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What are the Legal Liabilities of a Director in a Private Limited Company?

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Last Updated on June 22, 2024 by Kanakkupillai

The Indian corporate sector and our economics in the international market are growing due to the government’s attempts to liberalize foreign investment rules and create a conducive business climate. On the other hand, money-siphoning scams and frauds, irregularities in accounting, non-compliance, and corruption have all entered the business world and have created an uncharted region that requires rapid attention.

Consequently, it became extremely vital for us to grasp the Rights and Liabilities of the Directors of the Company with the implementation of the Companies Act 2013. Legal action against the company’s directors may be taken under the provisions of the 2013 Companies Act. Therefore, each individual should be aware of their responsibilities and liabilities before joining the board of directors of a corporation.

However, director liabilities—which include civil and, in certain situations, criminal liability—are not just confined to offenses committed in violation of India’s Companies Law; they also include offences in violation of numerous other legislations. To prevent potential legal repercussions, it is essential for directors to maintain knowledge of applicable laws and regulations and to assure compliance. Through this article, a deeper analysis of the same can be found.

Types of Directors in a Private Limited Company

According to the Companies Act of 2013 regulations, every company must have a minimum of three directors for public limited companies, two for private limited companies, and one for OPC. An organization may have a maximum of 15 directors. The general meeting (GM) might approve a special resolution if the organization needs extra directors. Generally, directors can be classified as either executive or non-executive.

1. Executive Directors

The executive director serves as the company’s working director full-time. The organization holds them to a higher standard. In all interactions between the organization and its employees, they must be effective and cautious. Both Managing Directors and Whole-Time Directors fall under this category.

2. Non-executive Directors

Non-executive directors are non-working directors without involvement in the organization’s daily activities. They can receive an invitation to participate in formulating plans or policies. They urge the executive directors to come up with choices and solutions that are in the business’s best interests. Likewise, they come in two types: nominated and independent.

Alternate directors, additional directors, and casual vacancy directors are some other categories of directors based on appointment. Other sorts of directors include shadow directors, women directors, residential directors, and small shareholders directors, represented as miscellaneous types of directors.

Key Liabilities of Directors

When it comes to organizations that have precautions in place for senior executives and owners, the responsibility of company directors is frequently non-existent. Even if someone in a senior position makes a poor choice, the law won’t hold them accountable until a specific obligation has been broken.

In addition, anyone found guilty of fraud involving at least ten lakh rupees or 1% of the company’s sales, whichever is lower, will be sentenced to imprisonment that cannot be less than six months. However, that might go up to ten years, and they would also be subject to a fine that couldn’t be lower than the sum involved in the fraud but could go up to three times that amount.

A director could be held liable to a company in the following scenarios:

1. Civil liabilities

  • Breach of statutory duties: The directors are subject to many statutory obligations under the Companies Act’s several sections. Penalties apply when these obligations are not fulfilled. The numerous statutory penalties a director may face for breaking the terms of the company’s act are mentioned when appropriate.
  • Breach of fiduciary duties: A director will be held accountable for a breach of fiduciary responsibility whenever they act dishonestly to serve the company’s best interests. As previously stated, most of a director’s abilities are “powers in trust,” which means they should be used for the company’s good rather than for the director’s personal gain or the gain of other members.
  • Ultra-vires act: Directors’ authority is limited by the Memorandum, the Companies Act, and the Articles of Association; going beyond these carries personal liability. However, if an act is intra-vires, the shareholders present at the general meeting may approve it.
  • Negligence: Directors are held personally accountable for the resulting damages once it is determined that they failed to exercise reasonable care and precaution. The mistake in judgment won’t be regarded as negligence, though.
  • Mala fide acts: The directors hold the organization’s assets and money in trust. They are accountable for violating the trust placed in them by their office if they abuse their authority. They can be required to repay the business for any damages brought about by such conduct.

2. Criminal liabilities

Offenses under company law

According to the business act requirements, a company’s director may be held accountable for any loss or damages incurred by the company due to any violations committed by him or her and failure to disclose a personal financial interest in a specific topic.

