POSITION OF NOMINEE DIRECTORS UNDER THE COMPANIES ACTS, 1956
By
GEETA NARULA*

The aim of this article is to analyse the position, duties, powers and importance of nominee directors under the Indian Companies Act, 1956. The article further tries to bring forward the role of nominee directors in the smooth functioning of a company and in the overall corporate governance.

Introduction

A company is the creation of the law. It is not a human being but is an artificial person. On incorporation, the company acquires a separate legal entity distinct from and independent of its members. Unlike a partnership firm, which has no separate legal entity, a company has a separate corporate existence. This principle of separate legal entity of the company was propounded by the "House Of Lords" in the case of Saloman v Saloman (1897). In this case all the members of the company belonged to one family. The court held that the fact that all the members were from one single family had no bearing on the validity of the company. The company is at law a different person altogether from the subscribers of the Memorandum of Association. Since a company has no physical existence, it acts through the Board of Directors. The Directors are managerial persons and elected representatives of the shareholders. They individually and collectively hold the position of trust and have fiduciary duties towards the company, the shareholders and others. The nominee Director, being one of them, has also to observe various statutory requirements, which come automatically with his office. He acts as a “watchdog” that primarily protect the interest of the institutions appointing him. He also protects the interests of the shareholders by strictly complying various procedures and requirements prescribed by different enactments.

Meaning of Nominee Director

The concept of 'nominee directors' could be said to be comparatively of recent origin. This concept has come into vogue because of the loan facilities provided by the financial institutions. Such institutions while granting loans to companies generally impose a condition as to the appointment of their representative(s) on the board s of the companies who avail loan from them. A Nominee Directors is expected to safeguard the interests of the financial institutions, whose nominee he is. The difference between such directors and other directors appointed by the shareholders is that the shareholders ' directors are subject to retirement by rotation and other applicable provisions of the Act, whereas, the nominee directors appointment and function is governed by the respective Acts, and they are beyond the purview supervision of the shareholders. The definition of Director given by the Companies Act, 1956 (hereinafter called the act) is an inclusive one and it provides that the expression" 'Director' includes any person occupying the position of the director, by whatever name called "(1). It further provides that any person in accordance with whose directions or instructions, the board of directors of a company is accustomed to act, shall deemed to be a director of the company(2). The Act does not contain any definition of the term nominee directors. The Act thus makes no distinction between the directors on the basis of their being nominee directors as far as liability for violation of the provisions of the Company Act and other Acts are concerned. As per the Company law, directors of the company occupy a fiduciary position. They are expected to work bonafide in the interest of the company and must not exercise their powers for any collateral reasons. A director must not place himself in a position where his duty to the company and his personal interests clash and he must not profit from his position as a director. This legal position is equally applicable to the nominee directors, whether appointed by the central government or by the financial institutions.

Appointment of nominee directors

The Act empowers the National Company Law Tribunal (hereinafter referred to as Tribunal) to appoint nominee directors for the regulation of the conduct of the company's affairs(3). Similarly, the Central Government has been vested with the powers of appointing directors on an order by Tribunal to effectively safeguard the interest of the company or its shareholders or of public to prevent mismanagement and oppression(4). These directors are neither required to acquire the qualification shares nor will they be taken into account for the purpose of calculating the total number of directors in the company. As far as their liabilities are concerned, these directors cannot claim any special privilege. They will have to prove that they had acted honestly and reasonably, and they are required to show that they can not be considered to be "officers in default" in respect of the alleged offence'.

Guidelines concerning nominee directors

The various guidelines and reports, as issued and given by the Government and various Committees respectively, have streamlined the position of the nominee directors. These guidelines and reports are in addition to the duties, responsibilities and powers as prescribed under the Act. Some of the important guidelines and reports concerning nominee directors are:

(1) CII’s Report on Corporate Governance in India:

Headed by Mr.Rahul Bajaj; it gave its report on April 1997. This report deals with the position of nominee directors in detail. It showed its great concern over passive role being played by the nominee directors on the various boards. It found that the largest debt-holders of private sector corporate India are public sector term lending institutions such as IDBI, ICICI and IFCI and they are also the substantial shareholder who sit on the board as nominee directors. There are to many companies where they are on the board but too few the competent nominee directors to do the task properly. As a result of which corporate governance and careful monitoring do not happen in the way as they are supposed to when a stakeholder is both creditor and owner of equity. And while nominee directors ought to be more powerful, they are not so. According to this report, holding of large number of shares by the government in these financial institutions is responsible for this inactive role of the nominee directors(5).

