CONCEPT OF A NOMINEE DIRECTOR:
A nominee director is an individual nominated by an institution, including banks and financial institutions, on the board of companies where such institutions have some ‘interest’. The ‘interest’ can either be in form of financial assistance such as loans or investment into shares. Such strategic investment may have a direct bearing on the profitability of a nominator and therefore, the appointment of nominee director becomes essential to facilitate monitoring of the operations and business of the investee company.
The main purpose of appointment of such person(s) is to safeguard the interest of the nominator, without conflicting with his/ her fiduciary duty as a director. Such a director has several roles and responsibilities, including adequate disclosure of interest, reporting to the nominator and protection of the interest of the company in its entirety. In case of holding such a position in widely held companies or publicly listed/traded companies,, the person should act in accordance with the operations of such entities, guided by industry specific statutory provisions in addition to the general roles and responsibilities expected of them.
Under Companies Act, 2013, the appointment of a nominee director is made in accordance with section 161(3):
“(3) Subject to the articles of a company, the Board may appoint any person as a director nominated by any institution in pursuance of the provisions of any law for the time being in force or of any agreement or by the Central Government or the State Government by virtue of its shareholding in a Government company.”
Conventionally, a nominee director is “nominated” by a nominator. The nominator has all the rights with respect to appointment, removals and the terms and conditions of appointment form part of agreement entered into with the company by such investor or creditor or other stakeholders.
Several recent developments have been symptomatic of corporate governance challenges and increasing the liability exposure to non-executive directors. The unexpected default at Infrastructure Leasing & Financial Services, triggered a liquidity crisis for non-banking financial companies, and other similar crisis resulted in an increase in the number of exits from the board. Companies in the country witnessed 316 exits by independent directors in financial year 2018-2019, which was 31.7% more than the previous year when only 240 independent directors had quit. Of the total, 99 independent directors left after their terms expired, 54 others cited preoccupation, 31 for personal reasons and 10 for health. In addition, about 50 of them quit without giving any reason. These numbers are startling and urges a relook into the ambit of liabilities that encompasses the non-executive directors.
This Article summarises the liabilities, duties, roles and responsibilities of nominee directors, also attempts to list down the best practices/do’s and don’ts of a nominee director and the position of nominee director under the law.
ROLES AND RESPONSIBILITIES OF NOMINEE DIRECTOR
Act as a ‘watchdog’: A nominee director needs to oversee the operations of the investee company and ensure the policy decisions are based on sound commercial lines, rationale and adequate safeguards and also act as liaison between the investee company and the nominator.
Participation and decision making: A nominee director is a non-executive director; however, he should be actively involved in decisions pertaining to financial performance of the investee company, fund-raising plans including debt-raising, investments, etc. He should make his presence felt by placing his expertise at the disposal of the Board of the investee company and actively participate in such meetings, which have a bearing on the interests of the nominator. He should also not abstain from voting on resolutions considered at the meetings of the Board of the investee company, involving the nominator, unless involving any personal interest of the nominee director.
Maintain Confidentiality: A nominee director should exercise adequate care and caution while dealing with unpublished price sensitive information, in case of listed entity, having come to know of the same or being in a position where he is likely to be aware of such information. The nominee director is always required to abide by the code of conduct to regulate, monitor and report trading by insiders framed by the listed entity.
In Harkness V Commonwealth Bank of Australia Ltd (1993) 32 NSWLR 543, the judge held that the duty of confidentiality of a director was greater than the duty he owed to his nominator.
Vision, mission and values: A nominee director should play a vital role in policy making of the investee companies and should take active part in development of investee company’s vision, mission and values and additionally also suggest good corporate governance practices in conducting the business which will help in building the good-will of the company.
The nominee director should also contribute to the growth of the investee company with his experience in analysing the market scenario.
