NOMINEE DIRECTORS

Subject: Corporate Law I

Submitted to: Dr. HarpreetKaur

Submitted by: Sonali 65/2008

Jasween Gujral 27/2008

Harsh Makhija 25/2008

B.A, LL.B (H)

4th year -7th semester

National Law University, Delhi

TABLE OF CONTENTS

CHAPTER 1 - INTRODUCTION

CHAPTER 2 – NOMINEE DIRECTOR

CHAPTER 3 - LIABILITY OF NOMINEE DIRECTOR

CHAPTER 4 - CONCLUSION

CHAPTER-I

INTRODUCTION

They can be appointed by certain shareholders, third parties through contracts, lending public financial

institutions or banks, or by the Central Government in case of oppression or mismanagement. The extent

of a nominee Director’s rights and the scope of supervision by the shareholders, is contained in the

contract that enables such appointments, or (as appropriate) the relevant statutes applicable to such

public financial institution or bank. However, nominee Directors must be particularly careful not to act

only in the interests of their nominators, but must act in the best interests of the company and its

shareholders as a whole. Nominee director are those Person who acts as a non-executive director on the

board of directors of a firm, on behalf of another person or firm such as an bank, investor, or lender. A

Nominee Directors is expected to safeguard the interests of the financial institutions, whose nominee he

is.

Research methodology :

The research methodology applied for this project is doctrinaire research and the sources are the books

present in the library of National Law University. Sources from internet have also been consulted for

completion of the project.

Research question :

To discuss the present legal position of nominee directors in the corporate structure, raising the plea for

defining their position in the corporate structure with more clarity.

Research scheme :

In this project, the researchers has tried to explain the concept of Nominee director and their

duties and liabilities. The clear division of chapters is made to make the research paper clear and simple.

The first chapter deals with an introduction to the topic. The second chapter deals with

____________.The third chapter deals with____________. The fourth chapter deals with the conclusion

and the suggestions given by the researchers.

CHAPTER-II

NOMINEE DIRECTOR

This term is not defined, indeed, it is not even employed in company statutes. Nor have the courts

adopted any single clear definition. In commercial practice persons may be nominated or elected to the

Board of Directors as of right by an individual shareholder, a class of shareholders, or some other groups

(e.g. a major lender to the company or the employees of the company), rather than by the general body

of shareholders.

The concept of 'nominee directors' could be said to be comparatively of recent origin. This concept has

come into vogue because of the loan facilities provided by the financial institutions. Such institutions

while granting loans to companies generally impose a condition as to the appointment of their

representative(s) on the board s of the companies who avail loan from them. A Nominee Directors is

expected to safeguard the interests of the financial institutions, whose nominee he is. The difference

between such directors and other directors appointed by the shareholders is that the shareholders '

directors are subject to retirement by rotation and other applicable provisions of the Act, whereas, the

nominee directors appointment and function is governed by the respective Acts, and they are beyond the

purview supervision of the shareholders. The definition of Director given by the Companies Act, 1956

(hereinafter called the act) is an inclusive one and it provides that the expression" 'Director' includes any

person occupying the position of the director, by whatever name called ". It further provides that any

person in accordance with whose directions or instructions, the board of directors of a company is

accustomed to act, shall deemed to be a director of the company. The Act does not contain any definition

of the term nominee directors. The Act thus makes no distinction between the directors on the basis of

their being nominee directors as far as liability for violation of the provisions of the Company Act and

other Acts are concerned. As per the Company law, directors of the company occupy a fiduciary

position. They are expected to work bonafide in the interest of the company and must not exercise their

powers for any collateral reasons. A director must not place himself in a position where his duty to the

company and his personal interests clash and he must not profit from his position as a director. This legal

position is equally applicable to the nominee directors, whether appointed by the central government or

by the financial institutions.1

1 http://india.indymedia.org/en/2005/04/210433.shtml. last visited on 15th November 2011.

Banks and financial institutions advancing loans to or holding equity shares in a public company

generally enjoy the right to nominate director(s) on its board, as do the government and foreign

collaborators in similar circumstances. The directors appointed in this manner are called “nominee

directors”, since they are not elected by the members, but are instead appointed.2 The Companies Act

has nowhere defined this term, but for a comprehensive understanding, the following definition provided

by the Companies and Securities Law Review Committee (New South Wales, Australia) may be found

useful,

“Nominee directors are those persons who independently of the method of their appointment, but

in relation to their office, are expected to act in accordance with some understanding or

arrangement, which creates an obligation or mutual expectation of loyalty to some person or

persons other than the company as a whole.”3

Initially, the appointment of nominee directors used to be thought of as essential for ensuring that loans

advanced by banks and financial institutions is used only for the stipulated purposes. However, there is a

potential conflict of interest that they may face after their appointment, this only being complicated in

the absence of a clear and coherent legal framework. This paper intends to discuss the present legal

position of nominee directors in the corporate structure, raising the plea for defining their position in the

corporate structure with more clarity.

