Directors’ responsibility, removal, disputes and remedies under section 397/398 of Companies Act, 1956?

As the shareholders of a Company can not meet so often to take decisions on day-to-day functions of the Company, directors are elected by the shareholders in accordance with the provisions of the Companies Act, 1956. Ultimate control over the directors rests with the shareholders and shareholders can remove a director in the General Body Meeting in accordance with the regulations in the Articles and the provisions of the Act. The role and responsibilities of directors require concentration in respect of largely held Public Limited Companies in view of the interests of various shareholders and the public interest. However, when it comes to the issue of directorship in closely held companies, it normally

depends upon the agreement or understanding between or among the shareholders or groups. Though, certain companies are run like proprietaryship concerns and partnership firms, Company is a separate juristic person enjoying privileges as per law. In reality, directors play a very big role in the functioning and success of any company and the shareholders may not concentrate much on the business issues and the day-to-day affairs of the Company. It is true in case of largely held Public Limited Companies. In view of the powers conferred on directors and realities of functioning of any Company, shareholding groups or the shareholders always tries to ensure that their people are elected or appointed as directors in the Company. When the trust among directors or the shareholding groups is lost, then, the disputes in the Company will normally get exposed through appointment or removal of directors. Ignoring the understanding, a Form may be uploaded with the MCA as if somebody has been appointed as Director though the procedure for appointment is not followed in reality. Some director may be removed or a Form can be uploaded with the MCA claiming that a particular Director has retired voluntary though that was not the factual position. These disputes over appointment and removal of directors force a substantial shareholding group to approach the Court of Law or the Company Law Board under section 397/398 of Companies Act, 1956. In view of the complications, the Company Law Board endeavour to settle the dispute among the warring groups in the interests of the Company and only when the reconcilement is impossible, the Board will pass such orders under section 397/398 and section 402 in order to put an end to the matters complained of and in order to regulate the affairs of the Company.

Responsibilities of Directors:

Conceptually, directors play a very crucial role in any Company and he is burdened with so many responsibilities. Dealing with the responsibility of Directors, the Hon’ble Supreme Court of India in M/s. Dale & Carrington Invt. (P) Ltd. & Another Vs. P.K. Prathapan & Others, 2004 (7) Scale 584, 2005 AIR (SC) 1624, 2004 (122) CC 161, 2004 AIR(SCW) 5143, was pleased to observe as follows:

“16. At this stage it may be appropriate to consider the legal position of Directors of companies registered under the Companies Act. A company is a juristic person and it acts through its Directors who are collectively referred to as the Board of Directors. An individual Director has no power to act on behalf of a company of which he is a Director unless by some resolution of the Board of Directors of the Company specific power is given to him/her. Whatever decisions are taken regarding running the affairs of the company, they are taken by the Board of Directors. The Directors of companies have been variously described as agents, trustees or representatives, but one thing is certain that the Directors act, on behalf of a company in a fiduciary capacity and their acts and deeds have to be exercised for the benefit of the company. They are agents of the company to the extent they have been authorized to perform certain acts on behalf of the company. In a limited sense they are also trustees for the shareholders of the company. To the extent the power of the Directors are delineated in the Memorandum and Articles of Association of the company, the Directors are bound to act accordingly. As agents of the company they must act within the scope of their authority and must disclose that they are acting on behalf of the company. The fiduciary capacity within which the Directors have to act enjoins upon them a duty to act on behalf of a company with utmost good faith, utmost care and skill and due diligence and in the interest of the company they represent. They have a duty to make full and honest disclose to the shareholders regarding all important matters relating to the company.”

Commercial judgment is not interfered:

If the commercial wisdom of the Directors is interfered at each stage, then, the Directors may not be able to discharge their functions effectively in the interests of the Company. It is true that the illegal exercise of power by the Directors can be questioned, but, a care is normally taken when it comes to making a judgment on the Directors’ judgment in the Company. Emphasizing at the commercial wisdom of directors and the need of being careful when it comes interfering with the collective and commercial wisdom of Directors in any Company, the Hon’ble Kerala High Court in Cochin Malabar Estates And Industries Ltd. And Anr. vs P.V. Abdul Khader And Anr. 2003 114 CompCas 777 Ker: 2003 45 SCL 170 Ker, was pleased to observe as follows:

“42. The company judge would normally start with the presumption that the directors are acting in the best interest of the company since they have been entrusted with the task of managing the company by the general body. The judges are ill-equipped to make business judgments. The court cannot as a rule adjudicate upon the commercial judgment of the board of directors. If they act prejudicial to the interest of a minority shareholder there is ample provision in the Companies Act to redress their grievance. A public limited company will have thousands of shareholders each will have his own interests. Their views can be voiced at the annual general meeting or to move the Company Law Board or the Central Government on Company Affairs if situation warranted. The company judge is not expected to resolve the dispute raised by the shareholders and substitute his wisdom for that of the board of directors. In Kanika Mukherjee v. Rameshwar Dayal Dubey [1966] 1 Comp LJ 65 a Division Bench of the Calcutta High Court held that where the affairs of a company were manipulated as to deprive a shareholder of his sizable amount of rights shares, the remedy open to him is before the Company Law Board and not before the High Court. The company court would not as a general rule interfere with internal management of a company. It is for the board of directors to decide the manner in which the affairs of the company are to be carried on. Courts determine questions of law and not questions of business management. The company court shall not interfere with the lawful decision of the board of directors of a company. Even a commercial misjudgment would not amount to oppression or mismanagement. The board of directors may err, every error cannot be a ground for action and the company court is not a correctional court for all errors. A shareholder has to yield to majority rule and the decision of the board of directors who are also invariably be shareholders. A shareholder cannot come to the company court with the fanciful idea that he could move the machinery of the company court to set right what he thinks correct and what the board of directors does is wrong. The shareholder if could procure the aid of the court in each and every action taken by the board of directors it would lead to endless litigation and pin down the company within the four walls of a company court. The company court should shut its doors to them and deny entry.”

