Corporate governance is to ensure that a system is in place to protect the individual as well as collective interests of all the stakeholders in a company. In this respect the role of Board of Directors becomes very important because by its very nature a company is an artificial juridical person in the sense that it can sue and can be sued. But it works through its directors who are its eyes, brain and muscle. Directors are the persons who run day to day affairs of the company and possess the first hand information about every aspects of its operations. Directors are also in the best of position to determine its future course i-e set objectives, formulate strategy, devise operational plans etc. Shareholders are the owners of the company who provide capital to the company for its operations but are not supposed to run its affairs and delegate this function to professional managers. These professional managers may also be shareholders of the company. This separation of brain and capital poses agency problem and dual role of directors, shareholders as well as directors creates conflict of interest with other stakeholders such as outside shareholders.
In the wake of recent financial crises and recent past failure of Enron, Worldcom and Parmalat, a heated debate is going on the role of directors and the board in the governance of corporate world. Much of the debate is centered round the structure of the board, integrity of the financial reports, auditing, shareholder activism, corporate governance rules and regulations etc. A very little attention has been given to the concept of borrowing powers of the directors. One of the elements of the powers enjoyed by the directors is that these may be misused and abused as well. If these are being misused, it means due care and necessary diligence has not been taken care of and if these are being abused, it means these are used for the purposes other than the benefit of the company. In both the cases, the tendency or some inclination to misuse and /or abuse powers can lead to disaster. As a precautionary measure, there is a need to put some checks on the use of powers enjoyed by the directors. One of the powers given to directors or used by the directors on behalf of the company is borrowing power. There is no restriction on the borrowing powers of the directors in Articles of Association and neither there is any law that restricts this power. However, there are rules and regulations for the lenders that prohibit them to lend in case of borrowing beyond a certain percentage of equity but generally there is no restriction on borrowers.
As directors manage a corporation for and on behalf of the shareholders who own it, it is critical that any regulatory and legal requirements placed on directors do not seriously compromise their goal of maximizing shareholder wealth. Directors’ behavior influences the efficient operation of corporations. If directors are subject to undue transaction costs in protecting themselves from personal liability, these costs will ultimately be passed onto, and borne by, the corporation itself. On the other hand, if directors are permitted to operate completely unfettered by regulation and a degree of shareholder control, investor confidence in the corporate may potentially be undermined. In this regard, it is clear from past experience, particularly in relation to the corporate collapses as mentioned above, that the conduct of directors through corporations can have a significant impact on public perceptions and market confidence.
While regulatory requirements are usually placed on directors as a means of protecting investors, or the general public, such protection may well be achieved at the expense of investors themselves. Accordingly, it is vitally important that any measures put in place as a means of promoting investor protection are properly assessed from an economic perspective to ensure that they do not ultimately act to the detriment of shareholders as a whole. To promote investor confidence and thereby facilitate expansion of capital market, investors need to be satisfied that they have sufficient opportunity for redress against a corporation and its directors in clear cases of negligent, reckless or fraudulent conduct. However, directors who effectively control the corporation, must not feel so over-burdened with a fear of responsibility that their decision-making is seriously constrained. Regulation in the area of directors’ duties and shareholders’ rights invariably involves a fine balance between maintaining investor confidence and encouraging commercial enterprise. In the interests of maximizing shareholder wealth and economic growth, directors need to be encouraged to take enterprising decisions. However, these decisions must be taken in the interests of the company and be challengeable if they are not bona fides and well informed.
In the backdrop of above deliberations, it is important to thoroughly evaluate the possibility of check on the borrowing powers of the directors. This paper shall examine the all possible ways in which such a check can be placed and a critical analysis of each alternative shall be put forward. Finally, a recommendation shall be made whether such a check is required or not and if required what necessary amendments in Company Law are required.
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