The diversity of strategies that can be pursued through the proxy process makes it the natural focus for

shareholder initiatives in an institutional environment characterized by concentrated ownership, and in

an economic environment characterized by broad questions of long-run competitiveness. Hostile

takeovers, whatever their merits, are expensive and all or-nothing in their ability to effect corporate

change. Moreover, we seem to be entering an era where the major concern is not the deconglomerating

of businesses through quick asset sales that characterized the 1980s,4 but rather effecting the resurgence

of American industry necessary to respond to global competitiveness. In this era the need is not so much

for the episodic and confrontational monitoring of the takeover market, but rather for the continuous and

textured monitoring said to characterize the German and Japanese corporate governance systems. In the

2 S Venugopalan, Appointment and Role of Nominee Directors, SEBI and Corporate Laws (Magazine), Vol. 34, Nov.-Dec. 2001, pp. 168-9 3 Companies and Securities Law Review Committee (New South Wales, Australia) Nominee Directors and Alternate Directors Report No. 8, 2nd March 1989 4JOHN POUND, CORP. VOTING RESEARCH PROJECT, RAIDERS, TARGETS, AND POLITICS: CHARTING THE NEXT ERA IN AMERICAN CORPORATE CONTROL (Oct. 1991)

United States the proxy process may be the mechanism of choice, precisely because it lends itself to

incremental strategies and to substantive debates over the future direction of corporate policy.5

Expert minority board representation is one method by which institutional investors and other large

shareholders can institutionalize the constructive engagement suited to the problems of the 1990s. In

contrast to traditional outside directors, expert directors proffered by large shareholders should have the

time and incentives to provide ongoing monitoring. It is central to the success of this strategy that expert

directors should comprise a minority of the board. Limiting such representation to a minority slate

assures management that there is no immediate threat of a change in control, yet assures that a minority

of directors have the distance and incentive to ask hard questions.6

The moderate nature of the constructive engagement strategy is underscored by what happens if

management and the minority directors disagree. In that event, the decision-making balance rests with

the traditional outside directors, a group that studies have shown may not be effective in a proactive way,

but is quite effective when a crisis shifts decision making authority and corporate resources to them. A

disagreement between management and minority directors thus elicits action by traditional outside

directors in precisely the setting in which they have been most effective. A minority representation

strategy, which we have advocated both in scholarship and through direct corporate action, should be

relatively non-controversial because it minimizes the threats inherent in the confrontational tactics of the

1980s--the goal is to monitor management, not replace them. And because it contemplates the

constructive engagement of large shareholders in the ongoing corporate governance process,7 it should

meet a more receptive regulatory reception as well.

Hence, it would be pertinent, in the light of aforesaid backdrop, to put a word as regards the structure of

the paper. The same has been divided into several chapters, dealing with relevant issues, commencing

with the conceptualization of nominee directors, then moving onto a subtle contextualization of the

same. I would thereafter, deal with the issue of scope and ambit of responsibility and liability of the

nominee directors, in the specific context of the short-slate problems being faced on a rapid scale.

2.1 The starting point of the practice of appointing nominee directors

5Randall Morck et al., Do Managerial Objectives Drive Bad Acquisitions?, 45 J. FIN. 31 (1989)6Ronald J. Gilson, The Political Ecology of Takeovers: Thoughts on Harmonizing the European Corporate Governance Environment (Oct. 1991) (John M. Olin Program in Law and Economics, working paper No. 84).

7Robert Comment & Gregg Jarrell, Corporate Focus and Stock Returns (May 1991) (working paper No. 91-01, Univ. of Rochester).

In the prominent case of Boulting v. ACTT, Lord Denning pertinently observed (referring to the practice

of appointing nominee directors) “There is nothing wrong in it. It is done everyday. Nothing wrong, that

is, so long as the director is left free to exercise his best judgment on the interests of the company which

he serves. But if he is put upon terms that he is bound to act in the affairs of the company in accordance

with the directions of his patron, it is beyond doubt unlawful.”8

This judicial ruling has categorically held that while appointing nominee directors is not in itself illegal,

requiring them to act solely according to the instructions of the individual or institution nominating them

is untenable, as this will cause a conflict of interest in their performance of duties. In India, the

recommendations of the Dutt Committee formed the basis for public financial institutions appointing

nominee directors on the boards of all assisted concerns in which they held a substantial financial

interest.9 However, this practice gained ground only in the period of the New Economic Policy (1991)

being implemented, when a number of companies started expanding their scale of operations, this

necessitating more capital, which often came from borrowings.