Dairy Containers Limited v NZI Bank Limited & ORS; Dairy Containers Limited v Auditor General & ORS, New Zealand Court in 1994, held that reporting by nominee director to the nominator is natural and comes out of loyalty. However, in case of any conflict of interest, the loyalty to the company overrides the loyalty to the nominator.
Similarly, in Bennetts v Board of Fire Commissioners of New South Wales((1995) 7 BOND L R), the following remark was made: “In particular, a board member should not allow himself to be compromised by looking to the interests of the group which appointed him rather than to the interests for which the board exists. He is most certainly not a mere channel of communication or listening post on behalf of the group which elected him.”
Disclosures: The nominee director should disclose his interests and disqualifications to the investee from time to time as required under section 184 and 164 of the Companies Act, 2013.Such nominee director is also responsible for updating the nominator on various developments of the investee company, which may have an adverse impact on their interest.
Updated with latest Policies and Laws: The nominee director should keep himself updated with the latest policy developments and amendments in applicable laws, which may have a direct or indirect bearing on the working of the investee company and/ or discharge of his duties as a nominee director.
LIABILITIES OF NOMINEE DIRECTOR:
Liabilities under the Companies Act, 2013:
- The duties of directors as codified under Section 166 of the Companies Act, 2013 do not distinguish between an executive and a non-executive director; hence, obligates a non-executive director almost on an equal footing as an executive director.
- The office of nominee director will become vacant if such director incurs any disqualifications and other provisions provided under the section 167 of the Companies Act, 2013 including being absent from board meetings, failing to disclose interest in any contract/arrangements or being convicted by a court of any defence etc.
- Section 149(12) holds non-executive director (including nominee directors) liable in respect of such acts of omission or commission by a company which had occurred with his knowledge, attributable through board processes, and with his consent or connivance or where he had not acted diligently.
M/S Daewoo Motors India Ltd. vs. WG CDR (Retd.) H.D. Talwani): The mere fact that the applicant was only a nominee director of company would not by itself be a ground to absolve applicant from liability of compliance with directions contained in Section 454 (2) of the erstwhile Companies Act, 1956.
Liabilities under the Shareholders’ Agreement:
The nominee director is liable to the nominator in terms of delivering his duties and managing the responsibilities. The nominee director being the representative of the nominator is required to ensure all the rights of the nominator are safeguarded by updating the developments in the investee company which may affect directly or indirectly the interest of the nominator.
The investee company should abide by the rights of the nominator in terms of providing required notices, obtaining consents for veto matters, serving information as required on timely basis. These rights bring in another layer of obligation on nominee directors to remain diligent while examining the information/documents and taking into consideration such information while discharging duties as a director and any failure in exercising utmost diligence can further cast the shadow of liabilities under various laws in India.
Liabilities under other statutory laws:
In respect to other applicable laws, while it is difficult to provide any standard that would determine an individual’s exposure to liability, it has generally been seen that ‘only those persons are held liable for wrongdoing committed by a company, who were in charge of, and responsible for, the conduct of the business of the company at the time of commission of an offense’. Such liability may not always be foreseeable, and actions such as the violation of environment protection laws, dishonouring cheques, offenses under the Income Tax Act of 1961 or Goods and Services Tax Act, 2016, violation of foreign exchange regulations, breach of securities regulations, non-payment of provident fund contributions, violation of the Shops and Establishments Act, or food adulteration, could result in liability that may not always be limited to the executive directors.
Further, it is vital to understand that the liabilities fastened on directors under the provisions of other legislations are enforceable as per the relevant legislation and the directors cannot take shelter under the immunity provided in the Companies Act, 2013.
POSITION UNDER THE LAW:
The Companies Act, 2013 outlines the provisions pertaining to the functionality of the nominee director. The key provisions to take note of are:
- The section 2(10) of the Companies Act, 2013 (the Act) states that “Board of Directors” or “Board”, in relation to a company, means the collective body of the directors of the company. Further, in terms of section 2(34) of the Act, “director” means a director appointed to the Board of a company.
