Mr. V. Umakanth had noted here the recent trend of imposing civil liability on auditors which are owed directly to shareholders. He had pointed out that this constitutes a departure from the traditional wisdom that the duty of reasonable care in such situations were owed to the company and not its shareholders. Along similar lines, V. Niranjan had discussed the recent decision of the Supreme Court in Reliance Natural Resources Ltd v. Reliance Industries Ltd. in the Indian Corporate Law blog. In particular, he had drawn the readers’ attention to observations in Justice Sudershan Reddy’s opinion that, “the board has to act in a fiduciary capacity vis-a-vis the shareholders”. While this controversial assertion (it runs contrary to the general understanding that fiduciary duties of directors are owed to the company and the company alone) is perhaps nothing more than a mere passing remark in the Reliance case, it seems to derive support from various other sources as well.
Prof. Gower, for instance remarks [Gower, Principles of Modern Company Law, 6th edn., p. 599-600]:
This however, does not mean that directors can never stand in a fiduciary relationship to the members; they well may if they are authorised by the latter to negotiate on their behalf with, for example, a potential takeover bidder. And something far less than the establishment of an agency relationship may suffice, particularly, as an important New Zealand decision illustrates, in the case of a family company, “depending upon all the surrounding circumstances and the nature of the responsibility which in a real and practical sense the director had assumed towards the shareholder”.
Courts have however not been able to precisely enumerate the circumstances when such a relationship may exist between the directors and shareholders. The decision of the Supreme Court in Sangramsinh P. Gaekwad v. Shantadevi P. Gaekwad [AIR 2005 SC 809] offers some guidance. The court in that case held:
A Director of a Company indisputably stands in a fiduciary capacity vis-à-vis the Company. He must act for the paramount interest of the company. He does not have any statutory duty to perform so far as individual shareholders are concerned subject of course to any special arrangement which may be entered into or a special circumstance that may arise in a particular case. Each case, thus, is required to be considered having regard to the fact situation obtaining therein and having regard to the existence of any special arrangement or special circumstance. [Paragraph 44]
Though the court conceded that “it is impossible to lay down a law which will have universal application”, it went on to enumerate at least two instances where the directors owe a direct duty to the shareholders. The first is when the directors take it upon themselves to advice shareholders and the shareholders act on such advice. This arises especially in cases where the shareholders are faced with the choice of accepting or rejecting a take-over bid. [Paragraph 79] The second is in a case of “transaction of sale and purchase of shares between the director and the shareholder”. [Paragraph 75] However, this was clearly not meant to be an exhaustive enumeration. Consequently, the Supreme Court ruling in Dale and Carrington v. P.K. Prathapan [(2005) 1 SCC 212] seems to add a third category of cases to this list. The court in that case opined:
It follows that in the matter of issue of additional shares, the directors owe a fiduciary duty to issue shares for a proper purpose. This duty is owed by them to the shareholders of the company.
The duty of directors to exercise powers conferred on them only for the purpose for which such powers were conferred is a well-established principle. However, the decision in Dale and Carrington arguably supports the view that every breach of the ‘proper purpose’ doctrine is a violation of the directors’ duty to the company’s shareholders which gives rise to an independent cause of action to the shareholder.
Prof. Wedderburn in his article in the Modern Law Review in 1965 had argued that the shareholders “over and above their specific rights under the articles (to dividend, share certificates etc.)” have “a personal right to have the company administered according to the terms of the articles”. [K. W. Wedderburn, “Contractual Rights under Articles of Association: An Overlooked Principle Illustrated”, 28(3) Modern Law Review (1965)] Is the decision in Dale and Carrington not implicit judicial recognition, albeit in a limited sense (i.e. restricted to cases improper purpose) of Prof. Wedderburn’s much criticised view?
Wonderful post, KP. Couple of points. First, I think we can draw an interesting parallel with the controversy over the contractual effect of section 20 contracts. However, do you believe that Professor Wedderburn’s view is consistent with other well-settled principles of common law, such as for example the principles on alteration of articles? The “bona fide in the interests of the company” test was rejected by the Court in Gambotto mainly because it fails offer adequate guidance to courts, but it does make the point that the company as an entity cannot be conflated with the shareholders. Further, given that there is generally no relationship of trust between the shareholders and the Board, do you think Dale and Carrington is correct?
Thank you, Niranjan.
On the first point, I don’t think Prof. Wedderburn’s argument is that the company and its shareholders are to be conflated, though in effect that might be the outcome of his view. His article seems to suggest that the right to have the company administered according to its articles is a personal right of the shareholder. While I concede that the article offers little guidance as to any common law principle to which this personal right could be traced back to, I think it could be argued that it arises from an implied contract. Consider this passage from Pennington:
“Probably a company may compel its directors to make good such loss even though they have no service contracts, on the ground that they are under a duty to the company to take proper care to prevent the company from suffering loss. Alternatively, the company could rely on the implied contract with its directors which arises from them serving as such, and undoubtedly a term prohibiting the misuse of their powers would be implied in that contract as in an express service contract.” [Pennington, 6th edn., p. 725]
Note that this implied contract arises purely from conduct and expectancy. Why can’t such an implied contract be inferred between the shareholders and directors?
On the second point, though Dale and Carrington technically seems to suggest that the duty to not breach “proper purpose” is owed to the shareholders, this rule has been applied only in the context of issue of shares. Similar is the position in England as well. [See, In Re Jermyn Street Turkish Baths [1970] 1 W.L.R. 1194; Howard Smith v. Ampol Petroleum, [1974] A.C. 821] Hence, while the wide interpretation of Dale and Carrington (that breach of “proper purpose” violates the shareholders’ rights) could perhaps be defended only on the basis of Prof. Wedderburn’s argument, the narrow view (that directors owe a duty to shareholders to issue shares only for a proper purpose) could find support on other independent grounds. Proprietary rights of shareholders over their shares, possibility of dilution of their stake in the company and the indirect impact that issue of shares could have on shareholders personal rights (the right to dividend, for instance) are a few possibilities that I can think of.
Stunning post, KP.
One observation: Even though Dale and Carrington seeks to adopt Prof. Wedderburn’s view by expanding the scope of fiduciary duty owed by directors towards the shareholders, Sangramsinh itself limits the scope of this duty (paras 62 and 69).
Great post KP.
If I understand you correctly, the three instances you speak of in which directors may owe a fiduciary duty to shareholders, albeit non-exhaustive, are:
1. when the directors take it upon themselves to advice shareholders and the shareholders act on such advice.
2. a case of transaction of sale and purchase of shares between the director and the shareholder.
3. a breach of the proper purpose doctrine (possibly only in relation to the issue of shares)
In the first two cases, as you yourself point out, the duty owes its origins to principles of contract law; and not company law. If that is true, is it not incorrect to say that ‘directors owe a fiduciary duty to shareholders’, since the duty does not bind the directors due to his position as a director alone, but due to an additional position he has assumed (possibly aided by his position as a director).
If this distinction were to be accepted, then the statement of the Court in Dale and Carrington seems suspicious. Because it is one thing to say that the breach of a doctrine will harm shareholders, and another to say that it is owed to shareholders. Because if it is owed to shareholders, the scope of the proper purpose will have to determined keeping in mind the interests of the shareholders over that of the corporation. This could put the directors in the unfortunate situation of their fiduciary duties conflicting. I haven’t read Dale and Carrington, but do you think that the Court, by talking of owing the duty to shareholders meant more that it was a duty, which if breached, will harm shareholders?