CHAPTER-III8 (1963) 2 QB 606 9 S. Venugopalan, Appointment and Role of Nominee Directors, SEBI and Corporate Laws (Magazine), Vol. 34, Nov.-Dec. 2001, pp. 168-9

POSITION OF NOMINEE DIRECTOR

A nominee director does not enjoy a special position within the company. He is not supposed to be in

charge of a company's affairs. The nominee is subject to the overriding and predominant duty to serve

the interests of the board in preference if a conflict arises to the interests of the appointer. The nominee

must exercise constant vigilance to ensure that he did not compromise or surrender integrity and

independence, which the nominee must use for the benefit of the board.10 The decision of the case of

Irish Press v. Ingersoll (1993),would be helpful to define position of Nominee director :

The position of the nominee directors can be a difficult one if they disagree with the views of the person

or body appointing them. Their duty is to act in the interests of the company. They have also got a duty

to act on the instructions of their nominating party. …. There is nothing wrong with the appointing body

or party having a view as to where the interests of the company lie and ensuring that its nominees follow

that direction provided that in so doing they are not seeking to damage anybody’s else’s interest in the

company.”

The position of nominee director is to act bona fide in the interest of the company. Where nominees

were appointed by a mortgage as governing directors of the company pursuant to a mortgage, the learned

Judge in Levin v. Clark,11 (noted: "I consider that the nominees did act primarily in the interests of the

mortgage once they resumed the exercise of their powers as governing directors. However, I consider

that it was permissible for them so to act. It is of course correct to state as a general principle that

directors must act in the interests of the company.

3.1 Nominee Directors – Non-Executive Directors, But Not Passive

In recent times, nominee directors are perceived to be essential not simply in ensuring that the interests

of banks and financial institutions are duly safeguarded, but also in adopting higher standards of

corporate governance. Nominee directors, if passive, may fail to detect financial irregularities. In the

case of the Indian Tobacco Co. Ltd. (ITC), for long thought of as one of India’s most professionally

managed companies, a number of senior executives were arrested for infringements under Foreign

Exchange Regulation Act. This is notwithstanding the fact financial institutions held a share of 34%

therein, and had appointed nominee directors.12

10 http://india.indymedia.org/en/2005/04/210433.shtml, last visted on 15th November 2011.11 1962) NSWR 686 (Aust).12 N Gopalaswamy, Corporate Governance – The New Paradigm, 1st Ed., 1998, pp. 62-63

In the course of performing their duties, directors enjoy considerable discretion. However, they are

always required to act in a bona fide manner, avoiding both potential and actual conflicts of

interest.13Will nominee directors always face a conflict of interest, by the fact of there being appointed

by a bank or financial institution? In the case of Levin v. Clark14, a mortgagee nominated certain

directors pursuant to the mortgage agreement. The Court held that nominee directors are free to act

primarily in the interests of the mortgagee, as long as they do not harm the company’s interests thereby.

This establishes that their appointment by an outside agency is not conclusive as to the conflict of

interest.

The law does not fully recognize the economic unity of nominee directors and their appointers. In actual

commercial practice, however, their relationship is essentially similar to that of a principal and an agent.

This has been held by the Privy Council in the case of Kuwait Asia Bank EC v. National Mutual Life

Nominees Ltd15, wherein the appellant bank, enjoying a beneficial interest in the respondent company

carrying on business as money brokers, nominated two directors to the company’s board. However, the

Privy Council categorically held that after their appointment, nominee directors are the company’s

agents, and therefore the bank cannot be held liable for their wrongs, since they are not supposed to act

purely in the manner indicated by the bank. However, the mere fact of nomination is not always

sufficient to establish this kind of a relationship.16 Influencing this judicial ruling is also the underlying

principle that since all directors may incur a heavy responsibility for their acts and decisions, it is highly

unlikely that they will be fully controlled by others.17

Nominee directors are essentially non-executive directors. They should therefore limit themselves to a

handful of clearly defined responsibilities, including the company’s overall financial performance, its

record in the repayment of debt, etc. The nominee directors, as members of the board, should put into

place the company’s overall policies, as well as the means for supervision and internal control for

implementing the same. Their presence on the board can monitor the executive directors.18

3.2 Whether nominee directors owe duties to their nominators

13 Lynden Griggs, John Lowry, Finding the Optimum Balance for the Duty of Care Owed by the Non-executive Director , as in Fionna Mac Millan, Perspectives on Company Law II, 1999, p. 203 14 (1962) NSWR 686 (Australia), as in (1963) 2 QB 60615 (1990) NZLR 513 16 The Right Honorable Justice EW Thomas, The Role of Nominee Directors and the Liability of their Appointers , as in Fiona Mac Millan, Perspectives on Company Law II, 1997, pp. 235-6 17 (1963) 2 QB 60618 Lynden Griggs, John Lowry, Finding the Optimum Balance for the Duty of Care Owed by the Non-executive Director, as in Fionna Mac Millan, Perspectives on Company Law 2, 1999, pp. 206-7

Nominee director are persons who are appointed by various interest to represent them on board of a

company. A Number of cases have shown how difficult their position may be in practice and in law.

Indeed nominee director may have to pay particular attention to the interest of those who have appointed

them to the board. There have been two opposing strands in the cases dealing with broad question. The

problem are emphasized where director find themselves having consider confidential information that

comes to them as a member of te board of the company to which they are appointed and which they

know will be of particular interest to their nominating company.

