Fiduciary Duties of Directors in America and India

The fiduciary duties of director (i.e. duty of good faith, loyalty and care) are non-statutory in nature and are determined on the basis of decisions by the courts in which the judiciary try to recognize the responsibility on part of the directors so as to make them more liable towards the shareholders and the company.

The judicial system of both America and India is heading towards a high liability zone for the directors, which is characterized by high liability attached towards the breach of its duties by the director i.e. in both India and USA, if a director breaches or even attempts to breach any of its duties he will be liable to the company and its shareholders for such a breach which lead to loss to both company and its shareholders.

PART I - CORPORATE FIDUCIARY DUTIES IN AMERICA

INTRODUCTION

There may be several different types of directors in a company depending upon the function of each directors and his function in the company. Two points are however, reasonably clear. First, that the directors of a company are persons of some importance and with a definite place in the constitutional structure of the company. It is they who in practice control the company and upon whom the fortunes of the company largely depend. But this does not mean that they can treat the company as their own, which brings us to the second point, that the directors have certain duties which they are obliged to fulfill.

There are generally two types of duties attached to director i.e. statutory duties (which are determined by the statute) and general duties (which may be fiduciary in nature). Statutory duties are those duties which are predetermined in the statutory books ad lays down the standard of conduct required by the law from the directors, on the other hand, general duties involves duty of good faith, duty of loyalty and

duty of care which are generally fiduciary in nature and cast a responsibility upon the directors to act in a good and a reasonable manner so as to safeguard the interests of the shareholders and the company.

These fiduciary duties being non-statutory in nature are determined on the basis of decisions by the courts in which the judiciary try to recognize such responsibility on part of the directors so as to make them more liable towards the shareholders and the company. In recent cases, the court system has warned directors that egregious conduct will not be tolerated and will expose the directors to personal liability. The courts, further, have put directors on notice that a lack of good faith will expose them to personal liability. Recent corporate debacles also have led to an increase in the scrutiny of corporate directors and their fiduciary duties.

The judicial system of both America and India is heading towards a high liability zone for the directors, which is characterized by high liability attached towards the breach of its duties by the director i.e. in both India and USA, is a director breaches or even tries to breach any of its duties he will be liable to the company and its shareholders for such a breach leading towards loss to both company and its shareholders.

Former Chief Justice Veasey have even foreseen a new corporate culture, which is characterized by increased litigation against the corporate directors for failing to exercise adequate oversight, as well as a greater number of lawsuits seeking to hold directors personally accountable for corporate misdeeds. The duty of good faith will be an increasingly prominent and one of the major components of this subtle shift toward heightened scrutiny of director conduct.

CORPORATE FIDUCIARY DUTIES IN UNITED STATES OF AMERICA

Over the past few years corporate scandals have rocked the very core of the American capitalist system and have raised many questions regarding proper corporate governance. So the USA courts have tried to reconcile the matters by making the directors liable for the breach of there fiduciary duties towards the company and their shareholders.

In USA, it is observed that Fiduciary duties which are owed by the directors and officers to the corporation and its stockholders, is a significant part of corporate law jurisprudence. Thus, fiduciary duties are those duties which are owed by the directors towards the company and the shareholders so as to work with reasonability, diligence, good faith, proper care and to be utmost loyal to them. There

are generally three types of fiduciary duties of directors such as duty of good faith, duty of loyalty and duty of care:

A. Duty Of Good Faith

The overall concept of good faith is based upon the conduct of a director, which requires a director to act with the honest belief that s/he is acting in the best interests of the corporation, and also allows for a more substantive investigation into director conduct.

The beginning of the good-faith standard can be traced back to the early Delaware case Graham v. AllisChalmers Manufacturing Co., which was the first time that a Delaware court recognized the directors duty to act in an informed and prudent manner. In Grahams case, the plaintiffs could not prove that the directors had actual knowledge of wrongdoing or even knowledge of facts that should have put them on notice of the occurrence of illegal actions within the corporation. The plaintiffs, therefore, argued that the directors were liable for their failure to take reasonable steps to learn of and prevent the activity. Thus, the court articulated that, if the director had recklessly reposed confidence in an obviously untrustworthy employee, had refused or neglected cavalierly to perform his duty as a director, or had ignored either willfully or through inattention obvious danger signs of employee wrongdoing, the law will cast the burden of liability upon director.

