Funds and financial institutions usually appoint nominee directors to safeguard their investments and guide portfolio companies toward achieving their business objectives. The issue of their liability is therefore of critical consideration. Their presence on the board may provide private equity (PE) and venture capital (VC) investors with significant operational insight and strategic influence.
The act unequivocally fixes obligations on all directors, including nominees. Section 166 requires that they act with due care, diligence and in the best interests of the company. Breach of these duties is punishable with fines. These requirements form the foundation of the framework for permissible conduct because nominee directors must fulfil them.
PE and VC investors usually nominate only non-executive directors because they play no part in the day-to-day operations of the portfolio companies. This class of directors provides a vital safeguard under section 149(12) of the act. They are only liable for acts or omissions that occur with their knowledge through board processes, with their consent or connivance or where they fail to act diligently. Liability is thus not automatically attached by virtue of designation, but rather through conduct determined by the facts. Circulars from the Ministry of Corporate Affairs and many court rulings have only strengthened this principle.
The Supreme Court, in such cases as Sunil Bharti Mittal v Central Bureau of Investigation and SMS Pharmaceuticals v Neeta Bhalla, has consistently held that the criminal prosecution of a director requires sufficient evidence of substantive participation in the company’s day-to-day operations or in the acts leading to the alleged wrongdoing. Mere designation is insufficient to attract liability, as courts do not presume a non-executive director’s involvement in daily operations. Consequently, attending board meetings or signing balance sheets alone is insufficient evidence to fix liability. As long as nominee directors restrict themselves to strategic oversight and do not involve themselves in the daily operational management of a company, no liability will attach to them for the company’s misdeeds. Although statutes such as the Negotiable Instruments Act, 1881, do not distinguish between executive and non-executive directors, courts have used the framework of the act to determine liability.
The law may be clear about the liability of non-executive directors. Nevertheless, nominee directors continue to face challenges in striking a balance between their loyalty to the nominator and their fiduciary responsibilities to the company. Each situation will turn on its own facts. The Supreme Court, in Tata Consultancy Services Limited v Cyrus Investments Private Limited, recognised that nominee directors owe an equal duty to their nominator in addition to their statutory duties owed to the company. The boundaries of what is in the best interest of the nominator and the company are always blurred. However, it remains to be seen how courts will interpret these decisions.
PE and VC investors should structure nomination arrangements in such a way that precisely sets out the appointee’s limited role. Nominee directors should focus on issues such as business strategy, compliance, governance and risk management, rather than on everyday operational matters. They must document any dissent, abstentions or reservations about board decisions, particularly when company and nominator interests diverge. This will be crucial evidentiary support if their role is later questioned.
The key takeaway is that although nominee directors play a vital role in safeguarding investor interests and enhancing value, investors and directors must understand the complex rules surrounding liability. Robust checks, detailed documentation and adherence to best practices will minimise the risk that board representation is subject to regulatory or judicial challenge. To this end, both legislative harmonisation and consistent adoption of prudent governance standards will best serve the interests of the PE and VC sector.