- The nominee director: (i) does not retire by rotation and not counted for purposes of number of directors liable to retire by rotation; (ii) is not required to hold any qualification shares; (iii) will be counted for the purpose of quorum at the meetings of the board of director of a company; (iv) is required to disclose his interests in other companies, firms, body corporates, etc; (v) is required to sign prospectus, register of contracts like any other director; and (vi) is entitled to sign other documents including financial statements, consents, attendance registers, advertisement for public deposits, returns, extracts etc.
- The nominee director of a company in his capacity as a “director” should abide by the duties as provided under the section 116 of the Companies Act, 2013. Accordingly, the nominee director should:
- act in accordance with the articles of association of the company;
- exercise his duties with due and reasonable care, skill and diligence and exercise independent judgment;
- act in good faith and for the benefit of the members of the company as a whole;
- not involve himself in a situation in which he may have a direct or indirect interest that conflicts, or possibly may conflict, with the interest of the company;
- not achieve or attempt to achieve any undue gain or advantage either to himself or to his relatives, partners, or associates. If such director is found guilty of making any undue gains, he can be held liable to pay an amount equal to such gain to the company; and
- not assign his office and any assignment made by him will be void.
The duties listed under Section 166 of the 2013 Act are general and broad to cover the lawful, fiduciary and ethical obligations of a director with respect to the company.
DO’s AND DONT’s BY NOMINEE DIRECTOR:
A nominee director should be careful and consider certain DO’s and DONTs while delivering his duties:
Discipline & Involvement: A nominee director should:
- attend the board meetings regularly and effectively and work in the spirit of co-operation.
- study the board papers thoroughly and use the good offices of the executive directors/officers for eliciting any information at the meetings of the board of directors.
- procure the board papers and follow-up reports on a definite time schedule.
Constructive & Developmental Role: A nominee director should:
- welcome all constructive ideas for better management and for making valuable contributions.
- Make efforts to provide required guidance and knowledge for effective management of the company.
- work as a team and not sponsor, or be prejudiced against any individual proposals.
Non-interference: A nominee director should not:
- interfere in the day-to-day functioning of the investee company.
- send any instructions/directions to the employees or officers of the investee company in any manner.
No sponsorship: A nominee director should not:
- sponsor any loan proposal, buildings and sites for company’s premises, enlistment or empanelment of contractors, architects, doctors, lawyers, etc.
- approach or influence for sanction of any kind of facility.
- participate in the board discussion, if a proposal in which he is directly or indirectly interested and should disclose the interest well in advance to the management.
- sponsor any candidate for recruitment or promotion or interfere in the process of selection/appointment or in transfers of staff.
- do anything which will interfere with and/or be subversive of maintenance of discipline, good conduct and integrity of the staff.
- involve himself in any matter relating to personnel administration whether it is appointment, transfer, posting or promotion or redressal of individual grievances of any employee.
- encourage the individual officer/employee or unions approaching them in any matter.
Confidentiality: A nominee director should not:
- reveal any information relating to any constituent of the company to anyone as, he is under oath of secrecy and fidelity.
- directly call for papers/files/notes recorded by various departments for scrutiny etc. in respect of agenda items to be discussed in the meetings. All information/clarification that they may require for taking a decision should be made available by the executive director of such company.
A nominee director plays a significant role as he/she will be the representative of the investor as well as guide / mentor to promoters of the company to drive the business towards larger growth in the ecosystem. The decisions of the nominee directors are always two folded given that neither the rights of the investor can be breached, nor the interest of the company/stakeholders can be affected. Hence, the nominee director has a key and balancing role between the investor and investee company.
This material and the information contained herein prepared by Algo Legal is intended to provide general information on a subject or subjects and is not an exhaustive treatment of such subject(s). Algo Legal is not, by means of this material, rendering professional advice or services. The information is not intended to be relied upon as the sole basis for any decision. Algo Legal shall not be responsible for any loss whatsoever sustained by any person who relies on this material.