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​Role of Board of Directors in Corporate Governance and corporate action

A company is an independent legal entity, which is treated separately from its shareholders and directors. Since it is a fictitious entity, it must be represented by an identifiable body of persons. In respect of a company, it is the Board of Directors which is entitled to represent and take actions which bind the company.
 The Board of Directors has several checks and restrictions on exercising its powers under the Companies Act and others which may be imposed in the articles. Moreover, Board of Directors is required under section 134 (3) of the Companies Act, 2013 to present to the company in the general meeting of the company, a report stating important financial and other information related to the company. You can download a sample Board’s Report here.
The nature of restrictions applicable on the board of directors is discussed below. 

Power of shareholders to make regulations applicable to Board of Directors
This general power of the board to make decisions and take actions is also subject to regulations that shareholders may pass in a general meeting. It is to be noted that the shareholders can make only prospective regulations and cannot invalidate a prior decision or action of the board by passing a regulation retrospectively. However, this provision is rarely useful in a private company as the majority shareholders also control the majority of directors and the shareholders can fire the directors at any point by calling an extra ordinary general meeting. However, if majority of directors on the board are professionals or people who are not under absolute control of the shareholders, they may choose to make certain regulations to ensure that the board of directors cannot stage sabotage or act against the interest of the shareholders if such a possibility exists.
To exercise certain powers of the board, the Companies Act requires it to pass resolutions at a board meeting. For instance, if the company has to borrow any money, through issue of debentures or any other way, the board must pass a resolution to that effect. Similarly, resolutions need to be passed in board meetings for investing the funds of the company or in order to make a loan. The Companies Act has specified some details to be mentioned in the resolutions, which should be studied at the time of making such resolutions.

2. Restriction on making political contributions under Companies Act  A company is not allowed to make any political contribution (donation, subscription or payment either to a political party or to a person for a political purpose) until it has been in existence for at least three financial years. A company which is eligible to make political contribution may only do so by passing a board resolution to that effect and may not make such contributions in excess of 7.5 percent (under the 1956 Act this limit was 5 percent) of its net profit in preceding three financial years.

3. Matters for which shareholder/minority consent is required in a private company In a private company, the board of directors has flexibility of operation and wide ranging powers while the shareholders control the board indirectly as the majority of shareholders have the power to hire or fire directors in a shareholders’ meeting. Let’s understand the rights for minority protection in greater detail:

Board related rights The minority shareholders are often unable to appoint any directors or take part in the decision making process by default – and may not be represented on the board at all. Hence, minority investors in private companies often ask for a set of minority rights – which includes right to appoint one or more directors on the board.

Usually appointment of directors would be pro rata to shareholding, with a minimum of one director being appointed by the minority shareholder. Sometimes minority shareholders appoint observers to the board who do not vote in the board proceedings but keep a tab on the activities of the board on behalf of the minority shareholders. Although they don’t have any right to vote, they have a right to be present in board meetings).

These matters have to be addressed in an investment agreement signed by the shareholders (shareholders’ agreement) at the time when the minority shareholder buys a stake in a private company, failing which the minority would not be able to participate in proceedings.

Under the Companies Act, 2013, to have a fair representation of the minority shareholders in a listed company (a shareholder having shares whose nominal value is less than twenty thousand rupees), such shareholders may elect one director to represent their interests.

b. Minority protection through list of reserved matters requiring minority consent Even if the minority shareholders get a place in the board, usually the directors appointed by the majority shareholders outnumber directors appointed by the minority shareholders in the board. Since the board makes decisions through voting, those shareholders who have majority of directors can effectively make any decision without consulting or taking consent of the other shareholders.

To protect the interests of minority shareholders, especially investors, a list of reserved matters is created. To make any decision related to this list of reserved matters, the board is required to take affirmative consent of the minority shareholders or their nominee directors. Affirmative consent of the investors can be taken in a shareholder meeting or their nominee directors in a board meeting. 

