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- Divya Khanwani & Suneel Kumar†
This article seeks to analyze the reasons why India does not mandate fiduciary duties by promoters towards minority shareholders, even while the former are majority shareholders. The authors first engage with the arguments given for the existence of such a duty from a theoretical standpoint. Here, disagreement is presented with the argument from equity and with the view that such a duty arises from the fact that majority shareholders are akin to shadow directors. The first point of critique offered is that directors are trustees of the company and not the shareholders, and their fiduciary obligations extend only to the company. Second, it is shown that even if directors are understood to be agents of minority shareholders, fiduciary obligations cannot be attributed to majority shareholders by construing them as shadow directors. Lastly, arguing from a practical standpoint, the authors show the impracticality of the imposition of fiduciary duties, in light of the restriction the same will have on majority shareholders’ powers and the already existing statutory protection of minority shareholders’ interests.
The corporate framework of India exhibits a concentrated ownership structure. The majority of shareholding is held by the promoters (controlling shareholders) in Indian market. The promoters, therefore, are capacitated to exercise unbridled power in decision making. Consequently, it becomes interesting to study why corporate India does not prescribe to the “custodian” model, wherein promoters wear the hat of “trustees” and owe fiduciary duties to minority shareholders.
The paper seeks to engage in a normative analysis regarding whether majority shareholders should owe a fiduciary duty towards minority shareholders in the Indian legal regime. We argue the negative from a theoretical and practical perspective.
I. THEORETICAL STANDPOINT
The theorists advocating in favour of attributing fiduciary duty to the promoters (majority shareholders) rely on two arguments.
The first argument is that controlling shareholders, by virtue of greater shareholding, can sway the decisions in their favour. Consequently, minority’s rights should be protected by imposing fiduciary obligations on the majority. This argument is based on the principle of equity.
We disagree with this view. The shareholding rights can be equated to the rights enjoyed by the owner of a property. When a shareholder votes for or against a resolution, she is exercising her right as a person having ownership over the property. The fact that the vote will affect and bind the other stakeholders of the company cannot be used to qualify her proprietary rights. However, the dominant shareholder is not the sole owner of the property and therefore, it is necessary that while exercising her judgement she does not act arbitrarily or unfairly. Her conduct is, therefore, governed by stringent regulations provided under Companies Act, 2013, which preclude her from acting in bad faith. These provisions will be covered extensively in the next section of the paper under ‘Practical Standpoint’.
The second argument is that a controlling shareholder dominates the company by exercising her influence over the directors. Consequently, she acts like shadow director and therefore, should assume the fiduciary duties which are imposed upon the directors.
We have two objections to this theory. First, directors do not have any fiduciary duty towards the minority shareholders. Second, even if they did, the director-shareholder relationship is different from shareholder-shareholder relationship.
A. Directors do not infact have any fiduciary obligations towards shareholders
The Apex Court in Sangramsinh P Gaekwad & Ors. v Shantadevi P. Gaekwad & Ors., held that directors are trustees of the company, not of shareholders, and company is a distinct legal entity separate from its shareholders. Therefore, the fiduciary obligation of the directors towards the company cannot be extended to the shareholders. Hence, the assertion that directors have fiduciary duty towards the minority shareholders in India is fallacious.
In addition to the judicially cemented position, we argue that it is theoretically misguided to conclude that directors have fiduciary duties to shareholders because a principal-agent relationship, which is essential for imposition of fiduciary duties, is absent in the shareholder-director equation.
The principal is made fully liable to the third parties on the assumption that he has the power to control his agent. Hence, in order to ensure agent’s accountability to the principal, fiduciary duty is imposed on the agent towards the principal. However, in contrast, a shareholder does not have full liability towards third parties. In other words, the company, owing to separate legal entity principle, is made fully liable to the third parties, which shields the owners, i.e. the shareholders, from third party liability. In absence of such liability, principal-shareholder and agent-director analogies breakdown. Therefore, fiduciary duty cannot be imposed on directors towards shareholders.
Another argument for imposing fiduciary duties on the director is a based in residual-claimant theory, in which it is argued that directors should have exclusive fiduciary obligations towards a shareholder because, in her capacity as a residual claimant of the company’s profit, she has the greatest incentive in maximising the value of the company. This, however, is untrue in the contemporary corporate structure of India, which has several residual claimants, like creditors and option holders, to the firm’s income. In the absence of any special position of the shareholders vis-a-vis the firm, the agents of the company (directors) will not be construed as agents of the shareholders. Hence, directors do not have any general fiduciary duties towards the shareholders.
