Directors’ ‘fiduciary’ Duty- A Critical Analysis through a global comparative study emphasizing on the Indian Perspective

Rahul Kanna writes on the growing global codification of laws with regard to directors duties and the Companies Act,2013 with its much needed extensive overhaul resulted in codification of directors duties and liabilities under Section 166, Companies Act,2013.

Introduction

The ‘Fiduciary duty’ of the directors to the company and the shareholders is certainly unique and ambiguous due to its diverse nature subject to a wide interpretation which has evolved constantly since its inculcation into the common law principles coupled with the recent codification exercise carried out in several common law countries including India, thereby effectively restricting and crystallizing its legal ambit concerning the company and its stakeholders. A Company is an artificial person with a separate legal personality and perpetual existence distinct from that of its members. The Directors are entrusted with the governance and management of the company and therefore have been often described as agents, trustees or representatives of the corporate body by virtue of their acts being in fiduciary capacity vis-à-vis the company and the position of a director has often been a rather ambiguous and arduous subject to deliberate¹, Similarly Bowen LJ in Imperial Hydropathic Hotel Co Blackpool v. Hampson observed that the director in a corporation holds a rather versatile position with the directors subject to a duty to comply with the constitutional provisions of the corporation as well as the current statutory legislations². In India the duties and liabilities of directors under the Companies Act, 1956 were not established by codifications leaving behind a wide interpretation to be observed and thereby making it necessary to inculcate common law principles under the ambit of directors duties and the Indian courts were ardently reluctant in dealing with cases pertaining to the duty and liability of directors due to the presence of statutory uncertainty, However the situation took a crucial turn with the growing global codification of laws with regard to directors duties and the Companies Act,2013 with its much needed extensive overhaul resulted in codification of directors duties and liabilities under Section 166, Companies Act,2013.

II.Global Comparative study of ‘Fiduciary Duty’; In light of the recent Codification Exercise Implemented in Common Law States

The fiduciary duties of directors is enshrined under section 166 ICA,2013 the legislature in codifying directors duty has inculcated certain structural socialistic values synonyms with the foundational value and the journey of our country and thereby the intention of the legislature is reflected in the language of the provision enabling it to adopt the pluralist model rather than the “Enlightened Shareholder Model”(EVS) as adopted by the United Kingdom in its crusade of codification of the director duties under Section 172 of the UK Companies Act,2006. Prior to the codification exercise the provisions of the director’s fiduciary duty was based on the essence of common law principles as the statutory principles governing the same was silent and thus giving the court a wide ambit in interpreting the roles, duties and liability of the directors and specifically to the question as to who the fiduciary duty was owed to, whether the company or the shareholders or the stakeholders or merely the company vis- à-vis shareholders. The law in UK makes it clear that hierarchy was to be given to the shareholders in exercise of fiduciary duties in relation to other stakeholders as the ESV model aims to have regard to non-shareholder interest ‘as a means ‘of enhancing the overall shareholder value in the long run.

However, in India it would seem as though the present model is contrast from the EVS approach in light of section 166(2) but the same does not hold good when delved deeper into the interpretation of the statute along with its judicial interpretations³.

Another paradigm that has been used globally at least in pertinence to common law jurisdictions such as the UK, Singapore and Hong Kong is that the application of these principles has been retained post the codification exercise in contrast the application of equitable and common law principles as applied prior to the ICA,2013 finds no mention in any statutory provision in the current legislation while Section 170 UK Companies Act,2006 and Section 157 Singapore Companies Act,2006 have specific mention of the applicability of these principle at least in principle with respect to interpreting the statutory provisions of directors duty and from the face of it this might appear to be a rather jurisprudential issue but in stark reality the uncertainty leads to all sorts of paradox when matters regarding section 166 ICA,2013 is taken up and in particular with the ambit of fiduciary duty of the directors, One might say the positive solution to this would be to look into the intention and history of the legislation, Yet to a great degree the legislative rational behind the drafting of this provision is ambiguous and vague as the Parliamentary Standing Committee on Finance⁴ which extensively reviewed the bill prior to the enactment did not pay any heed to the issue thus leaving room for uncertainty and ambiguity to the question whether common law principles are exhaustive of the codification exercise or can be employed in furtherance to the existing statutory provisions or if at all can be used to merely aid in interpretation of the statutory duties to be faced by the Indian Courts that have certainly over almost a decade has not gone into the issue out of sheer will and belief that the matter would be taken up by the legislature sooner than later instead of the Ad-Hoc judicial responses approach.⁵

