The duties of nominee directors require greater clarity
PremiumA hazy law and the Tata-Mistry ruling have raised questions of corporate governance that await answers
Recently, when the Securities and Exchange Board of India (Sebi) introduced changes to the institution of independent directors (IDs), some pointed out that the role of nominee directors (NDs) should be strengthened too.
However, more than role-strengthening, there is a need to clarify their duties: whether they can accord priority to the nominator’s interests over that of the company’s, and whether their duties should be more ‘dynamic’ than considered before.
This first ambiguity arises in light of the duties of directors under Section 166(2) of the Companies Act, 2013. This is furthered by the Supreme Court’s observations on the duties of NDs in the recent Tata-Mistry case, wherein the ousted chairman of Tata Sons alleged, among other things, that the company’s ND gave priority to the nominator’s interest over that of the enterprise.
If every director was meant to have the same duty of exercising independent judgement, the court wondered aloud, then why would there be a provision mandating the appointment of IDs to the board?
So, the question is: Can NDs accord precedence to their nominator’s interest?
In various jurisdictions, such as the UK, NDs cannot give precedence to their nominator’s interests. At best, they can ‘consider’ that interest. This is considered to be the legal position in India too.
Arguably, however, this is an outdated analysis of the duties of NDs under Section 166(2) of the 2013 Act. As per this section, a director should not only promote the objectives of the company for the benefit of its members as a whole, but also work in the best interests of employees, the community, shareholders and the environment. Therefore, it should be permissible for NDs to grant precedence to a nominator’s interest should it also be in the interest of employees, the community, environment or any particular faction of shareholders (like the nominator).
Scholars such as Umakanth Varottil and Mihir Naniwadekar may disagree with this view. They argue that prima facie, it may appear that under Section 166(2) directors can treat the interest of non-shareholders as an end in itself (called the ‘pluralist model’). However, on scrutiny, it emerges that such interests can be given importance only to ultimately enhance shareholder interests. So I disagree with their opinion in the context of NDs. First, Varottil and Naniwadekar have reasoned that non-shareholder stakeholders cannot enforce their so-called rights under Section 166(2) in case directors ignore their interests. While this viewpoint is correct, it only focuses on the failure of Section 166(2) to provide a ‘sword’ in the hands of non-shareholder stakeholders if directors fail to work for their welfare, and neglects the ability of the law to provide a ‘shield’ in the hands of a non-shareholder stakeholder or director in case directors prioritize the non-shareholder stakeholder interest over that of shareholders or the company. It is this ‘shield’ that should allow NDs to accord precedence to their nominator’s interests.
Further, Varottil and Naniwadekar interpret Section 166(2) in light of the committee reports and legislative debates preceding it. As per the rule of literal interpretation, this is not appropriate, especially while interpreting the duties of NDs. This is because the language of the section is clear and does not create the above-mentioned enforcement problems flagged by Varottil and Naniwadekar, specifically in the context of NDs.
Another concern which they’d had while arguing that Section 166(2) indeed adopts a pluralistic approach was that it would give unbridled discretion to directors by allowing them to work for the benefit of any stakeholder at the cost of the company. However, this concern does not apply equally to NDs, as they need to strike a balance just between the company’s and their nominator’s interest.
Hence, it may be legally possible for NDs to accord priority to the nominator’s interest, and principles such as the business- judgement rule would stop our courts in most cases from interfering with the exercise of an ND’s discretion over when to do so.
Next, are the duties of NDs or directors more dynamic than widely believed? The apex court in the Tata-Mistry case surmised that NDs may not necessarily have to act with full independence in relation to the company if there are sufficient IDs on its board to act objectively. The court also found that NDs may prioritize the nominator’s interest over the company’s on account of the profile of the nominator, in this case Tata Trusts, a group of charitable organizations working for the welfare of society and not private individuals.
This raises some legal questions. Can there be other circumstances (say, in the case of an ND appointed as a result of a joint-venture deal) that can influence the ND’s duties so heavily as to justify according priority to the nominator’s interest? On a separate note, by analogy, can this level of ‘dynamism’ exist in relation to the duties of ordinary directors? For example, can a director who is a promoter show less objectivity in company decisions if there are enough IDs on its board?
The language of Section 166(2) and the Tata-Mistry ruling have introduced new possibilities vis-a-vis the duties of NDs. More than strengthening their role, we require clarity on their duties, which can have ripple effects on the duties of other directors. Are our policymakers listening.
Anamika Dudvaani and Namrata Rawat, student research fellows at The Corporate House, contributed to this column.
Priya Garg is an advocate, Delhi high court, and assistant lecturer, OP Jindal Global University
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