In the case of Bennetts V. Board Of Fire Commissioners 19, the court observed that “each of the persons

on such a board owes his membership to a particular group, but a member will be derelict in his duty if

he uses his membership as a means to promote the particular interests of group which chose him.. the

member must not allow himself to be compromised by looking to the interest of the groups which

appointed him… there is also the ordinary obligation of resprecting the confidential nature of board

affairs. In the new south wales Supreme court decided allow nominee directors and the largest

Shareholders to avoid any obligation to the minority simply because they bend the will of their

nominator.

On other hand, in case of Harkness v. Commonwealth bank of Australia 20 court laid down a strict rule

on the duties of nominee director. The court felt that duty of confidentiality as being greater than the

duty owned to the nominator. However he also recognished that, ordinarily a director nominated to the

board of a company has duty to communicate knowledge received in that capacity to the director’s

nominator, where the director is functioning within another corporation and information comes to the

direction in course of the position . 21

3.4 Reinforcing The Position Of Nominee Directors

Nominee directors are required to ensure that companies to the board of which they are appointed, do not

commit financial irregularities. This requires them to carefully oversee the functioning of important

committees like the Audit Committee. They should take an active interest in the company’s affairs. Their

being non-executive directors does not mean that they should be negligent or passive in performing their

duties.22 They should regularly report to their appointers, who on their part, should monitor their

participation and performance in the boards and committees.23 This being lacking in the present legal

19 (N.S.W.) [1970] LB.20 (1993) 12 A.C.S.R. 165.

21 Professor Bob Baxt, Robert Baxt. “:Duties and responsibilities of directors and officers, 18th ed. 2005 –p.46-51.

22Nitish Nair, AsifIqbal, Nominee Directors and their Conflict of Interest: An Analysis, Company Law Cases (Journal), Vol. 49, No. 2, 2003, pp. 776-7 23PadminiSrivastsan, Nominee Director – Thou Art Blessed, SEBI and Corporate Laws (Magazine), Vol. 41, 2003, pp. 200-2

framework, warrants necessary legislative amendments to the Companies Act. The appointment of

nominee directors representing public financial institutions is a matter of concern for the government,

such institutions being the custodians of public finance. Therefore, the concerned public financial

institution are to periodically submit a report to the Department of Company Affairs, indicating the steps

taken by them so that their nominees are duly discharging their responsibilities, apart from separately

providing details of this in their Annual Report.

According to the Kumaramangalam Birla Committee Report, nominee directors should be appointed on

a selective basis. A single nominee director on the board of a large number of assisted companies will

only result in it being difficult to monitor. The Confederation of Indian Industry (CII), in its Report,

observed that the present system does not offer sufficient incentives for people to become nominee

directors. This apart, the present system fails to address the possibility of conflicts of interest, which may

arise if nominee directors are also shareholders and/or creditors in the same company.24 Nominee

directors are generally the employees of banks or financial institutions, or are professionals from the

panel of experts of such institutions. They often tend to play safe in the board meetings, by not paying

adequate attention to the company’s operations, so much so that their presence on the board fails to

check financial irregularities. They should be encouraged to provide information to their appointers on a

regular basis, for the latter to take decisions in respect of the financial institution. The Narayanmurthy

Committee has recommended that there nominee directors should be replaced by better auditing, in

addition to securing the independence of auditors being secured. This recommendation is rooted in the

premise that furnishing certified financial statements is better than an unwilling nominee on the board.

However, this is a wrongful approach, as the present mandate for the appointment of nominee directors

is not limited simply to prevent financial irregularities.25

CHAPTER-IV

FIDUCIARY DUTY OF NOMINEE DIRECTORS UNDER INDIAN LAWS

24 N Gopalaswamy, Corporate Governance – The New Paradigm, 1st Edition, 1998, pp. 74-5 25Jayant M Thakur, Should financial institutions and institutional investors be barred from nominating directors on the Board of Companies in which they make investments? SEBI and Corporate Laws (Magazine), March-April 2000, pp. 101-4

Fiduciary duty is defined as a duty of utmost good faith, trust, confidence and candor owed by a

fiduciary to a beneficiary. Fiduciary duty arises where a relationship between persons is fiduciary

in nature, i.e., where a relationship in which one person (the fiduciary) is under a duty to act for

the benefit of another (the beneficiary) on matters within the scope of the relationship. Fiduciary

relationships arise, amongst others, when one person places trust in the faithful integrity of another,

who as a result gains superiority or influence over the first.Where a relationship is fiduciary in

nature, the fiduciary is required to act with the highest degree of honesty, loyalty, an unusually high

degree of care towards, and in the best interest of the beneficiary. Directors of companies have

been traditionally considered as fiduciaries of the companies of which they are directors. The basic

principle under company law in this regard is the same which applies to any other fiduciary, and Indian

law in this regard largely continues to be guided by the principles of English law. While companies

are deemed to be independent juristic persons distinct from its constituent members, companies are

unable to act other than through its board of directors and other officers. Consequently, companies are

necessarily dependant on directors and other officers for undertaking any act. As a result of this

dependence, directors are agents and trustees of the company by default and are in a position to

exercise significant influence over the company giving rise to a fiduciary duty towards the company.

