Director’s Duty? Being a Director of an incorporated business is not a small deal. Directors undoubtedly enjoy a position of privilege and responsibility but they are also subject to certain obligations that are known as Director’s duties under common law.
One of such Director’s duty that the Director is bound to perform is Duty of Care, Diligence and Skill. A breach of this duty not only raises the question on the administration of the company but also pierces the corporate veil and allows creditors to hold the Director personally liable for any wrongdoing. Hence, it is a paramount duty that all Directors and business owners shall be well acquainted with the scope and ambit of the duty of care and diligence, lest they will fall victim to it.
EXPLANATION of Director’s Duty
- The abovementioned duty is explained under section 166(3) of the Companies Act, 2013. This section provides that “a Director of a company shall exercise his duties with due and reasonable care, skill, and diligence and shall exercise independent judgment.”
- The Supreme Court has described it as a failure of corporate governance on the part of directors if they fail to exercise due care and diligence thereby allowing fabrication of figures and false disclosure. They would be liable for such omissions and commissions.
Liability of Negligence
- The duty of care and diligence holds that a director of a corporation must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if they were a director of the corporation.
- Fidelity alone is not enough. A director has to perform his functions with reasonable care. He has to attend with due diligence and caution the work assigned to him.
- A director shall act at all times in what he believes to be the best interests of the company as a whole so as to preserve the assets, further its business and promote the purposes for which it was formed and in such manner as a faithful, diligent, careful and ordinarily prudent director would act in the circumstances.
- Every director of a company shall exercise the powers and discharge the duties of his office honestly, in good faith and in the best interests of the company and shall exercise the degree of care, diligence and skill a reasonably prudent director would exercise in comparable circumstances.
- The courts have recognised that directors must be allowed to make business decisions in the spirit of the organization.
- Many countries have laid down different theories related to the duties of the directors. For example, the New Zealand Companies Act, 1993 provides that a director must exercise his powers for a proper purpose.
- The Courts have been liberal in the matter of the expected standards of skill and care.
- In one of the Case laws, Overend Gurney & co. v Gibb 1872,
- A company was formed to take over a private bank. Without investigating the value of the bank’s assets and extent of its liabilities and with the knowledge that the bank was in a state of insolvency, the directors paid $50,000 for goodwill. Still holding them not liable, the House of Lords laid down that there should be violation of either the Act or the memorandum or the transaction was such that no man of ordinary prudence would have entered into.
Standard and degree of care and skill
- Quite apart from this statutory development, the courts have also been trying to reconsider the standard of care expected of directors.
- A british judge formulation is largely subjective, as a director has to use only such “skill as may be expected from a person of his knowledge and experience”.
- The standard of care required of directors at common law has traditionally been light compared with their duties in other areas. Usually it took gross negligence for directors to be liable.
- In the words of Justice Cardozo, the diligent director is the one who exhibits in the performance of his trust the same degree of care and prudence that men prompted by self-interest generally exercise on their own affairs.
- When exercising powers or performing duties, directors are charged with exercising the care, diligence and skill that a reasonable director would exercise in the same circumstances.
The taking care of the business risks and allowing directors a wide discretion in matters in business judgment requires a sober assessment by directors as to the company’s likely future income stream. Given current economic conditions, did the directors make reasonable assumptions in their forecasts of future revenue?
Creditors are likely to suffer serious losses if future outflows of cash inflows for the same period. If there is no profit margin on goods being sold or services provided the company will reach a stage where the shareholder’s risk capital has been exhausted and directors are instead using resources otherwise available to meet all creditors claims.