Very directors to a board of a

Very simply put, “nominee directors” are
directors appointed by third parties to the Board of Directors in a particular
company. These third parties may be financial institutions and other lenders,
foreign collaborators, holding companies or even the Government. Of these, it
is most common for lenders to nominate directors to the Board of a company. In
light of the large-scale expansion of private businesses today and their
corresponding need for capital, it has become imperative for businesses to
borrows huge sums of money from outside entities. These lending entities desire
to safeguard their interests by ensuring that the Board of directors of a
company do not make reckless use of the funds given or run the company in a
manner that would result in huge losses to the lending entity. Thus, they
nominate persons on the Board of a company who in their capacity as directors,
are supposed to act as per some understanding or arrangement which creates an
obligation or expectation of loyalty towards the lending institution.1
The practice of appointing nominee directors is practiced in several common law
countries such as the United Kingdom, the United States, Australia, New
Zealand, etc. In India, this practice has gained more and more significance
with the growth of the banking and finance sector and privatization of
different businesses.

Position before the
Companies Act, 2013

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Prior to the introduction of the new company law
legislation in 2013, no enabling provision for the appointment of nominee
directors existed in any statute. However, this practice was followed by
institutions by incorporating clauses that gave them the power to appoint
directors to a board of a company that they were providing assistance to. Thus,
the practice of appointing nominee directors was mainly guided by commercial
considerations. In June 1971, the Government of India issued a policy directive
which made it compulsory for institutions providing ‘substantial assistance’ to
a company to appoint nominee directors. The number of nominees to be appointed
by the creditor institution was left to its discretion. The institution was
supposed to decide the number of people it wanted to nominate based on the
nature and scope of the assistance provided and the importance of the relevant
undertakings. However, in practice companies rarely appointed more than two
nominee directors except in case of companies that were defaulting in
repayments or violating their loan facility agreements. 2
This policy directive of the government gained more and more significance after
the liberalization of the economy in 1991 after which private businesses began
to expand and consequently, their requirement for capital increased rapidly.

 

Position post the
Companies Act, 2013

 

1.     Definition of the term ‘nominee director’

Two provisions under the 2013 Act talk about
nominee directors. First, Section 161(3)
makes a provision for the Board to appoint as director any person who is
nominated by:

(1)  Any institution in pursuance of either a law or
any agreement; or

(2)  The Central or State Government by virtue of
their shareholding in a Government
company.

Second, the Explanation to Section 149(7) of the Act defines ‘nominee director’ for the
purposes of Section 149 that deals with the Board of Directors in a Company. It
states that a nominee director is a director:

(1)  Nominated by any financial entity under a law or
agreement; or

(2)  Appointed by a Government; or

(3)  Appointed another person to represent its
interests.

2.     Appointment of a nominee director

The enabling provision in the 2013 Act for the
appointment of nominee directors is Section 161(3). As per Section 161(3), all
companies except Government companies can have nominee directors in two
situations:

(1)  The appointment of such directors is mandated
under a law or

(2)  The nominating party and the company enter into
an agreement to such effect

An example of the second situation would be in a
case where a company enters into a loan agreement under which the creditor to
appoint its representative to the company’s Board. Hence, this is a commercial
arrangement which is mutually consented to by both parties involved in order to
further their own interests.

However, in the case of the first situation,
appointment of nominee directors is not guided by commercial considerations but
is made on the basis of public policy.

Section 161(3) enables the appointment of
nominee directors “subject to the Articles of the Company.” Thus, an important
condition for the appointment of nominee directors is that the Articles of
Association of a company must allow such an appointment.

In case of a listed company, the stock exchange
on which the company is listed must be intimated of the appointment of the
nominee director and his/her tenure if specified.3

3.     Duties of a nominee director

As previously discussed, a nominee director is
appointed to represent and protect the interests of its nominator in the
decision-making process of the Board. In reference to this role of a nominee
director, the obvious question raised is whether the nominee’s loyalty to his
nominator can cause him to take decisions which are beneficial to his nominator
but are not in the best interests of the company.  In order to answer this question, the two
types of duties to be fulfilled by the nominee in his capacity as a member of
the board must be understood.

§ 
Duties towards the Company

It is a well-established principle that a
director is in a fiduciary relationship with the company and must always act in
the bona fide interests of a company.4
Section 166 of the 2013 Act enumerates the duties of the directors of a
company. These duties listed under the different sub-sections of the provision
can be summarized as under:

1 Report of the Companies
and Securities Law Review Committee (New South Wales, Australia)

 

2 R.H. Patil, “Are Institutional Nominee Directors Required?”, Economic
and Political Weekly (2001) (Vol. 36, No.46/47)

3 Regulation 30, SEBI (Listing Obligations
Disclosure Requirements) Regulations, 2015

4 Yashovardhan
Saboo v. Groz- Beckert Saboo Ltd. And Ors. 1995 83 Comp Cas 371 (CLB)