Role of Nominee Directors : Balance is the Key

-Megha Mittal & Ajay Kumar

[corplaw@vinodkothari.com]

The idea that directors owe a fiduciary duty towards the company has been deep instilled in the very being of the corporate world – not only in spirit, but also in law. Section 166 of the Companies Act, 2013 (‘Act’) provides that “a director shall act in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of environment.” While section 166 of the Companies Act, 2013 sets out the duties of a director towards the company and its stakeholders in general, one must note that a company also has certain specific set of stakeholders, say lenders, whose interests must also be taken care of – enter “Nominee Directors.”

Nominee directors are usually appointed by financial institutions or investors, generally referred to as nominators, on the board of the borrower company for the purpose of representing and safeguarding their interest thereof. However, regardless of its appointment by a specific stakeholder, a Nominee Director is not relieved of his general duties as a director of the company inter-alia duties under section 166 of the Act. This dual role of a Nominee Director has given way to years of debate with respect to a Nominee Director’s actions affecting the company vis-à-vis its nominator.

While much has been deliberated on this state of pseudo-conflict, the conundrum has now come to rest as the Hon’ble Supreme Court, in its landmark judgement in Tata Consultancy Services Limited v. Cyrus Investments Private Limited & Ors. clarified that while a nominee director is entitled to take care of the interests of the nominator, he is duty bound to act in the best interests of the company and not fetter his discretion.[1]

In this article, we shall throw light on the role and nature of Nominee Directors, and discuss their rights, duties and actions in case of conflict, in light of the Apex Court’s order in Tata Consultancy vs. Cyrus Investments (supra).

Who is a Nominee Director

Prior to the discussion with respect to the rights and duties of a Nominee Director, it is important to understand who is a Nominee Director; what are its defining features; and how and when are they appointed.

Colloquially, a Nominee Director is a representative of a stakeholder/ stakeholder group (nominator) on the board of a company, appointed as such to ensure that the interests of the nominator are safeguarded. Strictly speaking, the provisions for appointment of nominee directors are primarily set out in sections 149 (7) and 161 (3) of the Companies Act, 2013, wherein the latter provides that-

“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.”

 Further, Rule 18(3) of the Companies (Share Capital and Debentures) Rules, 2014 also provides that 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.

Appointment of Nominee Director

At the outset, one must note that appointment of a nominee director on the board of a company is not a straightjacket requirement, and is instead subject to the existence of stakeholders who are entitled to act as nominator, either by law or by way of an agreement entered into by the company.

A nominee director may be appointed under several circumstances inter-alia;

• Where provision for appointment of nominee directors forms part of the Articles of Association (AoA). For instance, partners in a Joint Venture are often entitled to appoint their nominee on the Board of the JV;
• When any financial institution gives a significant financial assistance to a company, it generally appoints a nominee director on the board of the lending company to ensure that their interest as lenders are being catered to;
• Where a significant investment in the company (in form of shares, or otherwise) is made by a party, such investor is entitled to appoint a nominee director on the Board of the investee company, on account of the investment or an agreement entered into between the company (investee) and the investor;
• Where such right is bestowed upon a stakeholder on account of a contractual arrangement entered into between the company and such stakeholder;
• Where the statute explicitly provides for appointment of the Nominee Director on the Board. For instance, AIFs – Statues governing lay down explicit provisions for the appointment, functioning, resignation/removal of nominee directors, and it does not arise from any specific contractual obligations.

Office of Nominee Director

Having understood the various scenarios that warrant the appointment of Nominee Directors, the next question would be manner of appointment and holding office.

In this pretext, it must be noted that section 152(6) of the Act at least 2/3^rd of the directors of a public company shall be appointed by the shareholders in a general meeting, and whose office shall be liable to retire by rotation. The remaining 1/3^rd directors may be permanent. The said requirement often gives the impression that nominee directors, appointed at the behest of the nominator shall not constitute more than 1/3^rd of the total number of directors – however, such is not the case. If it were to be interpreted as such, a majority of companies (think JVs) would be running bad in law as their board significantly comprises of nominee directors only.

Section 152 (6) requires that the director must be appointed by the shareholders – which by its very essence shall include appointment of directors nominated by the nominator, and ratified by the shareholders in the general meeting. Undoubtedly, such directors would also be classified as having been appointed by the shareholders.