Earlier the concept of good faith had a very less ambit and application i.e. director should act in a informed and a prudent manner, but recently various cases have enlarged the area and ambit of good faith standard, so as to accord a greater degree of protection to the company and its shareholders against the directors corporate misdeeds, which have lead to losses to the company and ultimately to its shareholders

More recently, the following have been considered potential violations of the duty of good faith: intentional or unintentional misconduct; reckless behavior given a certain duration or magnitude; conscious disregard of known risks; and behavior that cannot rationally be explained on any other grounds. Furthermore, In re Walt Disney Co. case also it was observed that, directors may be liable for a good faith violation if they act as if they simply do not care about the risks inherent in the transaction at hand.

B. Duty Of Loyalty

The underlying principle of the duty of loyalty is that a director cannot personally prosper at the detriment of the shareholders who have entrusted him with the well-being of the corporation i.e. the duty of loyalty imposes personal liability upon the director, if a director uses his power for his own pecuniary benefit, rather then that of his own company. Generally, the fiduciary duties of directors are:

1) To exercise their powers within the companys constitution, bona fidely for the benefit of the company as a whole and for their proper purpose.

2) Not to use themselves in such a position in which their duties to the company and their personal interests may conflict i.e. they cannot take any unauthorized benefits from a corporate transaction, must disclose all interest in such transactions and must not compete with the company.

C. The Duty Of Care

The duty of care imposes upon directors an affirmative duty to use reasonable care under the circumstances in making corporate decisions. In other words the directors owe a duty of care towards the shareholders to act as a normal prudent person while exercising decision-making and oversight functions.

Various USA cases underline the very concept of duty of care and cast upon the directors a duty to act reasonable and prudently while handling the companys business. The Delaware Chancery Court in Disney II case also stated that duty of care requires the directors to use the amount of care which ordinarily careful and prudent men would use in similar circumstances.

In the case of Re Barings plc (No.5) it was observed by Jonathan Parker J. and it was also approved by the Court of Appeal that, directors have both individually, a continuing duty to acquire and maintain a sufficient knowledge and understanding of the companies business to enable them properly to discharge their duties as directors.

PART II - CORPORATE FIDUCIARY DUTIES IN INDIA

INTRODUCTION

When India attained independence from British rule in 1947, the country was poor, with an average percapita annual income under thirty dollars. However, it still possessed sophisticated laws regarding listing, trading, and settlements. It even had four fully operational stock exchanges. Subsequent laws, such as the 1956 Companies Act, further solidified the rights of investors.

In the decades following Indias independence from Great Britain, the country turned away from its capitalist past and embraced socialism. The 1951 Industries Act was a step in this direction, requiring that all industrial units obtain licenses from the central government. The 1956 Industrial Policy Resolution stipulated that the public sector would dominate the economy. To put this plan into effect, the Indian government created enormous state-owned enterprises, and India steadily moved toward a culture of corruption, nepotism and inefficiency.

Thus we can say that prior to 1991; Indian businesses functioned in a closed economy where licenses and permits were required for importing goods and raw materials, for changing production patterns, and for diversifying. To obtain these licenses, political connections were a necessity. This system nurtured monopolies and ensured that the businesses remained in the hands of the rich and the politically connected families. Thus, most Indian companies were dominated by family business houses in the license-permit raj (era). The boards of directors of these family-run companies derived their power from majority or controlling shareholders. Therefore, there was no way that they could discipline the same.

The liberalization of the Indian economy eventually ended years of licensing and permit practices that nurtured the dominance of a powerful class of Indian businesses. In spite of the economic reforms program in the last decade, the dominant shareholding pattern continues to control the Indian corporate sector.

CORPORATE FIDUCIARY DUTIES IN INDIA

Nevertheless, the Indian corporate sector has undergone significant changes in the last decade. Delicensing encouraged the formation of companies with diversified shareholding and the entry of foreign companies into the Indian business sector, thus creating competitive pressure. Research, analysis, and transparency increased considerably due to the presence of a large number of foreign institutional investors in Indian equity markets.