III. Indian Scenario- “Concentrated Shareholding & Regulatory Restrictions”

The Directors fiduciary duty has long been a common law principle and which has evolved into codified laws over the past two decades, yet, this concept encompasses a larger theory than it suggests including ‘stakeholder v shareholder’ approach & the constantly academically deliberated question as to who does the director owe fiduciary duty towards? Is it the company & its objects or the shareholders of the company or both?

These questions have been mundanely answered using various propagated theories & general practice, yet, in essence the same can only be answered based on analytical & empirical analysis & examination of shareholding patterns & corporate governance norms established in our country.

The major listed companies in India has a large concentration of promoter shareholding even post the corporation going public or for the matter even after the mandatory lock-in period imposed by SEBI. Over the past two decades beginning from 2001 the average shareholding of promoters in listed companies across the country has been at around 50% which means half the voting rights in the company. This is indeed an implication in the investor confidence in the country owing to the majority shareholders specially in pertinence to the promoter group carrying on its vested interest & putting the interest of the other shareholders including the various stakeholders of the corporation in a detrimental situation. This growth of promoters shareholding has been under surveillance in the country’s regulatory body ( SEBI) and it has taken up the limitations & implication of the same , for instance the Kotak Committee report⁶ in 2017 on corporate governance under the auspices of SEBI emphasized that corporations need to adopt the ‘custodian’ model taking cue from ‘Gandhian Principles’ whereby the board of directors including the promoters groups needs to work for the betterment of all the stakeholders including employees, customers, shareholders etc through the façade of ‘Trustees’ & implicated that this would be the way forward for the corporate growth in India, However this seems really assuring when heard or seen on paper but yet the very foundational principle of a ‘corporation’ continues to be enhancement of profits with minimal considerations towards other factors, thus removing this façade it is apparent that this type of concentrated ownership only helps in ensuring the growth of those in the management & majority shareholders including maximization & accumulation of wealth by the promoters group.

In analysing data over the past two decades from 2001-2018 it is exemplified that the promoter’s shareholding in the top 500 listed companies has been at an average of 50% and with regard to ownership of concentration of companies with promoters holding 50% or more has increased to 66% in 2018 from previous 56% in 2001 and there has also been a substantial increase from 5% towards 9% since 2001⁷ until 2018 in terms of promoter’s concentration of more than 75% in the listed companies. Another astonishing fact is that individual Indian promoters on an average held between 40%-50% over the periods between 2001-2018⁸ and between 48%-53% since 2006⁹ which is post certain amends to the SEBI guidelines with regards to disclosure requirements which made it mandatory for disclosure of promoters & non promoter holding in detail as a part of the overhaul of listed companies’ guideline post the May 18th, 2006 which was the steepest fall in the BSE since its establishment. In another category Indian companies were also the largest promotional investors in other Indian companies in the top 500 Listed companies. Another disappointing revelation has been that while the institutional investors shareholding concentration has steadily gained over the past two decade until 2018 the individual investors under the non-promoters category which include the public has ultimately reduced in terms of shareholding from 34.1 % - 25.9% from 2001-2018¹⁰, which has shown a gradual slope in public investor confidence, considering the above factual data is with regard to the top 500 Public Listed companies which in effect resonates the countries losing confidence in stock market coupled with the growing dominance by promoter groups including their corporation & certain institutional investors.