Under the principles of common law, directors and officers, as agents and trustees of a company, owe a

high duty of care to the company and are required to act in a bona fide manner and in the best interests

of the company. While directors, at least in theory, are agents and fiduciaries of the company, and are

required to have regard only to the best interest of the company and be immune to extraneous

influences, there are circumstances where directors on the board are nominated by certain third

parties, and consequently, also represent the interest of such third parties on the board. The most

common instances of representations of such third party interests are directors nominated by

banks and financial institutions from which the company has raised debt, directors nominated by

private equity and venture capital investors, directors nominated on the board of

subsidiaries by holding companies and directors of joint venture companies who are nominated by the

respective joint venture partners. In such cases, nominee directors may be under a tacit

obligation towards the nominators to act under the instruction of their nominators or further the

interest of the nominators as against the interest of the company. The obligation of directors to act in

the best interest of the company gives rise to the “no-conflict” rule, i.e., directors must not place

themselves in a position in which their personal interests or duties to other persons are liable to

conflict with their duties to the company, without the informed consent of the company. This is

an enunciation of the principle that good faith must not only be done but must also manifestly

seen to be done and the law will not allow a fiduciary to place himself in a position in which his

judgment is likely to be biased and then to escape liability by denying that in fact it was actually biased.

Given this proposition, initially even the validity of the practice of appointment of nominee directors

was challenged. However, the validity of nominations was confirmed by Lord Denning in Boulting v.

ACTT, (1963) 2 QB 606, however, with the caveat that the nominee director should be free to exercise

his best judgment in the interest of the company that he serves. Lord Denning further observed that if

the nominee director agrees or is bound to act in the affairs of the company in accordance with the

directions of the nominator, such stipulation is clearly unlawful. This view has been upheld over the

years, and is consistent with the principle that a director, being a fiduciary, is not permitted to

contract with other directors or with third parties in such a way that his right to function as a director

according to his own discretion is fettered. A nominee director’s role on the board of a company

cannot be restricted to those of a mere observer and representative of the interest of the nominator. In

this context, the law does not distinguish a nominee director from other directors. While this is often

disregarded in practice, similar to other directors, nominee directors continue to be obligated to consider

and proactively advance the interest of the company, disregarding extraneous considerations, including

the interest or instructions of the nominator. While the legal requirement relating to fiduciary

obligations of nominee directors have been affirmed from time to time in unambiguous terms, in

practice, nominee directors have largely continued to act as mere executors of the decisions of

nominators. Legal considerations aside, this may be reflective of the commercial reality behind

the object of nominating directors. Lenders and investors with significant financial interest in a

company would seek representation on the board to have a degree of control over the course

of action proposed to be adopted by the company, which from a commercial perspective is not

unreasonable. While such control could also arguably be achieved by such nominee directors acting

in their independent wisdom and judgment, such control may be most effective if the nomine

directors were to act keeping the interest of the nominator paramount. In the Indian corporate

scenario, it may in fact be desirable to have directors nominated by financial institutions and

investors. Unlike companies in more developed countries which are characterised by truly

independent and empowered boards, Indian companies are largely promoter controlled, and the

interest of financial institutions and institutional investors may be in line with best corporate

governance practices. Justifications or benefits notwithstanding, the law clearly prohibits

nominee directors from acting otherwise than in their independent judgment. Since the rigid legal

requirement applicable to directors to completely ignore the interest of nominators may be misaligned

with commercial reality, Australian courts have attempted to reconcile the real-world position of

nominee directors with their duty to act taking into account only the interest of the company.

Particularly, in the context of closely held joint venture companies, Australian courts have discussed

the possibility that the normal fiduciary duties might be modified where a company has been set up as a

joint venture between two or more participants on the understanding that each of them would be

separately represented on the board by nominee directors. In such cases, the legal proposition of

collective responsibility of directors towards the company as fiduciaries has been reconciled

on the basis that when the articles of association empower a specific shareholder or group of

shareholders to nominate its own directors, it may not be unreasonable to state that in addition to the

responsibility which such directors have to the company and all shareholders collectively, they

may have a special responsibility towards the shareholder(s) who nominated them.

However, this view is based on the presumption that the articles of association were so formulated with

the intent and belief that such a special responsibility towards one class of shareholders was also

conducive to the interest of the company as a whole. Accordingly, this view will clearly not be

applicable where the interest of such class of shareholders conflicts with the best interest of the

company. While the above observations were made specifically in the context of joint venture

companies, this approach should also work in any closely held company scenario. To

conclude, nominee directors considering the interests of the nominator where such interest also

furthers the interest of the company should not be treated as a breach of fiduciary duty, and companies

could consider incorporating a provision to this effect in the articles of association. While the validity

of such a provision and whether such a provision would absolve a nominee acting under

instructions from the nominator being in breach of fiduciary duties is untested, it is at least a

straightforward reflection of corporate reality.

