Covid-19 has substantially affected the way of living for everyone. Whilst the world is trying to adhere to the new normal, companies are finding it extremely difficult to manage in these volatile and uncertain times. The central figure in all this chaos are the directors of companies. They are struggling to navigate businesses with limited or no cash flows and as a result have been compelled to take tough decisions; this situation is likely to continue till operating conditions improve.
In case of a company, the role of a director is of utmost importance. A director is personally responsible for managing the affairs of a company and has a fiduciary duty towards the company and its various stakeholders. Pursuant to Section 166 of the Companies Act, 2013, a director is duty bound to act in good faith to promote the objects of the company for the benefit of its shareholders, and has to act in the best interest of the shareholders, employees, community, and even towards protection of the environment. However, the Covid era is witnessing unprecedented changes in law—challenging judicial pronouncements as well as difficult business environments—that are bound to put directors in a tough spot. This begs the question whether their actions can result in personal exposure of directors trying to discharge their official duties.
The challenges faced by directors emanate from every corner, be it in relation to compliance with legal and contractual obligations, adapting businesses to ‘operate from home’, ensuring health and safety of employees while rebooting physical office space, etc. The role of directors in each of these situations is tricky and they are often forced to make tough decisions that could arguably be viewed as a compromise of their fiduciary responsibilities. Highlighted below are certain high-level issues situations where this dichotomy is likely to play out:
Governments have come up with various binding and non-binding advisories/directives on aspects such as reduction of salaries of employees, letting go of employees, etc. Whilst the legal position on these obligations of employers is being tested and is pending the Supreme Court’s decision, the directors of companies which were forced to reduce salaries and/or lay off employees have started facing legal action by disgruntled employees and even labour authorities (in a few states).
The central government has issued a directive declaring Covid-19 to be an epidemic and characterising it as equivalent of an ‘act of God’ and has also declared the current situation to be a ‘force majeure’ event in an official memorandum. Whilst there is abundant jurisprudence on what is ‘force majeure’ and when it can be enforced, in the current scenario, parties are at loggerheads on the applicability of this doctrine. Adding to the complexities, in certain situations parties are increasingly claiming that the underlying contract itself is voidable since their ability to perform their part of the contract is rendered impossible on account of the doctrine of frustration, enshrined under Section 56 of the Indian Contract Act, 1872. While the veracity of these claims is mostly based on specific facts, it is par for the course for notices to be served on directors of companies that are party to such confrontations. These situations again raise the question as to what position should a director take to be on the right side of her duties.
Various companies are facing concerns vis-à-vis their financing arrangements. For example, the Reserve Bank of India has guided banks and NBFCs to provide relief to the borrowers in the form of moratorium on loan payments. The directive being not binding allows lenders to exercise their discretion, leaving many borrowers in the lurch. Lenders are not only taking action against the borrower company but also against their directors, thereby exposing them to personal liability and possibly exposing them to the risk of being categorised as wilful defaulters.
With everyone working remotely, directors are facing issues in managing security of their IT systems which were not built to withstand these real-time complexities. They also need to ensure that their own critical data and/or that of the client remains protected at all times.
In each of the above scenarios where the interest of different stakeholders is polarised, it is debatable whether directors have done justice to their fiduciary responsibilities. While its only when the facts of each specific situation are put to test can this dilemma be addressed to some extent, directors and companies have certain risk mitigants available, which should be considered.
In this regard, while Section 166 of the Companies Act, 2013, enshrines the fiduciary duties of a director, it also provides for the ‘business judgement rule’ i.e. a reasonableness and diligence test. In other words, if a director can demonstrate that she acted keeping in mind all the factors at hand and then took a business decision, it should help safeguard her from personal liability. Further, a director who is recorded as a non-executive director or an independent director has a good defence that he/she is not involved in the day-to-day management of a company and should be accorded protection vis-à-vis actions which are undertaken by a company without her knowledge.
Other risk mitigation factors which can be considered are contractual indemnity protection and director and officer liability insurances. These are external protection elements which can be sought by directors to protect their interests. However, it should be noted that indemnities and insurance are synthetic products and (a) they need to be in place prior to the action taking place; (b) they don’t safeguard the relevant person against the regulatory and criminal liabilities. Another approach to keep in mind is that whilst the directors monitor developments, they should map them against the contractual obligations. Wherever needed, the director should communicate the stress points to the counterparty well in advance. Such discussions often help in preserving the relationship and facilitates problem solving.
Given that the current situation is unprecedented, and every action taken seems to be a knee-jerk reaction, it would be unfair to criticise anyone for this increase in liability of directors. Since, business situations will continue to remain tense and directors will keep facing certain tough decisions, it is advisable that they should tread the path with utmost caution.
Views are personal.
The authors are co-founders of Bombay Law Chambers, a Mumbai-based boutique law firm.