When can a nominee director be interested, by Nitu Poddar

Nominee directors are usually appointed by the financial institutions or investors (”Nominator”) on the board of the borrower company for the purpose of representing and safeguarding their interest thereof. Such Nominee directors are liable to perform duty towards the borrower company and its stakeholders under section 166 and other provisions of the Companies Act, 2013 and also towards its Nominator for representing and safeguarding its interest.

As per Explanation to section 149(1) of Companies Act, 2013, Nominee Director for the purpose of the section means a director nominated by any financial institution in pursuance of the provisions of any law for the time being in force, or of any agreement, or appointed by any Government, or any other person to represent its interests.

Further as per section 161(3), subject to the articles of a company, the Board may appoint any person as a director nominated by any institution in pursuance of the provisions of any law for the time being in force or of any agreement or by the Central Government or the State Government by virtue of its shareholding in a Government company

Furthermore, as per Rule 18(3) of the Companies (Share Capital and Debentures) Rules, 2014, it is one of the duties of the debenture trustee to nominate a director on the board of the issuer company in case such company defaults with respect to service of the debenture (interest or redemption) or with respect to creation of security.

The matter of discussion is that, law largely prohibits / restricts the participation of an interested entity in any decision making. In case of nominee directors, such director is deemed to be interested in any matter concerning the nominator. Question is whether such nominator will not participate in such matters when the whole purpose of nominating such director on the board is to secure the interest of the nominator.

1. The concept of “interested director”

As per section 184 of Companies Act, a director is considered to be interested in a matter if such matter is in respect of another company where the director in question (either singly or along with other fellow directors) holds more than 2% of the shareholding of such another company.

Generally, a nominee director is independent to the nominee company and as such does not hold any shares of such company. Therefore, technically speaking, a nominee director is clearly out of the ambit of the definition of interested director as per Companies Act.

Next, if one is to look at the intent of restricting an interested director to cast vote in the matters he is interested – this should be understood that the word ‘interest’ in the context of the term “interested directors” used at various places in Companies Act, 2013 (“Act, 2013) should be construed to mean conflict with the “duty of directors” and not the “generic interest of a director”

As a part of duty of the director, he is expected to adhere to the clauses of any agreement entered on behalf of the company. Accordingly, in case a director is nominated by any financial institution which has extended any facility to the company; the financial institution becomes eligible for any benefit on occurrence of default, the nominee directors shall surely participate in the board meeting, if any with respect to allowing such benefit. For eg, if the facility agreement provides that the loan will be converted to equity shares on occurrence of event of default, the nominee director will very much participate in the meeting of the board where decision to transfer the share f the company is being made.

In any case, that the loan will be converted to shares on account of failure to service such loan is very much a part of the facility agreement and hence on the occurrence of event of default – the director had ideally no option than to agree to such transfer. This should be noted that, generally, in a closely held company, the terms of the facility agreement is approved by the shareholders. And directors are nothing but the representative of the shareholders.

In this regard, it is pertinent to draw one’s attention to the ruling of Yashovardhan Saboo vs Groz- Beckert Saboo Ltd. And Ors[1]  wherein the Company Law Board, Divisional Bench stated the following obiter:

The provisions enacted in sections 297, 299 and 300 of the Companies Act are founded on the principle that a director is precluded from dealing on behalf of the company as himself and from entering into engagements in which he has a personal interest conflicting or which possibly may conflict with the interest of those with whom he is bound by fiduciary duty. A director occupies a fiduciary position in relation to a company and he must act bona fide in the interests of the company. If a director makes a contract with the company and does not disclose his interest he will be committing breach of trust. 

Further, in the Company News and Notes dated July 1, 1963 (pages 81 and 82), the Company Law Administration (‘CLA’) had discussed the meaning of the word ‘interest’. In this clarification, the CLA referred to the ruling of In re Public Prosecutor v. Khaitan2 wherein it was held that only such contract or arrangement is covered by section 299 of Companies Act, 1956 (‘Act, 1956’), in which the director has personal interest conflicting with his duties towards the company and does not cover a case in which there is no personal interest involved. Similar view has also been held in the case of Fateh Chand Kad v. Hindsons (Patiala) Ltd.

