Diversion of Business Opportunities by a Director for its Own Benefit

You know that a company is a legal entity under provisions of the Companies Act,2013 separate from its promoters, members and other stakeholders. Being a corporate person an an artificial person a company does has its own mind to perform its business. It depends on humans and a collective body of natural persons to manage its day to day business. Persons collectively managing affairs of a company are called Board of Directors and they are the minds behind success and failure of a company.

These directors are working in a fiduciary capacity. The duties of director vary according to the nature and size of the company, and have to be ascertained on the facts of each case. But in all cases in discharging the duties of his position, he must act honestly and without negligence, this is, with that amount of care which an ordinary man will be executed to take, as if business of the company was his own.

The duties of directors have been explained in GOWER'S PRINCIPLES OF MODERN COMPANY LAW,6the Edition, 1977 as follows

In applying the general equitable principle to company directors four separate rules have emerged ; these are

1. That director must act in good faith in what they believe to be in the best interests of the company;
2. That they must not exercise the powers conferred upon them for the purpose different from those for which they were conferred;
3. That they must not fetter their discretion as to how they shall act; and
4. That without the informed consent of the company, they 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.

The Hon'ble Supreme Court in case of Official Liquidator Vs. PA Tendulkar(1973)43 Com cases 382: AIR 1973 SC 1104 has said that ; “ a director may be shown to be so placed and to have been so closely and so long associated personally with the management of the company that he will be deemed to be not merely cognisant of but liable for fraud in the conduct of the business of the company even though no specific act of dishonesty is proved against him personally. He cannot shut his eyes to what must be obvious to everyone , who examines the affairs of the company even superficially. If he does so he could be held liable for dereliction of duties ——-even if he is not shown to be guilty of participating in the commission of the fraud. It is enough if his negligence is of a such character as to enable frauds to be committed and losses thereby incurred to the company.”

DIVERSION OF BUSINESS OPPORTUNITIES OF THE COMPANY

In some cases a director put himself in a position that his personal interest is in conflict with interest of company. Diversion of business opportunity of the company creates a conflict of duty and interest. The conflict of interest rule is universal and inflexible. In this case the directors entered into an agreement without informing the company to exploit good business opportunities at the cost of the company. It well settled that the rule that. A fiduciary. Is not allowed to enter into engagements in which he had or could have, a personal interest conflicting with or which might be conflict , with those to who he is bound to protect is universal and inflexible. Where a fiduciary such as director of a company ,exploited a commercial opportunity for his own benefit, which otherwise available for the company ,, is required to disclose the same with. The company ,before acting in such manner.

Crown Dilmum Vs. Sutton (2004))1BCLC 4688(ChD) where an investment opportunity came before the company. , but its director. Failed to disclose it to the company and instead diverted it to another company and made an investment in that opportunity pursuant to an agreement,, it was. Held that the director could not hav. Had a genuine belief that the company was not interested in that opportunity. He had ,therefore no right to make any decision to take opportunity which came his way whilst ,he was a director of the claimant (company). He has right to exploit all and every opportunities after proper disclosures and getting permission from the company to exploit the same. He was liable to the company for its loss and it was no defense that the company would not have been interested in the opportunity. The breach of statutory duty commences from. The moment of failure to make. Full disclosures.

DUTY OF DISCLOSURE

It is well settled that the duties of a director are in general higher than those imposed by law on an employee since he is not a senior manager of the company but is a fiduciary and with his fellow directors is responsible for the success of the company's business. His fundamental duty is to act in what he is in good faith considered to. Be I the best interest of the company. There is no authority for proposition that a. Director , as opposed to an employee, is not under a duty of disclosure by virtue of his position as fiduciary. So it is duty of a director to disclose his interest. In a business transaction with the company. The duty as a fiduciary is combined with duty of loyalty, honesty towards the company.

Various provisions of the Companies Act, 2013 and SEBI(LODR) Regulations, 2015 are required for disclosure of interest by directors in the Board Meeting and same will be noted by the Board on duly convened Board meeting of the Company. An interested director is required to absent on voting and discussion from the matters in which he is interested at the meeting of Board and his presence will not be counted for quorum ,while discussing those matters. A director may be disqualified to continue as director to to be appointed as director in case e fails to disclose his interest in other entities according to the provisions of the Companies Act, 2013.