(2) Kumarmangalam Birla Committee Report concerning Corporate Governance:

It considered the role of nominee directors in the context of Corporate Governance. In this regard it made two important recommendations:
(1) When companies are well managed and performing well, the need for protection of institutional interest through nominee directors is less and hence in such cases they should be appointed on a selective basis pursuant to a right under the loan agreement.
(2) When a nominee of the institutions is appointed as a director, he should have the same responsibly, be subject to same discipline and be accountable to the shareholders in the same manner as any other director of the company(6).

(3) Naresh Chandra Committee on Corporate Governance:

According to this committee, a nominee director cannot be considered as an independent director and said that an independent director actually is a non-executive director of company. It gave a criteria to define the independent director and suggested to make that criteria to be applicable for all listed, as well as unlisted public limited companies with a paid-up share capital and free reserves of Rs.10 crore and above or turnover of Rs.50 crore and above with effect from the financial year beginning 2003(7).

(4) Disqualifications of directors:

Similarly by issuing General Circular on disqualification of Directors under Section 274(1)(g) of the Act, the liability of the nominee directors were made clear. It says:
(1) Nominee Directors appointed by the Public Financial Institutions and Companies established under the Acts of Parliament having non-obstante provisions over the Companies Act, 1956, like IDBI, LIC, UTI, IIBI etc., in their respective statutes shall not be liable to be disqualified for appointment as directors by virtue of Section 274(1)(g) of the Companies Act, 1956.
(2) Nominee Directors appointed on the Boards of assisted concerns or other public companies by (a) public financial institutions within the meaning of Section 4A of the Companies Act, 1956; (b) Central or State Government: and (c) banking companies are also exempt from the provisions of Section 274(1)(g) of the Companies Act(8).

(5) Narayana Murthy Committee on Corporate Governance:

According to this committee's view, there shall be no nominee directors. The institution of nominee directors creates a conflict of interest that should be avoided. It has opined that if the institution whether as a lending institution or as investing institution, wishes to appoint its nominee on the board, such appointment should be made through the normal process of election by the shareholders similarly the nominees of government. It suggested that all the directors, whether representing institutions or otherwise, should have the same responsibilities and liabilities(9).

Position of nominee directors

The law is not settled when dealing with conflicts between the director's duty to the organisation and the interest of the member nominating that director. A related issue is the fact that nominee directors are often in receipt of information in their capacity as a director, which in the best commercial interest of their nominator should be disclosed to their nominator, which may be subject to the duty of confidentiality owed as a director. Nominee directors owe their duties to the organisation to which they are appointed and can only act according to duties owed to their nominators if this does not cause detriment to that organisation.
A nominee director does not enjoy a special position within the company. He is not supposed to be in charge of a company's affairs. The nominee is subject to the overriding and predominant duty to serve the interests of the board in preference if a conflict arises to the interests of the appointer. The nominee must exercise constant vigilance to ensure that he did not compromise or surrender integrity and independence, which the nominee must use for the benefit of the board. In the case of an ordinary commercial company this is readily understandable. The unthinking compliance by a nominee with instructions given by the nominee's appointer may constitute oppression of the minority. If the company is merely a convenient or advantageous means of holding assets for the purposes of the trust then the possibility of such conflict would seem to be small. If the company is carrying on a business then the scope for conflict is greater. The need for caution on the part of the trustees will not necessarily be reflected in the commercial approach to be adopted by the board. A director may not be entitled to see everything concerning a company's affairs. Any confidential information cannot be disclosed by a director against the interests of the company. In the case of a nominee director information may be withheld from the nominee if there is a risk that it will be disclosed by the nominee to the appointer. This would suggest that before appointing a nominee it should be established that the nominee has a right to disclose information without regard to possible conflicts. Such a right needs to be established as against the company and not just between the nominee and the trustees.