With this the duties of the directors towards shareholders, creditors and the economy, has also changed, since initially with the coming of Companies Act various statutory duties were recognized in addition to that various codes of corporate governance are being recognized and implemented by the companies from time to time like in 1998, the Confederation of Indian Industry (CII), Indias premier business association, unveiled Indias first code of corporate governance. It required the directors to honestly discharge their fiduciary responsibilities and duties towards the companys shareholders as well as creditors. However, since the Codes adoption was voluntary, few firms embraced it, between 1998 and 2000, over twenty-five leading companies voluntarily decided to follow the code. In the year 2000, another Code was formulated known as the Combined Code it also enumerated that, All directors should bring an independent judgment to bear on issues of strategy, performance, resources, including key appointments, and standards of conduct.

But going on the other side of the problem, that even though there are laws in India which quite clearly underlines the existing laws of the directors but when we see them with an wider perspective we come to an conclusion that these laws are no sufficient, as according to the World Banks Ease of Doing Business survey, Indias director liability index stands at four out of a maximum score of ten. For the OECD countries as a group, the index stands at 5. This data suggests clearly that Indias laws, compared to those of other nations, do not subject directors to a high level of liability.

Under current Indian law, a director is not liable for misfeasance if he can demonstrate that he acted reasonably as well as honestly and with due diligence. While the due-diligence and reasonableness requirements inject objectivity into the rule, it remains overly subjective by allowing directors to escape liability by demonstrating subjective honesty. To better protect investors, Indias director-liability laws should be revised. Like in Section 210 (5) of the ICA provides a fine for directors of up to 10,000 rupees and six months imprisonment. But there is no accountability in the real sense because liability is incurred only if the director has wilfully defaulted or committed the offence and does not address negligence or failure to take the duty of care. Thus, the same section also provides for an easy exit route to avoid the penalty or imprisonment. Thus, directors are able to avoid liability even after committing a corporate offence.

JUDICIAL INTERPRETATION ON FIDUCIARY DUTIES OF DIRECTORS

The Indian Judiciary in various cases has observed that the first and the foremost duty of persons in fiduciary position is to act with honesty; it also observe that, Greatest good faith is expected in the discharge of their duties.

In G.D. Bhargava v. Regitrar of Companies, the High Court of Allahabad ruled that protection under Section 633 of the Companies Act shall not be available, where the negligence of the director amounts to an offence so as to attract the provisions of the IPC relating to fraud or forgery.

It was also observed in Om Prakash Khaitan v. Shree Keshariya Investment Ltd that it would be proper to relieve directors of consequences of defaults and the breaches unless they are directly involved in the acts or omission complained of or have otherwise not acted honestly or reasonably or have financial involvement in the company.

In the case of Nanalal Zaver v Bombay Life Ass. Co. Ltd, it was observed that, if he power to issue further shares is exercised by the directors not for the benefit of the company but simply and solely for their personal aggrandizement and to the detrimental of the company, the court will interfere and prevent the directors from doing so.

In the case of P.K. Nedungadi v Malayalee Bank Ltd., it was observed that, where any director has misapplied or retained money or property of the company or has been guilty of breach of trust or misfeasance, the court may examine into his conduct and order to him to repay or restore the money or property to the company or to pay compensation.

PART III - CONCLUSION

Nowadays, directors have been under increased scrutiny as shareholders, creditors and the public demand greater accountability and transparency. Nowadays, it is when directors take the helm, they

assume legal and fiduciary responsibility, which prohibits them from serving their own interests at the expense of the corporation, and requires them to use good business judgment. This means that directors are required to be competent, diligent and act in good faith when they make business decisions. The directors fiduciary duty of care, loyalty and good faith is owed to the company and its shareholders, and sometimes its creditors, tax authorities and employees. Moreover, these fiduciary duties act as an addition to the statutory duties, since the statutory duties can in many cases be easily avoided by the directors, as it is in case of Section 210 of the Indian Companies Act, 1956.

Furthermore, after analyzing the status of corporate fiduciary duties in both the countries we can certainly come to the conclusion that the fiduciary duties of directors in India are fewer and of less relevance as compared to America and there is certainly a requirement of amendments in Indian laws in which the liability of the directors towards the shareholders, creditors and to the general economy, is enhanced according to the present corporate scenario.