Promoters as directors which is an exception across the world and specially with growth of corporate governance norms in the 21st century has rather been a norm & a mundane practice in India, This can be attributed to the concentrated ownership pattern & family owned Indian corporations this number has also increased substantially but overall number is still low, however most of these promoters place nominee directors in their role thus the duty for the concentration of promoter to director proportion is factually lower at around less than 1% and above 0.2% from 2001-2018¹¹. The issue of promoters forcing their views and oppression of the promoter group over minority shareholder is not novel to the Indian jurisprudence in recent times the NCLAT, in a case¹² instituted by Cyrus Mistry over the alleged oppression by the promoters of Tata Sons Ltd. which is a typical case of domination by the nominee directors of the Tata family which prevented the running of day-day affairs of the company by Mr Mistry and the alleged domination by the promoter group reached its epitome when the independence of independent director was also apprehended and one such director Mr Wadia was removed from the board due to disagreements with the tata group which ensured control over the corporation through its trusts & nominee directors, but the tribunal stood in favour of Mistry and further gave directions including the restriction in the application of certain provision of the AOA of the company specifically Art 75 from being used by the majority detrimental to the minority shareholder & further stated such provisions if used can be done in exceptional circumstance following the due process including the reasoning & informing all the shareholders of the implication of such action along with the same the NCLAT also limited the role of Ratan Tata by asking him to restrict his intervention to that in advisory capacity rather than indulge in day-day affairs of the corporation¹³.

IV.Regulatory Assistance

The regulatory agencies in the country have been the guardian angels of the minority shareholders in the country & have played a pertinent role in increasing investor confidence & encouraging the general public towards stock market investment which was the need of the hour as the situation of India is very unique given its rather archaic & orthodox approach in contemporary investing. The regulatory agency undertook policy of ‘free floating ‘of shares with an aim to reduce the promoters share in the company post going public but the policy was soon reversed as the promoter’s group was important post the IPO stage for successful growth of the company over a sustained period and hence introduced the mandatory ‘lock-in ‘period of 3 years since the date of listing i.e. 20% shareholding was done to prevent the occurrence of ‘vanishing companies’ which became a common phenomenon until the regulatory body’s intervention. In another scenario of promoters ‘pledging shares’ as collateral for investments were brought under regulatory lenses¹⁴ and further in a recent disclosure strengthening agenda for listed companies the guidelines required mandatory disclosure as to the reasons attributed to such pledges if the same was in excess of 20% of promoters shareholding¹⁵.

V. Global Comparative Jurisprudential Analysis of Shareholding trend & theoretical Discourse:

The UK & US have a rather different scenario in comparison as the shares of the corporation are widely diversified and not concentrated in the hands of either the promoter group or few families. Thus, it is no surprise that in UK less than 30% of all the publicly listed companies possess shareholders who control more than 1/5th of the total shares of the company¹⁶ and the situation is no different in the US where majority or promoter’s shareholding concentration in a corporation is rather an exception than a norm distinct in characteristic to our country.¹⁷ This system of operation is referred by scholars as ‘outsider/ arm’s- length’ system.¹⁸ The reasoning postulated by the theory is that this system mitigates the concentration of power in the hands of few individuals and rather widely dispersed among individual investors & institutional investors thus effectively keeping oppression or insider ‘influence’ in the companies affairs at a minimalistic level and the alternative name of ‘arms-length’ suggest the freedom endowed towards the managerial members of the corporation in handling the companies affairs whereby the investors or shareholders keep away from constant indulgence in these matters¹⁹ while in contrast to this system is the ‘insider/control-oriented’²⁰ which refers to a group of shareholders having a large acumen of shares in the corporation and exercising control over the management & managerial decisions. Countries with these types of systems include Germany & Japan and a typical characteristic trait of such system includes the banking system taking a foundational role in the economy & the capital markets dependence for corporate financing is a typical example of the ‘bank ‘backed financial system which is not prevalent in the US & UK systems, where the debt market plays a pertinent role while the same is minimal in the ‘insider’ system. Another peculiar aspect is the development of equity & debt markets being novel in our country while the same has been an established system of investment & financial planning in the UK & US for nearly a century.

