Directors and Officers Liability Insurance

Sidebar_image1 Sidebar_image1 Sidebar_image1
1 3 2 4 5 6
Sidebar_image1 Sidebar_image1 Sidebar_image1

Introduction– The Companies Act, 2013 (“The Act”) defines a director to mean a director appointed to the Board of a company. The Act consists of the concept of an ‘officer who is in default for the purposes of affixing liability on such person in respect of any contravention of the provisions of the Act by the company. The ambit of ‘officer who is in default’ is wide and includes, inter alia, every whole-time director. 

1. Liability to the company:

  • Breach of fiduciary duty: Directors hold the office of trust along with power and are expected to exercise this power in the best interest of the company. If such duties are discharged dishonestly, there is a breach of fiduciary duty. In conflicts of interest, the concerned director should make complete disclosures and obtain the confidence of stakeholders to prevent liability. 
  • Ultra-vires act: Directors have powers subject to the Companies Act, Memorandum, and Articles of Association, and exceeding these makes them personally liable. But if acts are intra-vires they can be ratified by the shareholders in the general meeting. 
  • Negligence: As long as the Directors exercise reasonable care and due diligence, they are fulfilling their duties. But if there is a failure to exercise such care and caution, they are deemed negligent in their conduct and are personally liable for the consequent damages. But, an error of judgment is not considered negligence.  
  • Mala fide acts:  Directors are trustees for the money and property of the company. They hold an office of trust and if they misuse their powers, they will be liable for breach of trust and may be required to reimburse the company for any loss suffered because of such an act. 

2. Liability to third parties 

The directors as agents of the company are not usually personally liable to third parties for any transaction entered on behalf of the company. They can be held personally liable only in exceptional circumstances when they contract in a personal capacity, or when the principal is not disclosed, when it is a pre-incorporation contract, or when the contract is ultra-vires the company and is not ratified subsequently.

3. Criminal liability of directors- 

  • Liability based on attribution The debate on whether the director is held responsible for criminal acts of the company by applying the concept of alter-ego is settled by the Supreme Court in Sunil Bharti Mittal v. Central Bureau of Investigation. In the case, the Court mentioned that the concept of alter-ego can only be applied to make the company liable for the acts of the directors. However, any director cannot be made responsible for the criminal offenses committed by the company unless the statute specially provides for the same.
  • Vicarious liability A significant question is a matter of debate in the Indian Corporate landscape, i.e. can a company be held responsible for the criminal act done by its employees? This question has been settled by the Supreme Court in the case of Iridium India Telecom Ltd v. Motorola Incorporated, wherein, the Supreme Court analyzed the criminal liability of the company for the action of its employees. In this case, the court observed that the criminal liability arising from the actions of the person in control of the company will be attributed to the company but not the other way around.
  • Fraud under the Companies Act – In section 447 of the Act fraud is defined as any act or abuse of position committed with an intent to deceive, to gain undue advantage from, or to injure the interests of a person, company, shareholders, or creditors whether or not there is wrongful gain or loss then the person will be liable for imprisonment up to 10 years. However, if no express provision is provided for the director for vicarious liability under the statute then the individual cannot be prosecuted unless the active role was played by him with criminal intent. Moreover, the Indian Penal Code does not contain any provision on vicarious liability which means that a director can only be prosecuted if he has played an active role with criminal intent.
  • Liabilities in case of Independent Directors and Non-Executive Directors- The Independent Directors and Non-Executive can be held liable only if the following conditions are satisfied: – Acts of omission or commission by a company which had occurred with his knowledge, attributable through Board Process;
    and – with his consent or connivance or where he had not acted diligently. 

Safeguarding tools 

  • Indemnification– It is settled law in India that companies are criminally liable for offenses committed by its employee if committed within the scope of their employment. However, courts have repeatedly held that the other way is not true, an employee cannot be held liable for the offenses committed by the company but still, the jurisprudence on this subject is under development. Hence, it is important for directors to hedge the risk arising therefrom. As there is no bar under the existing provisions of the Companies Act, directors must insist on the indemnification clause in the shareholder’s agreement and also in the appointment letter issued by the Company. The foregoing mechanism will help the directors to safeguard themselves in case of any claim arising from any third party due to their bonafide actions in the company.
  • Directors & Officers Liability Insurance: Another tool available to the directors is to push the company to obtain the Directors and Officers Liability Insurance to hedge against any pecuniary liability arising on the directors.
    Ideally, these insurances should have a part of the sum assured reserved for non-executive directors.

NOTE: For ascertaining liability, the participation of the director is immaterial, as even if the director did not take part in the board meeting, but, if the information about a contravention is contained in any of the proceedings of the board received by him, he is deemed liable. Hence, a director must ensure that any objection raised by him at a board meeting is recorded in the minutes and that any minutes received by him are read.