A detailed analysis of the provisions with respect to appointment and office of Nominee Director has been done in our article titled Note on Nominee Directors[2]

Features of a Nominee Director

Thus, from the discussion above, the defining features of a Nominee Director may be enlisted as follows –

• One who safeguards the interests of the nominator

A nominee director oversees the operations of the company, to ensure that the policy decisions are based on sound commercial lines and rationality, with adequate safeguards such that the interests of the nominator are not jeopardized;

• An Information Bridge

The nominee director also acts as liaison between the investee company and the nominator for regular flow of information. Here, it must be noted that the question of confidential information being shared by the Nominee Director would crop up.

In this regard, reference may be made to guiding judicial principles which suggest that while the Nominee Director has the right to receive information about the Company[3], a nominee director is not bound to share information with the nominator merely by virtue of such nomination; rather, such duty of sharing information may arise out of separate agreement entered into between the nominator and the nominee. The said principle was also appreciated in Hawkes v Cuddy[4].

• Participation in decision making

The nominee director actively involves in discussions pertaining to the financial performance of the company, future plans, fund raising, etc. The objective is to apply his/her expertise on the matters placed before the board with the intent to protect the interests of the nominator.

• Maintenance of confidentiality

Though a nominee director has allegiance towards the nominator, the nominee director is always expected to abide the code of conduct for directors & key managerial personnel. The responsibility adds up where the investee company is a listed entity, as there are compliance requirements in respect of un-published price sensitive information.

In Harkness V Commonwealth Bank of Australia Ltd (1993) 32 NSWLR 543, it was held that the duty of confidentiality of a director was greater than the duty he owed to his nominator. (See discussion below)

Is Nominee Director Independent?

As per Section 149(6) of the Companies Act, 2013, an independent director means a director other than a managing director or a whole-time director or a nominee director who does not have any material or pecuniary relationship with the company/ directors and fulfils such other criteria as specified in the Act.

Thus, it explicitly clear that a nominee director is not considered as independent director under the Act.

For Detailed discussion regarding independence of Nominee Directors, see our article When Can a Nominee Director be interested[5] by Ms. Nitu Poddar.

The Dilemma of Dual Duty

The term ‘Nominee Director’ by its very nomenclature suggests a dual duty – as a nominee as well as a director. Duty as a director of the company on the whole has wider connotations vis-à-vis duties as a nominee towards a single nominator, and the onus of ensuring adherence to both lies on the Nominee Director only – This two-fold duty often puts the Nominee Director a position of conflict where it has to choose between the interests of the company versus its nominator.

In its order in Tata Consultancy vs. Cyrus Investments, the Apex Court made several observations with respect to the role of nominee directors, and such conflict of interest that may be witness. Key observations are –

• What is ordained under Section 166(2) is a combination of private interest and public interest; but what is required of a Director nominated by a charitable Trust (read: any nominator) is pure, unadulterated public interest;
• nominee director is entitled to take care of the interests of the nominator, he is duty bound to act in the best interests of the company and not fetter his discretion.

In light of the above, it becomes reasonably clear that in a situation of conflict between the interests of the company and the interests of the nominator, the prior shall supersede over the individual interest of the latter, and the nominee directors shall act accordingly.

In this pretext, while the Hon’ble Supreme Court has clarified this position with much elaboration, the subject has been a matter of extensive jurisprudence, with Indian as well as international courts pronouncing on similar line. A few such cases are mentioned below –

In Bennetts v Board of Fire Commissioners of New South Wales[6], it was held that

“In particular, a board member must not allow himself to be compromised by looking to the interests of the group which appointed him rather than to the interests for which the board exists. He is most certainly not a mere channel of communication or listening post on behalf of the group which elected him.” (emphasis supplied).

Again, in In Ionic Metalliks v Union of India it was observed that nominee directors

“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 … 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”

Similarly, in Harkness v. Commonwealth Bank of Australia Ltd[7], it was held that the duty of confidentiality of a director was greater than the duty he owed to his nominator. There are several instances where the matter in question is confidential in nature; a nominee director should handle such matters with due care and should not report the same forthwith to the nominator, merely because it is material, instantly breaching the duty of confidentiality.