B. Shareholder-director relationship is different from shareholder-shareholder relationship
It is established that directors do not have any general fiduciary obligations towards the minority shareholder. But, for the purpose of this section, a director is deemed to be a fiduciary (agent) of the minority, in order to argue that even if the conclusion of the former section (director does not owe fiduciary duty to the shareholders) is overturned, fiduciary obligations cannot be attributed to majority shareholders by construing them as shadow directors. We aim to establish that by expounding on the varying characteristics of two associations (shareholder-director and shareholder-shareholder).
Fiduciary status is associated with relationships of trust. This can be either deferential trust or vigilant trust. The former is where the trusting person extends partial or complete deference to the decisions of the trusted person. This trust emanates from feelings of security and affection. In the latter, there is an absence of vulnerability or unreserved faith but a mere expectation to act faithfully. The expectation underlying this kind of trust is that of fair dealing between competent and capable persons.
Logically speaking, the relationship of director and shareholder will be a relationship of vigilant trust. However, a majority shareholder and minority shareholder do not constitute a trust relationship. They are co-owners of the property. When two persons deal with each other or affect each other without the aid or use of intermediaries they are each considered to be a principal. Therefore, this is a principal/principal relationship. No fiduciary obligation is presumed to exist in such a relation.
Another way of looking at it can be that a company is the nexus of contracts. The nature of the contract between the shareholders and directors is indicative of the separation between control and ownership. The premise for the separation is that one party, who owns property but who lacks the necessary skill and information to manage its property, delegates open-ended management power to another person. In such a legal relationship, the controllers have the incentive to use their powers for their own benefit rather than to enrich the owners. In those situations where it would be costly or impracticable for the owner to monitor and effectively discipline the controller’s performance, the rights of the owner must be protected by the statutory fiduciary duties owed by the controller. In the corporate context, the separation between ownership and control implies an open-ended delegation of powers from shareholders to the board of directors. In large public corporations, such separation results in acquiring by the management of a largely autonomous position in relation to shareholders.
In light of this, the rights of the owners are shielded by imposing fiduciary obligations on the controllers. However, in a contract between majority and minority shareholders, parties come together to own the property (the shares of the company). Hence, in the absence of any separation between control and ownership, it is illogical to impose any fiduciary obligations on promoters.
II. PRACTICAL STANDPOINT
We argue that imposition of fiduciary duties is illogical and unnecessary in India. The Indian legislations impose sufficient statutory obligations on controlling shareholders/promoters to avoid any violation of minority shareholders’ rights. In light of stringent legal duties and statutory reliefs, the imposition of additional fiduciary duties is a needless exercise, which will open flood gates of moral policing by the judges.
This position is also recognised in the Common Law. However, the legal structure in Britain recognises two restrictions on shareholder’s powers, which are envisaged as fiduciary duties of the majority. We argue that neither of these fiduciary obligations can be imposed on majority shareholders in India because those limitations are already accounted for in the Companies Act, 2013 and therefore, it is irrational to rely on the legal structures of other jurisdictions. We will expound on two restrictions individually.
A. First Restriction
It limits a majority shareholder’s power to alter the memorandum of association and articles of association. The majority has to adhere to the principles of equity during alteration. The Companies Act, which overrides the AOA and MOA, anyway takes into account interests of the minority when any variations are introduced. S13 provides that the unutilised money, which was raised through prospectus, shall not be used for any other objects unless approved by a special resolution. Hence, it protects the minority shareholder’s property by affording an opportunity to participate in the process. Furthermore, the dissenting shareholders are given a window to exit at conditions specified by SEBI.
B. Second Restriction
It limits the majority from committing fraud on the minority. This, again, is taken care of by elaborate provisions under s447, which attributes individual liability on any person committing fraud against shareholders. Besides, under s221, the act warrants the intervention of a tribunal to avoid actions prejudicial to the interest of shareholders. It also punishes every officer, including but not limited to majority shareholders, for every action which is prejudicial to the interests of the shareholders.
Hence, in light of ample statutory protections, there has not been any requirement for placing reliance on fiduciary obligations of the promoters.
III. CONCLUDING REMARKS
The imposition of fiduciary duties on Indian corporates is theoretically absurd and practically unnecessary. Hence, the claims of protecting the minority shareholders with fiduciary duties (in addition to statutory duties) are merely moralistic without any legal or logical backing.
†Divya Khanwani and Suneel Kumar are fourth year students at National Law School of India University, Bangalore.