CHAPTER-V

THE LIABILITY OF NOMINEE DIRECTORS

Nominee directors are immune from all liability, as long as they are acting in good faith. 26 Ordinarily,

they cannot be held liable along with the executive directors, until and unless the whole board is being

held liable.27 This represents the underlying principle that they, not being appointed to oversee the

company’s operations, should not be held liable for the company’s routine operations, of which they are

not supposed to possess full information in the first place. However, while conferring upon them

immunity from liability is called for, this should not extend to immunity from prosecution. 28 A number

of the offences specified under the relevant provisions of the Companies Act do not require mensrea for

sustaining a conviction. Nominee directors, being non-executive directors, are unlikely to possess

sufficient information about the company’s daily operations, and therefore should not be held liable for

such offences.29 This is an anomaly that needs to be rectified since none of the provisions in the

Companies Act distinguish the liability of nominee directors from that of other directors.

At the insistence of the All India Financial Institutions, the Company Law Board has formally advised

the Registrars of Companies to not initiate proceedings for defaults under the relevant provisions of the

Companies Act, against nominee directors appointed by public financial institutions, without prior

clearance from it.30 This has been done in pursuance of the Rajasthan High Court’s ruling in Ravindra

Narayan v. Registrar of Companies, in which it had been held legal proceedings in the case of default

should not be initiated against all the directors.31 Directors can be prohibited from accepting

directorships in future, on being found liable for defaults filing the annual accounts and annual returns,

repaying deposits and interest thereon, and redeeming debentures.32 However, this does not apply to the

nominees of banks and public financial institutions. This is unfair, since curtailing their responsibilities

in this manner, in relation to important matters such as the aforesaid, not only serves no purposes, but

also is clearly undesirable.33 The Committee on the Companies Bill (1997) has recommended that there

should be an amendment to Section 5, Companies Act, that defines “officer in default”, so as to include

nominee directors as well, their liability to be decided in the course of the prosecution.

No Liability in Absence of Fraud or Bad Faith: 

Where a bank nominated two of its employees as nominee directors on the Board of a company carrying

on business as money brokers. The company contacted with the trustee of its depositors to give him

monthly and quarterly certified statements of its financial position on behalf of the directors. These

26Geetanjali Mills Ltd. v. Thiruvengadathan, (1989) 1 CompLJ 232 (Madras HC) 27 Circular No. 24 of 1994, Department of Company Affairs (DCA) 28 TN Pandey, Independent Directors in Companies’ Boards – Concept as Conceived by Naresh Chandra Committee in the Context of Effective Corporate Governance, SEBI and Corporate Laws (Magazine), Vol. 42, 2003, pp. 93-108 29Id.30 S Venugopalan, Appointment and Role of Nominee Directors, SEBI and Corporate Laws (Magazine), Vol. 34, Nov.-Dec. 2001, p. 17231 Circular no. 6 of 1994 (Dated 24th June 1994) 32 General Circular no. 5 of 2002 (Dated 22nd March 2002) 33PadminiSrivastsan, Nominee Director – Thou Art Blessed, SEBI and Corporate Laws (Magazine), Vol. 41, pp. 198-9

statements turned out to be false. The company ran into winding up and the trustee was able to recover

only half the amount of the deposits. He sued nominee directors and nominating bank for the loss.

Rejecting his claim, the court observed: "In the absence of fraud or bad faith, a shareholder or other

person who controlled the appointment of a director, owed no duty to a company's creditors to ensure

that the director discharged his duties with diligence and competence; that the directors appointed by the

bank became the agents of the company and if they had committed any breach oftl1e duty they owned to

the plaintiff under the trust deed, they were acting in an individual capacity and as directors were bound

to ignore the interests and wishes of their employer; that, accordingly, the bank, against which no

impropriety was alleged, could not be liable for the acts of the two directors either as employer or as

principal."34

Nominees guilty of Neglect : 

In re, Rashtriya Mill Mazdoor Sangh vs. Khatau Makanji Spg. & Wvg. Co. Ltd. (2000) 100 Com Cases

33 (Born.), the court held that the direction contained in the order dated May 6, 1997, was couched, in

terms of a mandate to the company to pay to its workers salary for the month of February, 1997, on or

before May 20, 1997. Such order passed by the court in exercise of its extraordinary jurisdiction under

article 226 of the Constitution of India, when not complied with and if will fully disobeyed, would

definitely render the company liable to civil contempt under the contempt of Courts Act, as well as

under article 215 of the Constitution of India. The said order was challenged by filing a Letters Patent

appeal and the appeal was dismissed by the Division Bench on 11.6.1997. The direction was required to

be obeyed by the company and financial difficulties could not be permitted to be set up as a defence for

disobeying the direction of the Court particularly when it related to the payment of wages to the workers.