In Boulting v Association of Cinematograph, Television and Allied Technicians[8]  Lord Denning stated that there is nothing wrong with a director being nominated by a shareholder to represent his interests. The Court observed that “...so long as the director is left free to exercise his best judgment in 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.“

Recently, in Bhardwaj Thiruvenkata Venkatavaraghavan v. Ashok Arora[9] the Hon’ble High Court of Delhi held that nominee Directors must be particularly careful to act not only in the interests of their nominators, but must act in the best interests of the company and its shareholders as a whole.

In this pretext, while jurisprudence provides for manner of treating such conflict, it is important to understand what would constitute “conflict”

Understanding ‘Conflict’

In AES OPG Holding (Mauritius) and Ors. v Orissa Power Generation Corporation Ltd and Ors. it was noted that-

“conflict of interest would arise when a person owes allegiance to two or more entities or persons and is placed in a situation to take a decision which would affect the interests of all those to which or whom he owes allegiance…..” (emphasis supplied)

To understand whether there exists a conflict of interest, it is crucial to ascertain whether the nominee director has a vested interest in the company – either in personal capacity or as a nominator.

Interest in a personal capacity

The tenet behind appointment of a nominee director is that such a person would not be guided by his/ her personal interests in the nominee company, and as such would independently ensure that the nominator’s interests are protected. Thus, generally, a nominee director does not hold any shares in a nominee company – therefore, technically speaking, a nominee director is clearly out of the ambit of the definition of interested director.

Nevertheless, if a nominee director happens to have a personal vested interest in any transaction against the interest of the company or the nominator, the nominee director shall not act in his own interest. A similar observation was also made in AES OPG Holding (supra) wherein it was held that “If directors of a company are placed in such a situation, either they should recuse themselves, or they are duty bound to take the decision that would be in the interests of the company, failing which they would be in breach of their fiduciary duties”

Interest as a Nominee

On the general law of interests of a nominee director, if it were to be argued that a nominee director will not vote on matters concerning the interest of the nominator, it would frustrate the very concept of appointing nominee directors. 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 vex the very purpose of nominator.

Hence, it is important to understand that the question of conflict would not crop up on every instance where the nominee director acts in the interests of the nominator. The dilemma of conflict exists either in case of a vested interest in personal capacity or where the nominee director may act pro-nominator at the cost of the company’s interest.

 In Hawkes v Cuddy (supra), the Court of Appeal dealt with the position of a nominee director (i.e., a director appointed by one particular shareholder) where there was a potential conflict of interest between the allegiance to the nominator and the duty towards the company. The Court of Appeal upheld the decision at first instance and held that the nominee could take account of the interests of their nominator provided this did not breach the duties they owed to the company. The Court held that “the fact that a director of a company has been nominated to that office by a shareholder does not, of itself, impose any duty on the director owed to his nominator”.

 In Dairy Containers Limited v NZI Bank Limited & ORS; Dairy Containers Limited v Auditor General & ORS, New Zealand Court in 1994, the Court held that reporting by nominee director to the nominator is natural and comes out of loyalty. However, in case of any conflict of interest, the loyalty to the company overrides the loyalty to the nominator.

Conclusion

In light of the discussion above, it is observed that a one-fits-all approach may not be useful to determine the role of a nominee director towards the nominee company and the nominator. The Hon’ble Supreme Court in its order has provided that “coming to the argument revolving around the duty of a Director, it is necessary that we balance the duty of a Director”. Hence, it may be concluded that actions of a nominee director shall be guided by the primary principle that the collective interest of a company over and above the nominator’s individual interest.

[1] Para 19.30

[2] http://vinodkothari.com/wp-content/uploads/2018/11/Note-on-Nominee-Directors-19.11.2018.pdf

[3] Milstein v. DEC Ins. Brokerage Corp Del. Ch., C.A. Nos. 17586 and 17587, Lamb, V.C., Bench Ruling Tr.(Feb. 1, 2000)

[4] (2009) EWCA Civ 291

[5] http://vinodkothari.com/2017/06/when-can-a-nominee-director-be-interested-by-nitu-poddar/#:~:text=Nominee%20directors%20are%20usually%20appointed,and%20safeguarding%20their%20interest%20thereof.

[6] (1995) 7 BOND L R

[7] (1993) 32 NSWLR 543

[8] [1963] 2 QB 606 – https://vlex.co.uk/vid/boulting-v-association-of-793802137

[9] https://www.casemine.com/judgement/in/58d8947a4a93263621912b6e (CRL. M.C / 4270/ 2016)