Government & Politics

A Critical Essay on Sections 297 and 299 of the Companies Act, 1956

This is an essay on one of the most complex sections of Indian Companies Act, 1956. This Essay Critically explores the implications of Section 297 and 299, ie, the interest of Directors in the contracts executed by the company.
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    A Critical Essay On Sections 297 And 299 Of The Companies Act, 1956   Author : Miss Shelly Ghosh    Abstract – the directors of a company holds a position of trust and to act in utmost good faith. They hold a fiduciary position which requires them to disclose their interest, whether direct or indirect, inany contract or any transaction they have entered into with the company. This duty of disclosureensures fairness in the dealings with the company and avoidance of conflicting interests between thecompany and the director. The paper tries to deal with the consequences of non-disclosure, theremedies available to a company under such circumstances by attempting a comparative study between the Indian and the English Laws. I. Introduction -  The position of directors in relation to the company is an amalgamation of several elements. Thedirector can be an agent in that he acts not on his own behalf but that of the company. He can besaid to be a trustee, in that although he does not own company assets he controls the assets andexercises powers for the company’s benefit and not his own. As such he owes fiduciary duties to thecompany. He can be an employee, in that a paid, executive director has similar rights and duties tothose of any other employee. He can also be a professional advisor, in that he renders services forreward and must accept the burden of skill and care which falls upon independent contractors of thattype. The director does not exactly fall within any of these categories, but his duties can be derivedfrom these principles and can be divided into duties of good faith and duties of care and skill. 1 Therole of equity provides that no fiduciary may profit from his position as a fiduciary. No man whostands in a position of trust towards another can in matters affected by that position, advance hisown interests for example by making a profit at that other’s expense. 2  The activities of fiduciaries canbe categorized into two broad groups- v   Cases where the fiduciary has acted with proven dishonesty or has acted contrary to hisprincipal’s interest; and v   Cases where the fiduciary has acted honestly and in the best interests of his principal. 3  As the rules of equity implicate, once a fiduciary is shown to be in breach of his duty of loyalty hemust disgorge any benefit gained even though he acted honestly and in his principal’s best interests,  even though the principal benefited as well as he from his conduct. 4  The directors as fiduciaries must not place themselves in a position in which there is a conflictbetween their duties to the company and their personal interests or duties to others. The courts haveadopted a severe method of ensuring that the trust and confidence reposed in a fiduciary such as adirector are not abused, and the fundamental principle was stated by    Lord Herschell in Bray v Bradford. 5 It cannot however be said that a director owes a duty to the company not to make anunauthorized profit and not to be in a position in which interest and duty, or duty to the company and duty to another, conflict. 6 The law should be analysed as if a director does make unauthorizedprofits from the directorship, or is in a position of conflict of interest and duty, or conflict of duty tothe company and duty to another, then the company will be given a remedy by the courts. 7 If atransaction between a company and one of its directors profits the director or involves a conflictbetween the director’s duty to the company and personal interest and duty to another, then thetransaction is voidable at the company’s option. 8   This paper tries to critically examine the director’s disclosure requirements. The paper is broadly divided into four parts. Part II deals with the director’s duty of disclosure under the English law. PartIII examines the Indian position with a detailed study of sections 297 and 299 of the IndianCompanies Act, 1956. Part IV concludes with an analysis of the slippery slope situation the directorsfind themselves in. II. The duty of disclosure of interest and the English law—  By the middle of the nineteenth century it was firmly established that the fiduciary position of thecompany was liable to vitiate any contract involving transactions with the company. 9 In the absenceof express provision in the company’s articles, the only effective step for the directors was to makefull disclosure to the members of the company and to have the contract entered into or ratified by thecompany in the general meeting. This provision was recognized by section 29 of the first Joint Stock Companies Act of 1844. This section was omitted from the Act of 1856 and only an article in theoptional Table was inserted. It provided that any director, directly or indirectly interested in any contract with the company (except an interest merely as shareholder of another company) should bedisqualified and vacate office – a provision which was taken from the Companies Clauses  Consolidation Act of 1845. 