Entire financial powers vested in the board of directors and all directors were equally responsible. Three

nominee directors had tendered unconditional apology for their acts and omissions. After receipt of show

cause notices, they made efforts to ensure that financial institutions released the funds and the order

passed by the court was complied with. Their apologies were to be accepted and the directors were to be

cautioned to take immediate steps to implement the order dated May 6, 1997. The director of finance

(who was nominee of State Bank of India) and the executive director, even during the pendency of the

contempt proceedings, had acted in a manner which compounded their culpability. They failed in

discharging their duty and honouring their commitment which had resulted in tremendous hardship to

six thousand employees of company and of course non-compliance with the court's order. These two

directors were to undergo a sentence of simple imprisonment for one month and fine of Rs. 2000 each

34Nominee Directors and their Liabilities Under Companies Act By C M Bindal, http://www.shilpabichitra.com/shilpa2002/ent179.html.

which would stand waived if the entire wages for the month of February 1997, were paid to the workers

within two weeks.

The role and responsibilities of nominee directors on the boards of assisted companies have been under a

great challenge as they are expected to balance the priorities of representing institutions and the overall

interests of the companies whom they serve as part-time directors. While following instructions of the

institutions whom they represent, they cannot overlook the timely requirements and realities with the

company. They have undoubtedly fiduciary duties and are considered equally with other directors on the

Board of Directors. They need to be loyal to the company and cannot claim immunity from prosecution

without evidence upon trial as to their bona fide.

The growing menace of sickness in industry in general has been attributed to several factors-lack of

finance, management incapability, change in fiscal policy, obsolescence in business and industry, poor

quality of products, global competition, and so on. Nonetheless the aforesaid position, our policy and

programmes have faith and belief in financial institutions on whose behalf nominee directors take more

active and aggressive role in corporate governance. Their role has to ensure "best" and not just "good"

corporate management and the same can be possible when they keep the entire realities and

circumstances with the company in view and provide their wisdom to the needs of it to ensure not only

"good" decision but the "best" decision. For this purpose may be that they have to carry out some

homework before they participate in deliberations as directors to establish their bona fide as notified by

the Securities and Exchange Board of India, the Rules of Corporate Governance (applicable to listed

companies) have stated the institutional directors as independent directors. They being independent and

responsible directors have in effect to playa much greater role in achieving the objects of bodies

corporate efficiently and in bona fide manner to strengthen the companies to face new challenges in

global economy.

CHAPTER-VI

THE SHORT SLATE PROBLEM CONCEPTUALIZED

The short slate problem is inherent in any majority-rule election in which an outside shareholder

nominates a smaller number of candidates than the total up for election. For firms with unclassified

boards that re-elect all directors annually, the problem is not restricted to minority representation; it

arises with any slate comprised of fewer director nominees than there are directors on the full board. 35

The short slate problem is less critical in firms with classified boards. Such firms elect only a fraction

(usually one-third) of directors annually, so that one seeking only a minority of the total board may often

contest all seats up for election and thereby avoid the problem. However, the problem does not entirely

disappear even in the presence of a classified board if the company’s board is large enough.

Time-Warner’s board, for example, consists of twenty-seven individuals classified into three equal

cohorts; each annual election thus involves nine board seats. For a shareholder who seeks to inject fewer

than nine new voices into the boardroom, the slate will be short even in the presence of the classified

board. Consider the mechanics of soliciting votes for a short slate in opposition to a management proxy

listing a full slate of candidates for the board. To put the matter in context, assume the company’s board

is not classified and is comprised of fourteen incumbent members, each of whom is standing for re-

election on a management slate. Further assume that the outside shareholder has nominated three

candidates for whom votes will be solicited on a separate proxy card. Under standard corporate voting

rules each shareholder is entitled to cast one vote for each of the director slots on the corporate board for

each share held. Each share in our example thus has fourteen votes. Finally, assume the company does

not have cumulative voting so that only one vote can be cast with respect to each of the fourteen board

positions. The fourteen nominees receiving the highest number of votes are elected.

Now consider the alternatives confronting shareholders deciding how to vote in this contest. At first

glance, it may appear that the shareholders have the same choices with respect to this short slate contest

as they would if all fourteen board seats were contested: to vote either for all fourteen management

nominees, or for the three-member dissident slate. However, the presence of the short slate presents a

third possibility: shareholders may vote for the dissident’s three-person short slate, and also vote for

eleven of management’s fourteen nominees. Through this strategy, shareholders can cast votes for all

fourteen positions, and still support the dissident slate.

35Nonetheless, the primary impact of the short slate problem falls on one seeking minority representation. If control is sought, there is little difference between contesting a majority of board seats and contesting all seats.