This works as a veto right in favour of the minority shareholders and is a significant way in which minority investors in a company retains decision making authority over important matters that can significantly impact the business and profitability of the company. 
These limitations are also first negotiated into a shareholders’ agreement and later incorporated into the articles of the company, and is a standard procedure after a company receives funding from angel investors, VCs etc.

Minority rights in articles The articles of association of a company can place limitations on the power of directors to take certain actions. The restrictions placed on majority through an investment agreement and other minority rights are hence incorporated into the articles of association as far as possible in order to make the same binding on the company as well as shareholders.

Note: The earlier Companies Act formally recognized only two kinds of shareholder resolutions – ordinary resolutions (greater than 50 percent vote) and special resolutions (greater than 75 percent vote).

Pursuant to investment documentation, investors used to include an affirmative rights clause which added a list of reserved matters into the articles. This clause in the articles stated that their consent must be taken if any action is taken on any of the reserved matters.  Depending on the provisions of the Companies Act, actions on these matters could be taken if there was director or shareholder consent from the requisite majority (which should include the investor or their representatives as well.

The Companies Act 2013 has specifically permitted companies to insert clauses in their articles which are ‘entrenched’ – that is, directors cannot take actions on these clauses without consent from the requisite proportion of shareholders (which could be even higher than 75 percent). Essentially, this allows shareholders to include ‘supermajority’ provisions in the articles (i.e. requiring even higher than 75 percent shareholder vote).

If used judiciously, these powers can be very handy in ensuring adequate checks in corporate governance mechanisms within the company.

4. Matters for which shareholder/minority consent is required in a public company Public companies have many safeguards in the Companies Act in form of limitation on the power of the board of directors. In case of a listed company, there would be further elaborate limitations and checks on the powers of the board imposed by SEBI guidelines, rules and stock exchange regulations. For instance, even at the stage of forming the board, a listed company is required to include independent directors who are not interested in the business of the company or connected to the promoters. Earlier, this required as per Clause 49 of the Listing Agreement – this requirement is now reiterated in the Companies Act, 2013 with respect to listed companies.

Restricted powers of delegation:
The prohibitions listed below, in cases (a) and (b) are absolute, while in cases in (c) and (d) delegation is permitted to limited categories of persons, and subject to certain conditions that were specifically mentioned under the Companies Act, 1956 (these are listed below). As per the new Companies Act, 2013, the Board is free to stipulate any conditions under the resolution prohibiting delegation.
The restricted powers of the board are:
(A) the power to make calls on shareholders in respect of money unpaid on their shares;
(B) the power to issue securities, including debentures;
(C) the power to borrow money (otherwise than on debentures).

This power could earlier be delegated to specified categories of persons (listed below) by a board resolution specifying the total amount outstanding at any one time up to which moneys may be borrowed by the delegate.

The Companies Act 2013 does not specify any stipulations that the board resolution must mention – the board can specify the restrictions on the delegate that it feels appropriate.

(D) the power to invest the funds of the company
This power could earlier be delegated to specified categories of persons (listed below) by a board resolution specifying the total amount up to which the funds may be invested, and the nature of the investments which may be made by the delegate.

The Companies Act 2013 does not specify any stipulations that the board resolution must mention – the board can specify the restrictions on the delegate that it feels appropriate.

(E) the power to make loans, issue guarantees or provide security for loans
This power could earlier be delegated to specified categories of persons (listed below) by a board resolution specifying the total amount up to which loans may be made by the delegate, the purposes for which the loans may be made, and the maximum amount of loans which may be made for each such purpose in individual cases.

The Companies Act 2013 does not specify any stipulations that the board resolution must mention – the board can specify the restrictions on the delegate that it feels appropriate. 

The Companies Act 2013 also restricts delegation in respect of the following functions:
  1. Authorization of buy-back
  2. Approval of Board’s report
  3. Diversification of business of the company
  4. Approval of amalgamations, mergers and reconstruction, takeover or acquisition of a controlling or susbstantial stake in the company
  5. Other matters that the Central Government may prescribe

Categories of persons to whom powers mentioned in (c) to (d) may be delegated has remained similar under new Companies Act 2013 as well - a committee of directors, the managing director, the manager or any other principal officer of the company (or a branch office) may be delegated these powers. 

