Usurpation of Corporate Opportunity by Directors: Expanding the contours of Fraud

Author: Pallavi Agarwal, 4th year, National Law School of India University (NLSIU), Bangalore

A company’s management is a treasure house of extensive information about the company as well as other market players. It is surely desirable that the management puts that information to use only to further the interests of the company and its stakeholders. However, the corporate opportunities flowing from such information are often diverted by the directors of the company to fulfil their own personal interests. To prevent this, Section 166 of the Companies Act, 2013 (the “2013 Act”) stipulates fiduciary duties to be followed by the Directors of every company and prescribes a monetary punishment for breach of such duties. Along with fiduciary duties, the 2013 Act brought into framework a whole new codification under Section 447 for fraud committed by a company through its management. Basing on the insufficiency of Section 166, this paper argues that usurpation of corporate opportunity by the Directors against the interests of the company should be construed not as a mere breach of fiduciary duty under Section 166 but also a fraud on the affected company under Section 447.

Fiduciary Duty and Fraud

The fiduciary duties under Section 166 are essentially a miniature incorporation of Sections 171-177 of the Companies Act, 2006 (the “UK Act”) applicable in the United Kingdom (“UK”). These duties are not just against the company, but also other interested parties such as members, shareholders, employees, community and environment. The idea of corporate opportunity has not been clearly defined under the 2013 Act but sub-clauses (4) and (5) of Section 166 can be recognized as the ‘conflict rule’ and ‘profit rule’ respectively which embody the principle that Directors should not knowingly steal an opportunity that ideally belongs to the company. The conflict rule directs that Directors are expected to not enter into dealings or utilize opportunities in a manner that stands in conflict with the interests of the company. The profit rule, really a subset of the conflict rule, requires that the Directors should not make any profits for themselves or their relatives by sidelining the interests of the company.[1]

Now, in the context of company law, Fraud finds its own definition within the Explanation to Section 447 of the 2013 Act. The definition is pretty broadly worded and can include a host of actions (and inactions) within its ambit. The Explanation states that acts, omissions, concealment of facts or abuse of position can be considered as fraud if they are done with an intent to deceive and to gain undue advantage or to injure the interests of, inter alia, the company. The provision recognizes such actions with respect to any person and does not require the occurrence of any wrongful loss or gain. Thus, if a Director comes across a corporate opportunity during his Directorship but he knowingly misuses it for his own gain, that could, literally, fall within act, concealment of fact or abuse of position under Section 447. Since the action is mala fide in nature, it would satisfy the element of ‘intention to deceive’. Further, as the provision does not require any tangible gains to be caused to the Director or tangible losses to be caused to the company, liability for fraud can be fixed even for merely preventing the company from utilizing an opportunity which it could potentially have if it wanted to.   

Unfortunately, apart from the traditional cases of fraud, the definition under Section 447 has not undergone much scrutiny by the Indian courts. Nor do the other provisions relating to fraud under the Act provide an exhaustive list of instances which could be termed as ‘Fraud’.[2] Thus, taken elementally, one could say that usurpation of corporate opportunity can be categorized as a fraud caused to the company by the Director. This is needful as the present punishment envisaged under Section 166 does not seem sufficient to penalize for the loss caused to the company by such usurpation. A fine of Rs. 5 lakhs, which is in fact the highest permissible under Section 166,[3] is not an adequate sum to deter a Director making loads of money by usurping even one opportunity.   

However, a natural question would arise as to why should we selectively label only the breach of duty towards the company as fraud and not the breach of other duties i.e., towards other stakeholders. Firstly, sub-clauses (4) and (5) of Section 166 are focused particularly on the interest of the company being protected. Secondly, for the other stakeholders, there are usually special laws protecting their interests and imposing specific lability on the company/management. For instance, the interests of shareholders are protected under the SEBI regulations,[4] harm to the environment is penalized under specific environmental laws concerning water, forests, etc.[5] But a loss caused to the company due to breach of fiduciary duty is presently covered solely by Section 166. Hence, it shall be prudent to consider such a breach as a fraud over and above the application of Section 166.              

Flexible Approach: Recognizing defences

It is important to recognize that including such a breach of fiduciary duty within Fraud would obviously expand the scope of ‘Fraud’ as defined under the 2013 Act. Criminal law jurisprudence guides that when extending criminal liability to an act, the construction of the offence should be done as narrowly as possible to prevent over-criminalization.[6] Thus, there is a further need to recognize the defences to usurpation of corporate opportunity to demarcate what all would not be considered Fraud.     