There are several reasons why shareholders who support the dissident slate are likely to take the third

option and vote a “split ticket” in a minority representation campaign. First, such a voting strategy is

consistent with the broad tenor of such campaigns. The point of offering candidates for only a minority

of board seats is not to challenge the entire board. Shareholders who vote only for the short slate are

effectively voting against all fourteen of management’s candidates, as well as supporting the three

candidates sponsored by the dissident shareholder. This voting strategy turns what is intended to be a

mixed message--constructive engagement but no change in control--into a “no” vote on the entire

management slate. Second, by not voting at all for the other eleven director positions, the shareholder is

foregoing the opportunity to indicate preferences among management’s fourteen candidates. Even if the

dissident slate is elected, so will eleven of management’s candidates, with some being more qualified

than others. Shareholders may conclude that voting only for the dissident candidates excludes them from

a central focus of the election--deciding who will comprise a majority of the board.

It is at this point that the short slate problem emerges. If a significant fraction of all shareholders elect to

split their votes, then the dissident’s short slate is in serious trouble.36 Suppose that 30% of the

shareholders vote only for the short slate, 40% of the shareholders vote a straight management ticket,

and the remaining 30% of the shareholders take the third option and split their votes, supporting the full

dissident slate and eleven out of the fourteen management candidates. Suppose further that, in the

aggregate, shareholders who split their votes select eleven candidates from among management’s

fourteen on a random basis--that is, such shareholders as a group do not favor any particular director, but

allocate their votes across all fourteen management candidates with equal frequency.

A plausible first reaction might be that the dissident’s short slate would prevail on these assumptions.

Each of the three dissident nominees would receive the votes of 60% of the shareholders. The logic is

that all three nominees, each having received more than a majority, would win seats on the board. In

fact, all three dissident candidates would lose. Each dissident candidate would receive 60% of the vote,

representing the combined votes of shareholders who support only the short slate and those who split

their vote. However, management candidates also would receive votes from two groups of shareholders:

the 30% of shareholders who support the dissident slate by voting a split ticket and who, as a group, vote

randomly for eleven of management’s fourteen candidates; and the 40% of shareholders who vote for all

fourteen management candidates. The per-candidate pro-management vote from the ticket-splitting

36Current SEC staff practice appears to require that a dissident running a short slate must disclose that election of the dissident candidates may result in the refusal of elected management nominees to serve on the board. DIVISION OF CORPORATE FINANCE, SECURITIES AND EXCHANGE COMMISSION, PROXY REFERENCE MANUAL 33 (1984), discussed in PAUL RICHTER, PROXY CONTEST HANDBOOK (1989). It does not appear that management nominees are required to disclose the conditions under which they will not serve if elected, nor is there discussion of why such conditions would not violate the bona fide nominee rule.

shareholders vote would be 0.3 (the percent splitting their vote) multiplied by 11/14 (the average number

of votes each ticket-splitting shareholder would cast for each management-sponsored candidate), or 23%

for each management candidate. Each management candidate thus would receive 63% of the vote and

the short slate nominees, who each receive only 60% of the vote, would lose.

This is an unexpectedly perverse aspect of the short slate phenomenon. We tend to think that majority

voting rules are simple and straightforward and that in any election one candidate will receive a majority

and win, and the other a minority and lose. This is not the case in corporate elections with short slates

because corporate voting rules give shareholders the right to vote for each director slot rather than a

choice between a single “dissident” and a single “management” candidate. Short slates open up the

possibility that both sides’ director candidates will receive more than a majority, and that a dissident’s

campaign to attain minority representation will fail despite having received a majority of votes.

CHAPTER-VII

CONCLUSION

On a concluding note, the position of nominee directors in the corporate structure needs to be more

clearly defined, this requiring a legislative amendment to the Companies Act clearly articulating their

rights, responsibilities and liability. They are not solely the watchdogs of their appointing bank and

financial institutions, but are also the company’s directors, being required to perform their

responsibilities arising there from. In the future, with loans by banks and financial institutions likely to

become a leading source of finance, it is likely that this shall gain ground, and therefore a clear and

authoritative legal exposition of their rights and liabilities being all the more called for.

The nomination and election of a minority of expert, shareholder-sponsored directors is a particularly

attractive way for shareholders to address long-term incentive and performance problems within the

corporation in a constructive, rather than confrontational, manner.37 However, the current proxy

regulatory regime imposes strategic barriers to pursuing a program of constructive engagement. The

bona fide nominee rule forces shareholders to run short slates composed only of their own nominees,

rather than full slates made up of a minority of their own nominees and a majority of management

nominees. As a result, shareholder proposed short slates may receive majority votes, yet still lose--hardly

a result in keeping with an efficient system of shareholder oversight. In this paper, I have described and

formalized the short slate problem, canvassed the options that are available to shareholders within the

existing regulatory regime, and proposed a simple regulatory reform that solves the problem. In the

course of its ongoing review of the proxy process, the subject is well worth the attention.

37 Victor I. Lewkow, PROPOSED SEC RULE ON DIRECTOR ACCESS TO COMPANY PROXY STATEMENTS FOR DIRECTOR NOMINATIONS, Cleary, Gottlieb, Steen & Hamilton.