The Directors of a Company act as agents of the Company and enter into contracts and arrangements on behalf of the company. Sometimes, in the course of such transactions, the Directors may have some personal interest in the transactions to be entered into by the company. Since they occupy such a key position requiring trust and utmost good faith, the Companies Act, 1956 has laid down extensive provisions to prevent the misuse of rights and powers by the directors. The object of these sections is to bring into the knowledge of the Board of directors, the extent of the interest of a director, in any contract proposed to be entered with the company by the Director or any of his specified associates.

Before applying the provisions of the Companies Act, 1956 (hereinafter referred to as the Act) it is pertinent to understand the concept of an interested Director.

A director is said to be an Interested Director if the party to the contract is

· A director of the company

· Relative of any director

· A firm in which the director or his relative is a partner

· Any other partner in such a firm

· A private company in which such a Director is a member or a Director.

PROVISIONS IN THE ACT

SECTION 299

Section 299 of the Companies Act, 1956 provides for Disclosure Of Interest By Directors.

It states that any director who is in any way interested, directly or indirectly in a transaction or arrangement to be entered into by the company shall disclose the nature of his interest in a meeting of the Board of Directors of the Company.

The section also states that a director who fails to comply with the section shall be liable to pay a fine upto fifty thousand rupees. The contravention of the section also results in automatic removal from the office of the director, not requiring a resolution by virtue of Section 283(1)(i) of the Act.

MODE OF DISCLOSURE

In the case of a proposed contract or arrangement, the disclosure shall be made at a Meeting of the Board of Directors or if the director was not, at the date of the meeting, concerned or interested in the proposed contract or arrangement, at the first meeting of the Board held after which he becomes so concerned or interested. In case of any other contract, the required disclosure shall be made at the first meeting of the Board held after the directors becomes concerned or interested into contract or arrangement.

Sub- section (3) provides that a general notice has to be given to the Board by a director, to the effect that he is a director or a member of a specified body corporate or is a member of a specified firm and is to be regarded as concerned or interested in any contract or arrangement which may, after the date of the notice, be entered into with that body corporate or firm, shall be deemed to be a sufficient disclosure for the purpose of sub-section (1) and (2) in relation to any contract or arrangement so made.

It has been further provided that such notice has to be renewed every financial year and it is the duty of the concerned director to ensure that such general notice or renewal thereof is brought upon and read at the first meeting of the Board after it is given.

However, it is pertinent to point out that the Act does not prohibit the company to enter into transactions in which the director is interested. It only casts a duty upon the director to make disclosure of his concern or interest as provided in the section. Failure to make the required disclosure renders the director liable to punishment, and gives an option to the company to avoid the contract, but does not make the contract illegal, unenforceable or void.

Sub-section (6) of Section 299 provides that disclosure of interest is not required where one, or more Directors of one company does not hold or holds not more than two percent of the paid up share capital in other company.

However, it is pertinent to point out the practical difficulty in this regard :

It is seen that without knowing the extent of the interest of all the other directors in the company concerned, it would not be possible for a Director to know whether the collective holding of himself and his colleagues was less than 2 per cent.

Although the object of sub section (6) is that the Directors would not be required to give even a general notice of interest when their interest in the company, which would otherwise have to be declared, was less than 2 percent. However, in practice the position remained that Directors could be certain of complying with the section only if they gave a general declaration of their individual interest in any other body corporate, whatever the extent of that interest.

The Act has also outlined provisions like Section 297, 300 and 301 which further ensure that the personal interest of the director is not prejudicial to the interests of the Company.

SECTION 297

The object of Section 297 of the Act is that the Board of Directors should have knowledge of the extent of interest of a director in any contractual dealings with the company, or of any person connected with the director in any of the ways mentioned in section 299(1), and accord their consent to such dealings. The consent contemplated is not a general consent but consent referable to each particular or specific contract.

Section 297 lays down the following contracts which require prior approval of the Board:

i) Sale, purchase and supply of goods, materials and services

ii) Underwriting the subscription of any shares or debentures of the company.

In companies with paid up capital of Rupees 1 crore or more, prior approval from the Central Government is required for entering into contracts covered under section 297.

Although the prior approval of Board of Directors is required under section 297, a relaxation under sub-section (3) of section 297 has been provided. In cases of urgent necessity, prior approval of the Board is not required but the consent should be obtained within three months by a resolution passed in the board meeting. This relaxation shall not apply to companies which require prior approval of the Central Government.

In a situation where the Board does not have a quorum of disinterested directors, the contract shall be approved by the shareholders in General Meeting.

CONSEQUENCES OF FAILURE

Failure to obtain the Board’s consent will make a contract voidable at the option of Board of Directors. The contract shall become void only when the Board of Directors avoids it. Also, if the Central Government’s approval is required, failure to obtain the same would render the transaction void.

EXEMPTIONS UNDER SECTON 297(2)

The prior consent of the Board will not be required in the following circumstances:

i) Contract for purchase of goods from the company or sale of goods to the company, which are for cash at prevailing market prices.

ii) Contract for sale or purchase of good or services in which the party regularly does business but upto Rs. 5000 in a year during the period of contract.

iii) Any transaction of the Banking/Insurance company in the ordinary course of business of such company with the specified persons.

SECTION 300

Further, Section 300 ensures that an Interested Director is not allowed to participate or vote in Board’s proceedings. The Act also anticipates the unnecessary inconvenience in this regard and provides that such a restriction would be applicable only if the combined holding of all the directors is more than 2 percent of the shareholding of the company.

Voting by an interested director will make a contract void in the following two cases if the exclusion from quorum would have resulted in ‘no quorum’ or if exclusion of his vote would have resulted in failure of such resolution.

IF INTERESTED DIRECTORS EXCEED NON INTERESTED DIRECTORS

Since the provisions of Section 300 cannot be disregarded on the ground that number of interested directors exceed that of non interested directors

The following alternative options may be adopted:

1. The difficulty in getting required quorum at the Board Meeting can be solved by increasing the strength of the Board of Directors or co-opting new members, if so authorised by the Articles.

2. Summon and get the approval of a general meeting by means of an ordinary or special resolution as the case may require, in conformity with the provisions, if any, in the Articles of the company.

3. If there is a provision for appointing additional directors, a sufficient number of additional directors may be appointed so as to have a quorum of independent directors.

The restriction under Section 300 is not applicable to private companies. Further, this restriction is not applicable in case of a private company which is a subsidiary of a holding company, enters into a contract with the holding company or contracts in a public company where the interest of the directors does not exceed 2 percent of the paid up share capital of the company.

SECTION 301

Section 301 embodies the principle of transparency and provides for maintenance of a Register of contract which includes all arrangements and contracts entered into by the company in which the directors are interested. Such contracts or arrangements are to be entered into within 7 days of meeting of the Board or approval of the Central Government. The register would be kept at the registered office of the company and will be open to inspection by any member of the company.

The Register has to contain the following particulars

· date of the contract,

· date on which it was placed before the Board,

· names of the parties,

· terms and conditions of the contract,

· names of directors voting for and against and remaining neutral

REGISTER OF CONTRACTS HAS TO BE MAINTAINED EVEN THOUGH SECTION 299 IS NOT APPLICABLE

Section 301 deals with the maintenance of the register of contracts in respect of the contracts to which either Section 297 or 299 is applicable. The mere fact that one of these sections is exempted from application in a particular case does not ipso facto lead to an exemption of Section 301. The register of contracts has to be maintained as required by Section 301 if the requirement of Section 297 is attracted even though the requirement of Section 299 is not applicable.