Even Permanent Director referred in Articles can be removed:

Many family owned businesses or the proprietaryship concerns were converted into Companies and when these conversion takes place, there can be specific regulation in the articles about the appointment of directors and certain persons are even named in the Articles as the Permanent Directors at times. In all these cases, unless the Competent Court feel it appropriate to keep some one in the Board in the interests of the shareholders or the Company, the shareholders in fact controls the directors and decide the issues of appointment and removals. There can be exceptions in law like a director appointed by the Central Government or nominee directors appointed by Public Financial Institutions. In many cases, where a permanent director named in the Articles is removed, it will lead to litigation. The shareholders in the closely held companies or the family companies lay emphasis on the principles of equity and agreed understandings rather the concept of company law and the provisions governing the functioning of Companies.

Dealing with the issue of removal of permanent director, the Hon’ble Delhi High Court, in Tarlok Chand Khanna And Another vs Raj Kumar Kapoor And Others, 1983 54 CompCas 12 Delhi, ILR 1982 Delhi 156, was pleased to observe as follows:

“23. The question still remains, if Khanna, a permanent director of the company, could have been removed by the company in a general meeting in spite of the provision in the articles. If neither of the two meetings were valid, because Khanna had no notice of these, even though he was intended to be removed from the board, his removal is bad in law irrespective of the way one looks at the power of the company in a general meeting to remove a permanent director, who is appointed as such by name in the articles. I would, however, consider the question since was raised. No doubt, Khanna was a permanent director named in art. 10 to hold office for life. In terms of art. 14, he also had a right during his life time to nominate his successor on the board in the event of his death. He could, nevertheless, be removed under s. 284 of the Act. Section 284 is based on s. 184 of the English Act and applies to all types of companies, public and private, and the only exceptions are those that are built into the section itself. A person appointed as a life director by the articles or by any agreement is, nevertheless, removable by the company in general meeting and has no security of tenure in office. While the shareholders have no power, apart from that given in the statute or the articles, to intervene in the management of the company's affairs, this section was designed to enable them to control the directors by their removal. The only exceptions are the directors appointed by the Central Govt. under s. 408, and life directors holding office on April 1, 1952. The only other exceptions are nominee directors of financial institutions, with which we are not concerned. No doubt, art. 14 empowers a permanent director to nominate a director to take his place after his death, but even that does not save the tenure from the operation of s. 284. True, s. 184 of the English Act specifically exclude the operation of articles which s. 284 does not, but that was not necessary in view of the scheme of the Indian Act, because s. 9 of the act provides that the provisions of the Act would have effect, notwithstanding anything to the contrary contained in the articles of the company. No further provisions for exclusion of provisions in the articles to the contrary was necessary. Khanna could have, therefore, been removed, if the requirements of s. 284 and of a valid meeting had been satisfied. This was, however, of no avail; because as observed earlier, the proceedings of the meetings which led to removal were invalid the absence of notice to Khanna either of the proposed motion, or of the proposed meeting of the Board and the extraordinary general meeting of the company. The effect, therefore, is that Khanna continues to be a permanent director notwithstanding his purported removal from the Board.”

Constant infighting provides jurisdiction to CLB under section 397/398:

If the directors keep on fighting, then, the interests of the shareholders or the Company will be at stake. When the disputes become irreconcilable, the litigation comes to Court and the aggrieved director or his group can either approach a Civil Court, Company Court on just and equitable clause or can even approach the Company Law Board under section 397/398 of the Companies Act, 1956. If the director or his group is qualified under section 399 of the Act, normally the Company Court may feel that the issues are to be settled by the Company Law Board under section 397/398 of the Companies Act, 1956. There should be oppression and mismanagement by a group of shareholders against other for approaching the CLB under section 397/398 of the Companies Act, 1956. But, the constant infighting too provides jurisdiction to the CLB to look into the disputes if a petition is filed. Dealing with the issue of constant infighting, the Delhi High Court in Chander Krishan Gupta vs Pannalal Girdhari Lal Pvt. Ltd. And Ors, 1984 55 Comp Cas 702 Delhi, 1982 (3) DRJ 295, was pleased to observe that:

“(10) Section 398 has two facts. The first is that positive acts are done by the management which results in prejudice being caused to the company. Secondly section 398 may be attracted even where no action at all is taken by the management and such non action results in prejudice being caused to the company The management of the company has miserably failed in protecting the Company's records and this failure results in prejudice being caused to the company. Moreover, the constant fight amongst the directors who were also the shareholders of the company had certainly adverse effect on the conduct of the company's business with the result that the company started incurring losses. To my mind, therefore, this by itself would justify appropriate orders being passed under section 398 of the Act.”

Directors’ dispute resolution would be complicated:

When there exist serious disputes between or among directors or their groups, dispute resolution is not easy and its complicated exercise. If the issues of directorship are to be decided by the CLB under section 397/398 of Companies Act, 1956, the CLB may consider plethora of issues while passing appropriate orders and the CLB is normally driven by the object that it should put an end to the matters complained of and regulating the affairs of the Company. CLB may not look into the procedural irregularities at times in view of other facts and may look into the technicalities strictly at times. Despite the prevalent majority rule, the CLB may appoint someone as director even against the wish and will of majority shareholders in the Company. In view of the fact that actual power is exercised by the Directors in any Company, a dispute among shareholders will have an inevitable reference to the action or inaction of the directors of the Company.