The policies and politics of a country also play a determinant role in the shape of the corporate structure & governance norms as Professor Roe eloquently states that ‘political contingencies’ establish a unique nexus between the ideological structure & the corporate ownership structure while suggesting ‘left-wing’ social democracies contain a greater degree of ownership concentration in comparison to ‘right wing’ democracies given the strong emphasize on employees over investors through regulation system in further enhancement of the political ideology in the former while the latter while extending its political ideology exhibits a capitalistic structure thereby giving preference over investors & shareholders. In essence UK & US have a shareholder economy while Japan, Germany & Scandinavian countries lean towards ‘Stakeholder’ approach.²¹ In the UK regulation & strong company laws were rejected as the key behind achieving diverse share ownership & for the prevention of shareholding concentration in the hands of the few and thus the ‘Law Matter’ theory in Corporate governance would not be a mandatory requirement for equal shareholding concentration,²² But However Professor Roe theory of regulations being appropriate & determinant as it aids in being a deterrent towards minority oppression & eventually leads to disperse ownership as in the case with US.²³ ‘Family Capitalism’ that refers to few families holding majority of shares & managing affairs through either being directors or managers and this system though prevalent in India till date, was once common in the late 1990’s in Italy.²⁴

VI. Analysis of the Legislative & Judicial Interpretation of Section 166, ICA,2013

Section 166(2) ICA,2013 reads as “A director of a company shall act in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of environment.” A plain reading of the statute would mean that there are two duties to act in good faith namely to promote the objects of the company and in the best interest of the stakeholders of the company. The statute can be interpreted in considering the Parliamentary Standing Committees view that there is no independent duty of fiduciary on the directors over the best interest of the stakeholders but rather the duty is simply one of promoting the objects and the objects are to be promoted in the best interest of the company as well as the stakeholders but the language of the clause as mentioned earlier contradicts the committee’s view ²⁵. The common law prior to codifications cast upon a duty of loyalty which included the duty to act in good faith in the best interest of the company represented in Smith & Fawcett ²⁶“[Directors] must exercise their discretion bona fide in what they consider – not what a court may consider – is in the interest of the company…” creating a rather subjective test. The present scenario in India has cast a positive duty towards the director to act in good faith to the interest of the shareholders and stakeholders in equal, but this also leaves an uncertainty as to whether the stakeholders have right to any claim in breach of the fiduciary duty promised by the provision. Similarly, the no conflict no profit common law principle as devolved in Keech v Sandford²⁷, Regal (Hastings) V Gulliver²⁸ along with corporate opportunity rule which was examined in Bhullar V Bhullar²⁹ has been codified under section 166(4) ICA,2013. The only Indian case to analyze the Corporate Opportunity Principle is Vaishnav Shorìlal Puri; Seaworld Shipping and Logistics Pvt. Lid ' v. Kishore Kundanlal³⁰ Sippy represents a vague application of UK and US position on the principle and the court applied Section 88 of Indian Trusts Act, 1882 to understand the duties owed by the fiduciary. There has been a lack of jurisprudence in dealing with corporate opportunity principle which highlights an earlier paradox of application of common law principles by Indian Courts in dealing with these provisions.³¹

VII. Critique & Reasonable Solution towards the existence of ambiguity in Directors ‘Fiduciary Duty’

Therefore in light of the above Common law judgements and the Indian court’s precedents it is evidentially clear that there does not exist a fiduciary duty of the directors over the shareholders in perpetuity but however there seems to be an exception to this rule when a special circumstance or situation exist and the courts in India have not clearly established any reasoning to identify such special circumstance where director’s breach fiduciary duty owed to the shareholders and thus this duty towards shareholders is established by a case to case basis after determining the facts and circumstances of the matter. I am of the opinion that courts should rather attempt to establish and identify certain situations where the fiduciary duty would apply as that would also aid in establishing a precedent and thereby removing the perpetual ambiguity with the fiduciary duty, further aided by the evolution of corporate governance and an increasing involvement of shareholders in the companies affairs but however I also understand that the possibility of existence of certain circumstances not brought under the ambit of special scenario principle by courts would exist and in those situations the court should look into the prima facie facts and circumstance on the matter and decide whether any fiduciary duty was owed to the shareholders.

