Overview of the Corporate Governance Regulatory Framework in India
Contributed by: Vaidehi Balvally, Nausheen Ansari, Poonam Sharma, Parag Srivastava and Karan Kalra
Part 1: Corporate Governance: What’s the Hype?
Corporate governance has clearly become the buzz word in India Inc., in more ways than one. But what is corporate governance and why is there so much fuss around it? The concept broadly refers to the set of principles and practices by which an organisation is controlled and managed, ensuring accountability and trust towards all stakeholders.
The OECD (2015) defines corporate governance as the process, structure and systems by which an organisation is governed and operated and often involves a set of relationships between a company’s executive management personnel (popularly called the c-suite), the board of directors, shareholders and other stakeholders. The key objective of corporate governance in an organisation is to enhance shareholder value and at the same time ensure long-term ethical management.
Origin and Development
Corporate governance began with the rise of corporations, especially with the increase in joint venture companies, where ownership was separated from management. Significant and rampant growth in organisations required the management to call the shots and expected shareholders to follow suit, leading to problems of agency in the said organisations.
One of the earliest examples of corporations adopting corporate governance principles is by the East India Company (incorporated in the year 1600), by separating ownership from management, maintaining a board of directors, subsequently issuing shares to the public, and following annual reporting to its shareholders.
However, it was in the early 1970s that, academic and regulatory discourse on corporate governance gained traction in the United States, following the bankruptcy of the Penn Central Transportation Company (one of the causes was attributed to poor board control) and revelations that several corporations had been making illegal political contributions, which prompted the American securities and exchange commission (SEC) and the New York Stock Exchange (NYSE) to consider regulatory reforms such as requiring listed corporations to have audit committees and inclusion of independent directors on the board.
The 1980s to the 2000s was a rebuilding and recovery phase, with organisations struggling to recover from the excessive risks undertaken by banks resulting in a collapse of financial ecosystems across the globe. Board of Directors were handed heavier responsibilities to implement measures such as transparency and accountability, making boards responsible to shareholders (especially public shareholders) for the acts and performance of the company.
Multiple instances of corporate fraud, both in India (Satyam and Sahara being leading examples) and globally (Enron, Lehman, Theranos, FTX etc.), have brought the attention of the industry and regulators to devising and enforcing principles for sound corporate governance (as referenced in the Supreme court case of Sahara India Real Estate Corporation Ltd. and Ors), at the industry as well as the statutory level. In India, one of the reasons for reformulating company law included improved corporate governance. Notably, in the case of Snowcem India Ltd. Vs. Union of India (UOI), 2005 (Bom). concerning the amendment of the provisions relating to disqualifications for directors in the Companies Act, 1956 (which provisions are also continued in the Companies Act, 2013), the Bombay High Court took note of the legislative intent of corporate governance and investor protection as an interpretative aid.
Fast forward to 2024-25, corporate governance in its modern form involves a focus on protecting stakeholders’ interests alongside developing the environmental impact, social and governance aspects of an organisation. The intent is not only to protect the interests of the existing stakeholders but to enable sustainable business practices for future generations, in an ethical manner. It is becoming imperative for organisations to determine their future, keeping in mind their environmental and social responsibilities, besides maintaining the bedrock of principles of accountability and trust.
Why do we need corporate governance?
Companies require corporate governance to be able to balance stakeholders’ interests while ensuring performance and growth of the company, in a sustainable manner.
Considering India’s startup ecosystem has grown multi-fold, it has also witnessed its fair share of corporate outrage. From reports ranging from financial statements manipulation to misuse / excessive use of loans in companies, poor governance practices can lead to organizational failure, red-tapism, depletion of funds (in the form of penalties imposed by regulators and other penal consequences, such as suspension of licenses) and fall in valuations. The reputational damage for key stakeholders is often difficult to control and may continue to last for a lifetime.