10 This situation remained till the 1948 Act. As contracts with directors became very common, such as service agreements and contracts in whichdirectors were interested, the disclosure requirements became common-form in the articles of registered companies. The legislature intervened and section 149 of the 1929 Act made it mandatory for the directors to disclose their interests in a contract or proposed contract with the company at ameeting of the directors. This section became section 199 of the 1948 Act, and the ambit wasextended from “contracts” to “contracts, transactions or arrangements” and applied to shadow directors. This section is now section 317 of the 1985 Act. 11   The inter-relation between section 317 of the 1985 Act and the general equitable principle wasconsidered by the Court of Appeal in the case of Hely-Hutchinson v Brayhead Ltd 12 and the Houseof Lords in Guinness v. Saunders. 13 Failure to comply with section 317 makes the director liable topay a fine. Failure to comply with the equitable duty of disclosure enables a company to rescind thecontract or claim the profits made by the director in the transaction. If a company A proposes tocontract with company B and a director of company A is a member of company B then themembership is an interest which must be disclosed under section 317 (1). 14 Disclosure of interest in acontract must be made even if the contract is a loan or other transaction which is illegal unders.330. 15  Disclosure is not limited to contracts which are considered by the Board. This is particularly essentialin the case of a sole director of a company who is interested in a company contract. He must hold aboard meeting and record his interest in the minutes in order to comply with s.317 (1). 16 An equitabledeclaration of interest by a director can be qualified or excluded by the Articles of Association of acompany. A general provision in the articles may by itself prescribe that declaring an interest is acondition for disapplying the rules: under Table A, declaration of an interest is required by Art. 84but that article only requires disclosure of any ‘material interest’ whereas section 317 (1) requiresdisclosure of any interest. III. Disclosure of interest by directors under the Indian law –  It is essential for the proper exercise of the function of the director, that he is disinterested and free  from any conflicting interest. The Indian Companies Act, 1956, lays down certain procedures to befollowed in sections 297 and 299. Section 297 deals with requirement of the Board’s sanction to berequired for certain contracts in which the particular directors are interested. Section 299 deals withthe disclosure of interests by director.  A. Board’s sanction required when director is interested (section 297) -  The object of the section is that the Board of Directors should have knowledge of the extent of interest of a director in any contractual dealings with the company, or of any person connected withthe director in any of the ways mentioned in subsection (1), and accord their consent to suchdealings. 17 The consent contemplated is not a general consent but consent referable to each particularor specific contract. Consent requires knowledge of the necessary facts and materials which leads tothe consent and cannot be given in a general or abstract manner. 18  Scope of the section – this section does not apply to contracts between two public companies andalso is not attracted to a transaction of loan made by a director to the company because it is not a saleor purchase of goods or a contract to render services. 19 If ‘A’ is a director of X Ltd. and also adirector or a member of Y Private Ltd., then this section will apply to contracts between these twocompanies, subject to the exceptions provided therein. However, if only the relatives of A aredirectors or members of Y Private Ltd., and not ‘X’ himself, then the section will not apply.Central Government approval required when directors are interested – this proviso was added by theCompanies (Amendment) Act, 1974, to check the abuse of power by the directors. As providedunder the section, for entering into such contracts, the director concerned only has to disclose hisinterest in the subject matter of the contract and have it sanctioned by the Board of Directors. This isnot considered sufficient to safeguard the interests of the company, especially when directors are in aposition to take advantage of inside information for personal gain. Also, even among the directors anunderstanding is created that when their turn comes they be accorded similar treatment, which is sortof a mutual back scratching policy adopted by them for overall benefit. Hence, it is proposed tostrengthen section 297; approval of Central Government is required in case of a company with a paidup capital of Rupees One Crore or more with the objective that the terms of the contract are at arm’slength. 20
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