There are no restrictions on the Board of a private company for the purpose of delegating any other powers. 
However, note that shareholders may place restrictions on the power of the board (both in a private company and a public company) to delegate the powers mentioned above through regulations passed in general meeting or through articles of association.
  1. Restrictions on director’s dealings with companies and related-party transactions
i) Purpose of regulating related party transactions

Related party transactions are governed by multiple legal and accountancy frameworks – Companies Act, Income Tax Act (for tax purposes) and under Accounting Standards (for accounting purposes). Related party transactions can potentially be used to distort the impact of tax laws by shifting income from one taxable party to another, an evil sought to be regulated by the concept of ‘transfer pricing’ under tax laws. Under the Companies Act, the primary intention behind regulating related party transactions is to prevent directors from deriving personal benefits at the cost of the shareholders by avoiding a conflict of interest.

The Companies Act has several provisions which regulate conflict of interest. As the company primarily acts through the board of directors, the conflict of interest provisions regulate conduct of directors at board or committee meetings.

Related party transactions could be of two kinds – i) transactions where the company is entering into contracts for purchase or sale of products or services, leasing of property, etc. or ii) purely financing transactions, where equity, debentures or loans are sought to be obtained. Additional restrictions are imposed on the second kind of transactions. They are explained later in this chapter and also separately in more detail, under the chapter on business structuring and inter-corporate finance. Currently, we will examine the governance requirements for the first kind of transactions. 

A particular director (it could even be multiple directors) may have an interest (apart from his interest in capacity as director of the company) in matters discussed at board meetings. For example, when a company is evaluating proposals from various suppliers with whom it may enter into a contract a board meeting. It may so happen that one of the directors of the company holds shares of the supplier as well. Although the director may act impartially, he will be required to follow certain procedures under the Companies Act.

We mention below the key provisions for regulating situations in which a conflict of interest can arise (such transactions are also known as ‘related party transactions’ in corporate law), and the obligations of directors in such situations.

ii) Identification and regulation of a related party transaction under company law

The Companies Act (both 1956 and 2013) requires prior board approval (at a meeting) if a company intends to enter into certain types of contracts identified below as ‘Restricted Contracts’, with a director or his relative, a firm in which a director or a relative (defined below) is a partner, any other partner of such a firm, or a private company of which the director is a member or director. These persons can be understood as ‘Related Parties’.

As a new development, the Companies Act 2013 has provided a definition of ‘related party’ – it includes:

  • a director, key managerial personnel (KMP), relative of a director or KMP
  • Firm or company in which a director / manager or his relative is a partner or director
  • Public company where the director / manager (along with relatives) holds more than 2 percent of the capital
  • Group companies (i.e. holding, subsidiary and associate companies)
  • Any person in accordance with whose advice the company acts (excluding advisors in professional capacity).

The list of restricted contracts has been expanded by the 2013 Act – broadly, the Companies Act 1956 regulated contracts for i) sale, purchase, supply of any goods, materials and services or ii) for underwriting the subscription of any shares or debentures of the company.


As per the 2013 Act, selling, leasing or otherwise transferring property, appointment of agents for sale, purchase or supply of goods and services and appointment of the person to an ‘office of profit’ (defined as any position where remuneration is received in any capacity other than director – receipt of salary, fee, commission and perquisites qualifies as remuneration for holding an office of profit) in the company or its group companies are also covered within the ambit of restricted contracts.

Thus, a contract which can be identified as a Restricted Contract which is entered into with a Related Party will be governed by the above requirements. 

What is the relevance of the clause requiring a Board resolution? 
Note that the Board is entitled to delegate certain functions to individual directors or to even third parties (this is done by passing a board resolution and executing a power of attorney in favour of the director or the third party). If any transaction qualifies as a related party transaction, it must be specifically authorized by the board pursuant to a resolution at a board meeting (a resolution by circulation will not suffice) - the individual director or third party who is exercising powers delegated by the board cannot enter into the transaction pursuant to the board resolution and power of attorney.

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