2. Duties of a Nominee Director and nominator being interested

Nominee directors are generally inducted in the board of a subject company by another institution / company if such institution / company have a substantial stake in the subject company.

The intent of nominating a director in the subject company is to supervise the functioning of the subject company so as to safeguard the interest of the nominator.

When the purpose of nominating a director is to safeguard the interest of the nominator – there cannot be a question with respect to such director being “interested” on matters where the nominator is involved. The whole purpose of inducting such nominee is to ensure that the nominator’s interest and rights are not prejudiced.

As long as the nominee directors are not interested in their personal capacity, they cannot be said to be interested in a matter and therefore are not suppose to abstain from voting.

Even otherwise, a regular director being a representative of shareholders is expected to act in view of the larger interest of its shareholders (whom the directors represent); likewise, the  nominee director is also expected to act in view of the larger interest of its nominator (whom the nominee represent).

3. Conflict of interest in case of nominee director

The question of any conflict of interest arises only where there is a conflict between the personal interest of the director, and that of the company in question.

The confines of such interest are anyways clearly laid in sec 184 (4) of the Act which talks about contracts between two bodies corporate – there, the director will be deemed interested only where he is holding shares of more than 2% in the respective body corporate.

On the general law of interests of a nominee director, if one were to argue that a nominee director will not vote on matters concerning the interest of the nominator, then the very purpose of nominating the nominee director on the board of the beneficiary company gets frustrated. Admittedly the sole purpose of a nominator putting a nominee on the board of the beneficiary is to protect, where needed, the interests of the nominator. If the nominee director is to turn Nelson’s Eye to the interests of the nominator by abstaining from voting, then such a proposition will frustrate the very purpose of nominator.

The law on this issue has been settled for years now. In an Australian ruling in Levin vs Clark[2], it was held that:

….It is of course correct to state as a general principle that directors must act in the interest of the company… However, that leaves open the question in each case – what is the interest of the company? It is not uncommon for a director to be appointed to a board of directors in order to represent an interest outside the company – a mortgagee or other trader or a particular shareholder. It may be in the interests of the company that there be upon its board of directors one who will represent these interests and who will be acting solely in the interest of such a third party and who may in that way be properly regarded as acting in the interests of the company as a whole. To argue that a director particularly appointed for the purpose of representing the interests of a third party, cannot lawfully act solely in the interest of that third party, is in my view to apply the board principle, governing the fiduciary duty of directors, to a particular situation, where the breadth of the fiduciary duty has been narrowed, by agreement amongst the body of the shareholders. The fiduciary duties of directors spring from the general principles, developed in courts of equity, governing the duties of all fiduciaries – agents, trustees, directors, liquidators and others – and it must be always borne in mind that in such situations the extent and degree of the fiduciary duty depends not only on the particular relationships, but also on the particular circumstances.

Among the most important of these circumstances are the terms of the instrument governing the exercise by the fiduciary of his powers and duties and the wishes, expressed directly or indirectly, by direction, request, assent or waiver, of all those to whom the fiduciary duty is owed…..

In Scottish Co-operative Wholesale Society Ltd v Mayer [1959] AC 324 the House of Lords held that where there is a conflict of interest between the interest of the nominator and that of the company, the nominee director must not disregard larger interest of the company. Hsowever, the conflict of interest is only one where there is conflict between the interest of the company and that of the nominator.

In case of a nominee director – the primary duty of such director is towards its nominator and to protect its interest in the event of default.

4. Clause with respect to quorum of the Company

Also, as a general practice, the facility agreement carries a clause saying that on the occurrence of event of default or even otherwise, for a meeting to quorate, the presence of nominee directors is mandatory. In such case, the meeting cannot be held valid without the presence of such nominee directors.

To say that the presence of a specific group is required to form quorum however such specific group should abstain from voting is counter-intuitive. One cannot impose a mandation and argue on such mandation at the same time. If the agreement is clear that a board meeting cannot be held without the presence of the nominee directors – this itself makes it further clear that the nominee directors have to be present and voting at every board meeting unless they are interested in their personal capacity.

[1] http://indiankanoon.org/doc/1893758/

[2]  http://www.unswlawjournal.unsw.edu.au/sites/default/files/26_redmond_1987.pdf

Nitu Poddar (nitu@vinodkothari.com)