This article explores the practical issues surrounding the vicarious liability of directors under Indian law. The views are based on relevant Indian legislation and judicial precedent. The article has been published by Chambers & Partners at Reviewing the Liability of Directors in India | Chambers Expert Focus.

Vicarious Liability of Directors under Indian Laws

Indian law establishes that directors cannot be held vicariously liable for offences committed by a company unless specifically provided for by legislation. In this context, penal provisions within various Indian laws stipulate punishments for such offences, holding both (i) the company and/or (ii) those in charge of and responsible for the company’s affairs to be guilty of the offence.

In both instances, and particularly concerning (ii) (ie, those in charge), certain individuals associated with the company, including directors, officers, and managers, are identified as being potentially liable. However, there are statutory safeguards available to these individuals, which are otherwise also codified as fiduciary duties of such individuals. They can avoid liability if they can demonstrate that the offending act was committed (i) without their knowledge, or (ii) that they exercised due diligence to prevent it, or (iii) that no negligence, connivance, or consent can be attributed to them. Consequently, the role and responsibility of the directors in relation to the company’s affairs becomes pertinent in the context of these safeguards. If evidence contradicts any of these three points – in other words, if any of (i), (ii), or (iii) cannot be established – then the corresponding liability can be imposed, as the exception to the deeming provision would not apply.

This raises the question: is a director, by definition, the person in charge of or responsible for the company’s affairs?

To answer this, we must determine what constitutes “affairs of a company” in relation to a director’s role. For example, if a director is specifically tasked by the board (through a recorded resolution) with ensuring statutory compliance, and non-compliance occurs, that director will be held liable. This responsibility could also be part of their employment terms, again resulting in liability for non-compliance. This principle also applies to closely held companies where promoters are also directors and manage the company’s affairs.

Conversely, if no such specific responsibility has been assigned and non-compliance occurs, the director must demonstrate that they were not in charge of or responsible for the relevant “affairs” of the company. In essence, they need to show how the statutory safeguards discussed earlier apply to their situation.

The term “affairs” should ideally be interpreted on a case-by-case basis. For instance, the involvement of a non-executive, investor, or independent director might be limited to the company’s “financial affairs” and not extend to “compliance-related affairs”. In such cases, “affairs” should be construed narrowly, focusing on financial matters, and not given a broad interpretation. Consequently, the “knowledge” criterion of the statutory safeguards mentioned earlier might not be established.

Furthermore, even a whole-time director’s involvement could be limited to financial affairs. Similarly, a company might appoint someone other than a director to be responsible for, say, statutory compliance. In such cases, the directors should not be held liable for any non-compliance. Therefore, the specific role played by the directors in question is crucial when considering the affairs of a company.

Practical Challenges Faced by Directors

In practice, government authorities enforcing penal provisions under various laws (such as labour inspectors, drug controllers, and inspectors monitoring air and water pollution) sometimes implicate directors simply because (i) an offence was committed by a company, and (ii) the company operates through its board of directors, therefore the directors must be liable.

Criminal complaints are often filed in court based on this premise. Furthermore, trial courts sometimes summon directors on this basis, creating fear of criminal prosecution and the potential for imprisonment where the relevant statute allows. However, a court summons should presuppose due application of mind, which is often challenged in these cases on the grounds that the implicated director had no actual role in the offence.

Additionally, the interpretation of the phrase “person in charge of/responsible for the company’s affairs” is often stretched beyond its reasonable meaning, even when evidence suggests otherwise. For example, consider a licensing violation at a company-owned unit managed by a designated manager. A director might still be implicated simply because their name appears in the records of the Indian Ministry of Corporate Affairs.

This is particularly true if the company has a managing director, who is often targeted on the basis that they are entrusted with significant management powers. In this regard, the Indian Companies Act, 2013 describes a managing director to mean, inter alia, a director who, by virtue of the articles of a company or an agreement with the company or a resolution passed in its general meeting, or by its board of directors, is entrusted with substantial powers of management of the affairs of the company. However, at times, no assessment through evidence is made in respect of (i) what the “substantial” powers of management are, or (ii) how, owing to such powers, the offending act would come within the purview of the role of a managing director, or (iii) a comparison of the powers of a managing director vis-à-vis another director, in order to conclude that owing to such additional powers/role, it was the managing director who was responsible.

Key Takeaways

Given the current landscape of vicarious liability for directors in India and the increasing risks associated with the position, even when involvement is limited, companies should consider the following: (i) reviewing employment terms; (ii) clearly defining the roles and responsibilities assigned to directors, especially managing directors; (iii) implementing awareness programmes for directors to emphasise fiduciary duties and provide an overview of director liability under Indian law; (iv) reviewing company policies, including those related to delegation of authority; and (v) establishing clear guardrails, where applicable, to mitigate risks.