The UK Act envisages typically strict approaches under Section 170 for the construction of the conflict rule and profit rule wherein the real probability of usurpation of corporate opportunity is not evaluated, rather the mildest of such a chance can invoke liability.[7] India has not seen much litigation around the issues of usurpation of corporate opportunity due to which this area remains blurry. The few cases in which the conflict and profit rules under Section 166 have been interpreted, such as Vaishnav Shorilal Puri & Ors. v. Kishore Kundanlal Sippy & Ors.[8] have presented a muddled application of the strict and relaxed approaches. But given that Section 166 (4) & (5) are straightly a mirror provision of Section 175 of the UK Act, it is highly probable that a strict approach may be adopted by the Indian courts too in an effort to track the legislative intent and history of the provision.

But countries like USA have taken a relaxed approach which should be embraced by India as well. Three defences, namely the ‘feasibility of corporate action’, ‘unwillingness of third-party’, and ‘waiver of corporate opportunity’, are majorly accepted in USA and have also gained recognition in a few English cases.[9] Feasibility of corporate action covers instances of financial inability of the corporation or inability due to any other reasons which will hinder the utilization of corporate opportunity by the company. Unwillingness of third party to deal with the concerned company can sometimes shut the doors to an opportunity and the director cannot be made liable in such cases. Waiver of corporate opportunity is when the company was aware of the opportunity but still chose to not grab it and let the director proceed with using it for personal gain.[10]

Even in all these three defences, it has been held that the Director should generally disclose the opportunity before the Board and it shall be essentially the Board’s decision as to what is to be done with it.[11] Of course, there are concerns of domination of the Board by the interested Director himself, or his connivers, leading to manipulated decisions, but that can be determined on a case-to-case basis. However, these general defences are necessary to be recognized prevent overcriminalization if we are to consider unauthorized use of corporate opportunity as Fraud under the 2013 Act.

Interestingly, these defences may be located within Section 456 of the 2013 Act which states that no legal proceedings lie against a person who has acted in ‘good faith’. Under the Explanation to Section 447, the presence of good faith is a basic requirement for the Director’s actions to not fall within the clutches of Fraud. These defences, even if not recognized in explicit terms, should be provided as forming a part of actions done in good faith. For instance, the company was financially weak and so the opportunity could not have been practically utilized by it. Assuming that the financial inability has not been deliberately created by the Director himself, the Director should not be made liable for fraud in this case if he proceeds to usurp such an opportunity because his actions should be deemed bona fide (as they are based on a proper evaluation of the prospects available to the company from the opportunity).    

Conclusion

It is, thus, concluded that a Director’s actions of encroaching upon a corporate opportunity ideally meant for the company should be viewed as not only a breach of fiduciary duty, but also a fraud committed upon the company where the Director maliciously injures the interests of the company. In simpler terms, Section 166 should be read with Section 447 of the 2013 Act while deciding on the penalty to be imposed in such a situation. However, there might be cases where the Director makes use of the opportunity in good faith, by application of his knowledge about the company’s position and evaluation of the possible benefits for the company out of the opportunity. Hence, the test in India for determining whether an usurpation has occurred or not should be relaxed by accounting for the three predominant defences as discussed above, besides the several other factors that have been considered by the American courts.[12]     


[1] Quarter Master (UK) Ltd v Pyke [2005] 1 BCLC 245.

[2] Approximately 20 sections of the 2013 Act talk about fraud committed by the directors, auditors, key managerial personnel, and/or officers of company – sections 7(5) & (6), 8(11), 34, 16, 38(1), 46(5), 56(7), 66(10), 75(1), 229, 213 Proviso.

[3] S. 166(7), The 2013 Act, n (2).

[4] See generally, SEBI (Investor Protection and Education Fund) Regulations, 2009.

[5] See S. 16, Environment Protection Act, 1986; S. 47, The Water (Prevention and Control of Pollution) Act 1974.

[6] Jeremy Horder, Ashworth’s Principles of Criminal Law (9th edn, OUP 2019).

[7] Also see, Keech v. Sandford [1726] EWHC J76; Regal (Hastings) Ltd. v. Gulliver [1942] 1 All ER 378 (HC).

[8] 2004 SCC OnLine Bom 1076.

[9] S.V. Joga Rao and Y. Shiva Santosh Kumar, ‘Understanding the Law on Corporate Opportunity: Inputs for India’ (2013) 55(4) Journal of the Indian Law Institute 531.

[10] Michael Begert, ‘The Corporate Opportunity Doctrine and outside Business Interests’ (1989) 56(2) The University of Chicago Law Review 827, 833-837.

[11] Industrial Development Consultants’ Ltd. v. Cooley, [1972] 2 All ER 162 (Assizes), Energy Resources Corporation v. Porter 14 Mass. App. Ct. 296 (1982).

[12] See generally, Anthony O. Nwafor & Chinwe K. Okoli, ‘The Corporate Opportunity Doctrine – An Inflexible or Flexible Rule’ (2013) 9 Corporate Board: Role, Duties & Composition 22.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this:
search previous next tag category expand menu location phone mail time cart zoom edit close