VIII. The Road Ahead

The Indian Legislature on dealing with the Indian Companies Act,2013 has certainly adopted the pluralist model which on the face of it is dissimilar to the EVS model adopted by the UK and contradicts the directory duty model adopted by the US that propagates the idea of supremacy of the shareholder, however a deeper and in complexity analysis makes the Indian model in a way similar to the EVS model as one aspect remains common between them is both these models ostensibly attempts to do what it really intended to do. In our country there are certain remedies available to the shareholders and stakeholders against breach of fiduciary duty of the director like derivative suits that are of prime importance and a foundational pillar of corporate governance as it can be used as an arsenal by the shareholders in asserting their rights, unfortunately there seems to be complete absence of any provisions in the current legislation and remains unclear to date. Interestingly Section 245 of the act allows for the institution of class action suits by members and depositors of the corporation when the corporation is being managed in a manner prejudiced to the members or the shareholders, in our country majority of the corporations are family owned and closely connected and the Board of Directors are often synonyms with the majority and thus leaves the effective utilization of this provision redundant or merely impractical in the Indian context. Section 241(2) provides the central government in applying to NCLT when it is of the opinion the affairs of the company are taking places in prejudicial manner to the public interest but this provision is used in exceptional circumstances as the government does not involve itself in matters of a corporation unless when the greater good principle needs to be invoked citing public interest. It can only be wished that a greater emphasis is laid on the level of scrutiny while dealing with matters under Section 166(2) and the shortcomings need be addressed to sooner than later either through intervention of legislature or Ad-Hoc judicial responses to overcome the uncertainty paradox dooming over director’s fiduciary duties in light of the current legislation.

IX. Conclusion

The concept of ‘fiduciary’ duty has been one of the well-established common-law principles including the ‘fiduciary duty’ of directors to the company, yet, the duty in retrospect to the shareholders has molded with the codification exercise carried out over the last two decades across the globe & with the legislation of Section 166 under the Indian Companies Act,2013. However, the room for ambiguity is large as the provision visualizes the extension of ‘fiduciary’ duty to all the stakeholders including the environment. The legislative intent behind the provision is to be applauded but theoretically it is impressive but the same in practice is yet to achieve the desired results, as one can abstract from the above analysis & global comparison of Indian listed companies shareholding pattern & practice to that of several western countries, the provision of the Act with the current shareholding concentration & practice of promoters as directors or their nominees would really not have far reaching effect and there needs to be a change in the topography of corporate law in the country. The government has also played its role in encouraging investor confidence through frequent SEBI guidelines & stringent disclosure norms but in reality the situation can be absolved only through pertinent changes in the corporate governance norms & overall structure of corporate structure in the country, ‘laws’ alone cannot be the only factor in intermediating the change as we have seen this system of ‘law matters’ theory has not really provided the desired result and instead there needs to be equal contribution for equitable balance of equity in our country, further these changes need to begin at the earliest as the current pattern in our country shows a gradual decline in the economy’s dependence on ‘banking system’ and investment through deposits in banks are no longer looked up as sustainable investment for the future given the alarming decline in interest rates across the country coupled with the governments bid to disinvest in major public sector banks & call for private corporations to establish their own banks, eventually leads to an economy where investment in stock market in equity & debt is likely the future of Indian investment for the majority of the population and our investment structure would soon resemble one of America & UK where the general population to a great extent invests in the stock market due to absence of interest rates from the banks, ultimately this would mean that major public listed companies lay a greater emphasis on corporate governance norms & contribute more towards corporate social responsibility ( CSR) and stronger judicial involvement is also expected in corporate law as gone are the days where almost all matters relating to corporate aspects are left for ‘legislative’ as it was seen as a more ‘policy’ matter than one involving complicated questions of law or matters of ‘judicial pertinence’.