LIABILITIES AS TO CORPORATE OPPORTUNITIES AFTER CEASING TO BE A DIRECTOR

A director has certain. Duties and liabilities even after he ceases to be a director. If a director makes preliminary arrangements to commute a breach of fiduciary duty while. He is a director and commits breach after resigning as a director,, he remains accountable to the company for any profit he obtains from the transaction as a whole.

CMS Dolphin Ltd. Vs. Simone (2001)2 BCLC704(ChD) -the director of an advertising agency resigned without giving notice to the agency and as established a new business. The carried the new business first as partnership and then after converted the same into a Company . He has recruited the whole staffs of previous advertising agency. The principal clients of agency has also shifted their business to new concern and also diverted the benefits of new. Business contracts to the company floated by the director. His new company made some profits and afterward became insolvent.

In this case the Court Said that -the underlying basis. Of liability of a director who exploits after his resignation a maturing business opportunity of the company of which he had knowledge as a result of his being a director is that the opportunity is to be treated as if it were a property of the company in relation to which the director held a fiduciary duties. By seeking to exploit the opportunity after his resignation he was appropriating for himself that property and became. A constructive trustee of the fruits of his abuse of the company's property, which he exploited b resigning from the company. Where the business of the defendant is not restricted to diverted opportunities but is wider, the fiduciary should be accountable for the profits properly attributed to the breach of fiduciary duty, taking into account the expenses connected with those profits and a reasonable allowance fo overheads ( but not necessarily salary for wrongdoers), together with a sum to take account of other benefits derived from those contracts. There must be some reasonable connection between the breach of duty and the profits for which the fiduciary was accountable.

It means that - a director remains liable to account for profits whether he exploits the opportunity, personally,through a partnership or through a company controlled by him.. he remains liable notwithstanding that the profits were made by a company against which there was no effective remedy because for reasons unconnected with the relevant contracts it was insolvent. Where. The director puts the contract into a partnership. He is fully accountable eve if his partners were entitled to part of the profit and were ignorant. Of his breach of fiduciary duty.

It is well settled that - a director remains under an obligation not to use for his own or another's benefit any confidential information ,,which he has obtained while he was a director. This obligations terminates only when the company releases him from the obligation or when the information is published or come under public domain.

SETTING UP A RIVAL BUSINESS CONCERN AND POACHING WORKFORCE

Lets' understand above situation through below mentioned case study; the four directors of a company conceived and developed a plan to leave jobs in the company and set up a rival company. The plan was kept secret from the company and the fellow. Directors. One of them the Managing Director , retired and let and allowed the three directors to remain for the time being in the company. The Managing Director floated a new company and has recruited workforce and trying to poached the skilled workforce of his previous company. Most of skilled workforce has shifted to the rival company. The remaining three directors who are aware of this plan did not disclose the same with the company, while they were on the Board. They have also joined the rival company after some time and old company came to be closed down.

The Court said that

1. In reference to the act of Managing Director- the MD was perfectly free to proceed and set up a company of his own and invite the employees from other organisation to join it.
2. The conduct of MD following is resignation as a director, in soliciting the resignations of the employees did not necessarily involved him in a breach of duty.
3. But continuation in office of the remaining three directors without disclosing to their fellow directors or the company that a determined attempt was being made by a potential competitor to poach the company''s workforce necessarily involved them in breach of their fiduciary duties.
4. The breach was not an act of excitement of the employees of. The company but to keep secret the plant known to them.
5. The four director were executive director of the company, they were charged with an trusted by the owners with the company's management on a semi—autonomous basis and having the primary responsibility for relations between the company and its workforce. They were held liable to the company for its losses for which the sum has been assesses.

CONCLUSION

Being a fiduciary a director must at for the benefit of the company. He should not bring himself in such a situation, where his personal interest are in conflict with the interest of the company. He should disclose his interest according to the provisions of the. Companies Act, 2013 before meeting of Board of Directors. He should not exploit. The business opportunity of the company for his own benefit or compete with company while acting as a director.

DISCLAIMER: The above write up is only for information and knowledge of the readers. It will not be considered as professional advise of the author.