to manage, represent and supervise the operations of the company so as to ensure that the Company fulfils its corporate objectives, while seeking to protect the Company’s general interests and create value for the benefit of all the shareholders. These functions are usually performed by several committees formed by the Board itself[47]. The Act does not provide for any specific committee within the Board of Directors, but, however, the most common committees that fulfil functions of the Board are:

  1. Executive Committee:The directors in the executive committee are the day-to-day managing directors also known as whole time directors. The function of the executive committee is to hold meetings of the board as and when necessary, to prepare strategic planning, fund-raising programs, to look over the promotional and marketing activities of the company and all matters which are ancillary to the running of the business of the company.
  2. Audit and Control Committee: As the name indicates, this committee of the board looks into financial and accounting aspects of the company. Audit is the official inspection of the accounts of a company to ensure all the accounting principles are appropriately followed by the company while maintaining its books of accounts. This inspection is done by an independent person called ‘the auditor’. The function of the audit committee is to submit proposals to the Board regarding the selection, appointment and substitution of the external auditor for the company. It serves as a channel of communication between other directors of the Board and the auditor. The committee also keeps an eye on the working of the auditor and controls auditor’s affairs within the business to ensure his/her independence.
  3. Nomination and Remuneration Committee: The main function of the committee is to assess the skills, knowledge and experience necessary in the Board of Directors. For these purposes, it shall define the functions and aptitudes needed of the candidates to cover the vacancies that may arise in the board. Ensures that each gender and class of people are equitably represented in the Board. It makes recommendations to the board for appointment of independent directors, additional directors and if required alternate directors. Besides the appointment of all key managerial persons, it submits proposals for their remuneration including salary, bonus and pay raise.

Conclusion

Board of Directors of a company is identified by its functions and not by the descriptive titles of its individual directors. It occupies a central position in the structure of the company law. The board reflects three purposes[48]. The first purpose is that companies are formed and managed by the directors for the benefit of the shareholders. This is achieved through the fiduciary obligations and functions exercising skill and diligence by the directors. The second purpose is that there should be safeguard to the actual and potential creditors. This is achieved by the supervisory function of the executive directors and the capital management committee of the Board of Directors. Finally, for the benefit of the community as a whole which is achieved by accounting disclosures and inspections by the Audit and Control Committee of the Board.


[1]Companies Act, No. 18, Act of Parliament, §2 (10), 2013 (India).

[2] Ashish Makhija, Corporate Directors 23 (1st ed. 2016).

[3]Companies Act, No. 18, Act of Parliament, §179 (1), 2013 (India).

[4]Companies Act, No. 18, Act of Parliament, §2 (34), 2013 (India).

[5] Bryan A. Garner, Black’s Law Dictionary 1065 (10th ed. 2014).

[6]Tesco Stores v. Nattrass, 1972 AC 153.

[7]Lennard’s Carrying Co. v. Asiatic Petroleum Co., 1915 AC 705.

[8] L.H. Leigh, The Alter Ego of a Company28 M.L.R. 584 at 585 (1965).

[9]Supra note 7.

[10] 2 A. Ramaiya, Guide to Companies Act 2273 (16th ed. 2004).

[11]Kamal Garg, Directors and Key Managerial Persons 03 – 05 (1st ed. 2016).

[12]Companies Act, No. 18, Act of Parliament, §§ 2 (47) and 149, 2013 (India).

[13]Companies Act, No. 18, Act of Parliament, §149, 2013 (India).

[14]Companies Act, No. 18, Act of Parliament, §2(69), 2013 (India).

[15]Companies Act, No. 18, Act of Parliament, §166, 2013 (India).

[16]Lords Grand Committee, 6 February 2006, column 254.

[17] Bristol and West Building Society v. Mothew [1998] Ch1, 16D, CA.

[18]Companies Act, No. 18, Act of Parliament, §166 (1), 2013 (India).

[19]Companies Act, No. 18, Act of Parliament, §166 (2), 2013 (India).

[20]Companies Act, No. 18, Act of Parliament, §166 (3), 2013 (India).

[21]Companies Act, No. 18, Act of Parliament, §166 (4), 2013 (India).

[22]Companies Act, No. 18, Act of Parliament, §166 (5), 2013 (India).

[23]Companies Act, No. 18, Act of Parliament, §166 (6), 2013 (India).

[24]Simon Mortimore QC, Company Directors: Duties, Liabilities and Remedies 241 (1st ed. 2009).

[25]NareshSanyal v. Calcutta Stock Exchange, AIR 1971 SC 422.

[26]Minmar (1929) Ltd. v. Khalastchi, (2011) BCC 485.

[27]Makhija, supra note 2 at 165 – 66.

[28]Ibid at 167.

[29]In Re: Smith and Fawcett Ltd. (1942) ChD 304, CA.

[30]Regentcrest plc v. Cohen, (2001) 2 BCLC 80.

[31]Mortimore, supra note 24 at 255 – 56.

[32]Hidden Harbour Estates v. Norman, 309 So.2d 180 (1975).

[33]Ramaiah, supra note 10 at 2311.

[34]In Re: City Equitable Fire Insurance Co. ltd., (1925) 1 Ch 407 (CA).

[35] Scottish Co-operative Wholesale Society Ltd. v. Meyer, (1959) AC 324.

[36]Mortimore, supra note 24 at 280.

[37]Ibid at 305 – 306.

[38]Aberden Railway Company v. Blaikie Bros., (1854) 1 Macq 461, HL.

[39]Bhullar v. Bhullar, (2003) 2 BCLC 241.

[40]CMS Dolphin Ltd. v. Simonet, (2002) 2

[41]Makhija, supra note 2 at 181-82.

[42]Mortimore, supra note 24 at 315.

[43] Shri Kishore Kundan v. Samrat Shipping Co. Pvt. Ltd., (2004) 58 CLA 298 (CLB).

[44] Cronin v. Grierson, (1968) AC 895.

[45]Ramaiah, supra note 10 at 2371.

[46]New Fleming Spinning and Weaving Co. v. KessowjeNaik, (1885) ILR 9 Bom 373.

[47] Garg, supra note 11 at 71 – 72.

[48]Mortimore, supra note 24 at 26.

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