Liabilities of Directors in Indian Companies : An Understanding (2nd October, 2022)

Almost 32 years have passed since India opened the way for the new era of commercial liberalization and reforms. This continuous and gradual opening up of the economy, driven by a robust growth in domestic consumer demand, has resulted in an increase of foreign investment, which in turn has strengthened Indian companies and it has also increased the duties and liabilities of directors of the Company. 

However, this impressive story of economic growth also has its dark side due to the wake of past various corporate scams and the initiation of legal proceedings against directors of several companies in India.

Therefore, it becomes very important for directors to understand their liabilities in the Indian corporate regulatory environment. However, liabilities of director, which includes civil and, in some cases, criminal liability, is not just limited to the offences committed under Companies law in India, but they are also liable for the offences committed under various other statutes like the Income-tax Act, Goods and Service Tax Act, Labour Laws and Foreign Exchange Management Act, etc.

Who’s the Director of the Company:

Though a company is a legal entity in the eyes of the law, it cannot act as a natural person. It must act through a human to control the management. Thus, the persons to whom the delegation is made are referred to as ‘directors’. 

The directors are the people who are responsible for the management of the company; they hold a position of trust towards the company and are accountable for the performance and control of the company. 

Some of the key liabilities of directors under various laws in India are: 

Companies Act, 2013: In terms of the provisions of the companies act, the director of a company may be held liable for any loss or damages sustained by the company as a consequence of any breach by him or her and due to failure to disclose a personal financial interest in a particular matter.

The whole-time director or key managerial persons (such as CEO, CFO, CS, and MD) are responsible for their association with the day-to-day operational activities of the company covered under the definition of officers. Under the act, liability for default by a company has been imposed on an ‘officer who is in default. 

Further, any other director could be held to be liable only with respect to specific contraventions which have occurred with such director’s consent or assistance. 

However, where the director was aware of violation by virtue of knowledge or participation in a board meeting without objection of the same, could make such director to the penal consequences. 

Income Tax Act, 1961: When any private company is wound up and the tax assessed in respect of any previous year, cannot be recovered, then every person who was a director of such private company at any time during the relevant previous year shall be jointly and severally be liable for the payment of such tax (includes penalty, interest, fees or any other sum payable under the act).

The liability does not extend to directors who did not hold office during the year with respect to which the tax recovery pertains. However, the burden of proof on a director to substantiate that non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on their part in relation to the affairs of the company.

Goods and Services Tax (GST) Act, 2017: GST Act provided that the personal liability of the directors jointly & severally in cases of default of taxes (including interest and penalty) committed by the companies for supply of goods or services or both for any period. Further, it says that anything mentioned in the companies act, that the company is a separate legal entity are automatically gets diluted when it comes to recovery of GST.

Labour laws: Currently, the labour laws applicable in India hold inter alia the director responsible for any non-compliances on the part of the company related to various norms prescribed for the company which needs to be followed by the companies (like payment of minimum wages, default in gratuity or wrongful disclosures etc.), unless he proves that the offence was committed without his/her knowledge or consent.

Foreign Exchange Management Act (FEMA), 1999: If the company contravene the provision of foreign exchange law in India, the “person in-charge” like director, who was responsible to the company for conduct of its business at the time when the contravention was committed, to be guilty of such contravention and director may also face the penal consequences and legal proceeding against them. 

Insolvency and Bankruptcy Code (IBC), 2016: The board of directors’ authority is suspended once the insolvency resolution procedure authorised under IBC 2016 begins, and a third party is chosen to manage the company’s business. Under IBC process, directors are held accountable for undoing the transaction or making a reasonable contribution to the company’s assets in order to protect the interests of the creditors. 

Other Laws: With Indian economy presents myriad and growing opportunities is evident that vicarious liability of a director, even though not absolute, is prevalent in a multitude of Indian laws such as the Prevention of Money Laundering Act, Prohibition of Benami Property Transactions Act, and Negotiable Instruments Act, etc. 

Possible measures for Directors to protect their interest:

With the multitude of legal compliances, and corporate frauds involving directors and management for tightening corporate governance norms. Therefore, it is the need of the hour for directors to be fully aware of their responsibilities and liabilities. 

However, for a director to have knowledge about every applicable provision of commercial laws is impossible, therefore director and officer of the company may opt for some of the following key measures to safeguard their interest.

  • Directors can mitigate the risk of personal liabilities through various safeguards like they may insist on the indemnification clause in the agreement with Company. This will help the directors and KMPs to safeguard themselves in case of any claim arising from any third party due to their bonafide actions in the company.
  • While taking part in the board meeting, directors must dissent to any activity or business which they feel is not correct in their view and they should keep in mind that their dissent must be recorded in the minutes of the meeting.
  • An inherent element of knowledge about every applicable provision, the management should outsource professional organization which may help directors and corporate to early detect and resolve any non-compliances with corrective measures.

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