The daily operational duties of the corporation that fall under the description of officers are the responsibility of the full-time director or key managerial individuals (such as the CEO, MD, CFO, and CS). An “officer who is in default” is now responsible for the company’s default under the statute.

Fraud and misrepresentation

The director may be held personally responsible for any debt incurred if they forged or misrepresented information when requesting credit or a loan on the company’s behalf. The directors must also keep up-to-date and correct company records. If he fails, he might be held personally responsible for some of the business’s debts.

Dishonoured Cheques

The act of signing a voided cheque is prohibited. If a director engages in such behavior, the firm and the director could face criminal charges.

Vicarious Liability

According to the idea of vicarious liability, a person is judged to personally bear responsibility for the wrongdoings of another person. The supreme court has ruled that a director of an organization cannot be held accountable on the company’s behalf unless the act has statutory support. Furthermore, a person can only be held specifically liable if there is strong evidence that they actively participated in the wrongdoings.

Protection and Risk Mitigation for Directors

The daily operations of a firm depend heavily on its board of directors. As a result, individuals are responsible for losses caused by their recklessness or irresponsible behavior. Directors should undertake their obligations with diligence and caution to avoid personal liabilities.

However, as a director can’t be knowledgeable about every relevant clause of commercial law, directors and officers of the firm may choose some of the following crucial steps to protect their interests.

  • Generally speaking, indemnification refers to paying for costs that someone else has incurred. Directors can now request an indemnification policy to cover any liabilities they may have in the event of allegations of negligence, duty violation, etc. It is crucial to remember that a director cannot receive protection from responsibility in civil or criminal cases in which they are proven guilty.
  • Directors present at the board meeting must object to any action or item they believe to be improper, and they must remember that their objections must be noted in the meeting’s minutes.
  • The management ought to delegate to a professional organization with a built-in understanding of all applicable provisions to assist directors and the company in identifying any non-compliances early on and taking corrective action to address them.
  • Additionally, according to the law, directors must:
  • Follow the company’s articles of association at all times.
  • Act in good sincerity to further the company’s goals.
  • Exercise independent judgment, the utmost competence and diligence, and the obligation of care.
  • Act to benefit the organization, its workers, the community, its shareholders, and the environment.
  • Furthermore, independent directors should have more expertise and experience than external directors since they oversee the company’s continuing operations. Schedule IV of the Companies Act also codifies additional responsibilities for independent directors.

Conclusion

A director’s identity is different from that of the organization. The basic idea of a company having a distinct and autonomous legal personality may be traced back to it. As a result, a director is typically not held personally responsible for the company’s debts.

Directors must evaluate the company’s expected future revenue stream to manage business risks and give directors broad discretion in business judgment decisions. Directors must take into account the company’s long-term performance as well as short-term gains while making decisions. Considering the current economic setting, did the directors make appropriate assumptions in their future revenue projections?

If there are further cash outflows from the same period’s cash inflows, creditors could sustain significant losses. However, because a corporation is a separate legal entity from its owners, the legal principles outlined in the company law regime are intended to ensure that the company bears the liability rather than the shareholders. Suppose there is no profit margin on the products sold or the services rendered. In that case, the business will eventually reach a point when the shareholders’ risk capital has been depleted, and the directors are instead spending resources that might otherwise be available to pay off all debtors.

In this case, Kanakkupillai is a reputable financial consulting company that can offer knowledgeable guidance on financial projections and risk management. We can work with businesses to create plans to minimize potential losses and guarantee long-term success. Kanakkupillai can also help with compliance, company registration, and other legal issues about business law.  Companies may make wise decisions with our assistance that will safeguard their interests and stakeholders’ interests and prevent potential liabilities. Get in touch with us to learn more.

Kanakkupillai

Kanakkupillai is your reliable partner for every step of your business journey in India. We offer reasonable and expert assistance to ensure legal compliance, covering business registration, tax compliance, accounting and bookkeeping, and intellectual property protection. Let us help you navigate the complex legal and regulatory requirements so you can focus on growing your business. Contact us today to learn more.