Liability of Nominee Directors for Company Offences

The following provisions of the Companies Act, 1956 provide that the Members or the Directors/nominee Directors of a company will be personally liable if:
(1) A company carries on business for more than six months after the number of its members has been reduced below seven in the case of a public company and two in the case of a private company. Every person who was a member of the company during the time when it carried on business after those six months and who was aware of this fact, shall be severally liable for all debts contracted after six months(10),
(2) The application money of those applicants to whom no shares has been allotted is not repaid within 130 days of the date of issue of the prospectus, then the Directors shall be jointly and severally liable to repay that money with the prescribed interest(11),
(3) An officer of the company or any other person acts on its behalf and enters into a contract or signs a negotiable instrument without fully writing the name of the company, then such officer or person shall be personally liable(12),
(4) The court refuses to treat the subsidiary company as a separate entity and instead treat it as only a branch of the holding company(13),
(5) In the course of winding up of the company, it appears that the business of the company has been carried on with intent to defraud the creditors of the company or any other person or for any fraudulent purpose, al those who were aware of such fraud shall be personally liable without any limitation of liability(14),(15).
The Company Amendment Act, 1988, by amending Section 5 of the Company Act has excluded nominee directors from the rigours of the prosecution and penal liability. However, this exoneration is limited to the offences committed by a company under the Company Act. Said Section 5 after amendment brings into purview of the definition " officer in default " only those directors and officers of the company who are in charge of the management of a company and not the nominee directors. However a nominee director could be proceeded against and they cannot claim wholesale exoneration from the proceeding merely by virtue of their being nominee directors unless there is an express provision to that effect under the statute for contravention of which the company and its directors are proceeded against. Further it is for the prosecution to establish that the nominee director was a party to the offence. But, by virtue of special provisions in the respective Acts governing different financial institutions such as IDBI, IFCI, LIC, UTI, etc., the nominee directors have been given immunity from action for any liability as a director. Further, by adding a proviso to the Section 141(1) of the Negotiable Instruments Act, 1881 through Negotiable Instruments (Amendment & Miscellaneous Provisions) Act, 2002 nominee directors have been exempted from the provisions of Section 141 concerning prosecution for dishonour of cheque.

Judicial response

In Girni Kamgar Sangharsh Samiti V Matulaya Mills Ltd(16)the directors failed to carry out directions of the court for arranging payment to the workers of the sick industrial company, the court said that the nominee director representing the BIFR in the company's board was not to be held liable for contempt of court.

On appointment by nomination, in the case of Bharat Bhusan V. H.B. Portfolio Leasing Ltd(17), the Delhi HC held that Section 255(2) leaves ample scope for appointment to be made in accordance with the company's article without being routed through the company's general meeting. An agreement among the shareholders may be imbibed in the article to the effect that every holder of 10% shares shall have the right to nominate a director on the board.

In the case of Geethanjali Mills LTD V. Thiruvengadathan(18), the liability of nominated directors under the Income Tax Act was discussed and it was held that the Nominee directors of creditors, institutions, government, joint venture partners etc, generally, do not enjoy any special immunity. Financial institution nominee directors, however, get immunity under the State Financial Corporation Act. But it has to be established that the accused person has acted in good faith.

Conclusion

The law have conferred and assigned a special status to the companies, which is not available to other forms of associations. It expects the companies to contribute for the growth and development of the nation. The companies are expected to perform their “Social responsibilities” so that people can enjoy a qualitative life. The role of the companies is so important that we can see provisions touching and regulating their functioning in almost all the spheres of life. This is particularly so in a country like India which is a “Welfare State” by nature. The State formulates various laws and regulations keeping in mind its welfare state role. Thus, a balance has been maintained between social responsibilities of the company on the one hand and conferment of absolute autonomy and freedom from interference upon the company on the other(19). The nominee directors are required to maintain this balance because the whole purpose of their appointment is superfluous if they do not contribute in sound corporate governance. They play a key role in fulfilling various statutory requirements under various enactments by keeping a close watch over the activities of the company. The interest of the shareholders and the institutions appointing them is also adequately safeguarded in their active participation and presence on the Board of Directors. Thus one can safely conclude that the nominee directors play an important role in bringing sound corporate governance and for meeting the various social responsibilities of a company.

© Geeta Narula. All rights reserved with the author.
* Advocate, Delhi High Court
Contact at:  advocategeeta@yahoo.com/  advocategeeta@rediffmail.com

(1) Section 2 (13).
(2) Explanation (1) to section 303 (1).
(3) Section 402.
(4) Section 408.
(5) (1997) 3 Comp.L.J 43 (Journal).
(6) (2000) Comp.L.J 23 (Journal).
(7) (2003) 1 COMP.L.J 62 (Journal).
(8) General Circular No: 8/2002, Issued by Department of Company Affairs, Government of India, Dated: 22-03-02.
(9) (2003) 2 COMP.L.J 22 (Journal).
(10) Section 45.
(11) Section 69.
(12) Section 147.
(13) Section 212, 214.
(14) Section 542.
(15) Praveen Dalal; “ Corporate entity in existing legal system-Its rights and liabilities under the Constitution and other enactments”, (2004) 61 CLA 96 (Mag).
(16) (2002) Cri.L.J 235 (Bom).
(17) (1992) 74 Comp.Cas 20 (Del).
(18) (1989) 1 Comp.L.J
(19) Praveen Dalal, " Corporate entity and judicial panorama", www.indymedia.org, posted on 30-03-05.