In current times, where companies attract significant attention from the general public, corporate governance has acquired renewed importance. A successful company would often follow a fund-raising journey from a proof-of-concept stage, to raising multiple rounds of equity investments at various stages from varied classes of investors that could include angel investors, venture capital funds, late-stage private equity funds and perhaps also retail and institutional public investors, if the company is able to access capital markets. Naturally, each of these investors have different exit horizons and would be keen to maximize value for themselves. In such situations, having strong governance norms is even more important – to prevent organizational failure, expectation mismatch and ultimately, value destruction. By adhering to robust governance standards, organizations can help build shareholder trust, mitigate risks and foster long-term sustainability.
Good governance necessitates practical measures and systems for transparency, accountability, checks and balances and risk management. This can be implemented by having a competent and responsible board of directors, who continually oversee the functioning and management of the company. Risk management can be achieved by putting in place to check necessary processes and policies for each department to prevent abuse and mismanagement and regular checks for compliance and critically, implementing whistleblower policies to enable shareholders to voice their grievances where required. Companies should believe in consistently evolving by improving their governance frameworks to international standards and establish a commitment to their stakeholders towards building an ethical, transparent and sustainable system. That said, while rule making and having SOPs is critical, it is equally important to ensure the right environment and culture that motives professionals to be honest, ethical and vigilant.
Thus, in today's dynamic environment, effective corporate governance is not just a regulatory necessity but has also become a strategic imperative for companies which seek long term profitability and sustainability.
Part 2: Corporate Governance: The Law in India
Let’s dive into the statutory framework for corporate governance in India.
The Companies Act, 2013 (Act) is the primary legislation governing companies in India. It replaced the Companies Act, 1956, introducing several reforms to enhance corporate governance standards. The Securities and Exchange Board of India Act, 1992 oversees the securities market, with the Securities and Exchange Board of India (SEBI) acting as the regulator for listed companies. Companies operating in industries with systemic implications or in which public interest is at stake such as the banking, finance and insurance are subject to additional governance norms by their respective industry regulators like SEBI, Reserve Bank of India (RBI), and Insurance Regulatory and Development Authority (IRDAI) and the regulations issued by them.
Who governs a company and how?
In India, the bodies/persons which govern a private company are the (i) board of directors (and its sub-committees), (ii) shareholders (exercising their powers through voting and activism) and (iii) the key managerial personnel which include chief executive officer, chief financial officer, managing director etc.
Board of directors and committees
o Composition: Every company under the Act must have a board with a minimum number of directors. Listed public companies have stricter requirements, including having at least one-third independent directors on their boards. Similar principles have been prescribed for board committees as well.
o Duties and fiduciary obligations: Directors must act in good faith, with care and independent judgment, prioritizing the interests of the company, its stakeholders as a whole, and the environment, as per Section 166 of the Act. The section also enshrines the principle that a director must absolve herself / himself in a conflict-of-interest situation. Collectively, these form the basic tenants of their fiduciary responsibility. Notably, nominee directors too must keep the interest of the company and all its stakeholders in the forefront. Courts have clarified that nominee directors owe duties to both their nominator and the company, but in conflicts, the company’s interests take precedence (Supreme Court of India in Associate Bank’s Officers Association vs State Bank of India and Ors. reported in 1998 (1) SCC 428).
Shareholders
o Voting rights: Equity shareholders make decisions by voting on resolutions at general meetings. Ordinary resolutions require a simple majority (more votes for, than against). Special resolutions need at least three times as many votes in favour as against, along with additional procedural and notice requirements (as per Section 114 of the Act). Preference shareholders can traditionally vote only on matters affecting their rights or alongside equity holders, if dividends remained unpaid to them for more than 2 years. However, private companies can now bring the voting rights of preference shareholders at par with equity shareholders by extending voting rights to them for all matters in a company, by excluding the statutory voting rights provisions in their articles.
o General Meetings: All companies (except one-person companies) must hold an AGM within prescribed timelines prescribed under Section 96 of the Act. An extraordinary general meeting (EGM) can be called by the board at its discretion. Pertinently, the board is obligated to call an EGM if requested by members holding at least 10% of the paid-up share capital or 10% of voting power (for companies without share capital).
o Powers of Shareholders: Certain major decisions (like asset sales, raising considerable debt, private placements of shares / debentures etc., changes to constitutional documents etc.) require a shareholder approval via a special resolution under Section 180 of the Act. However, some of these restrictions have been relaxed in recent exemptions extended to private companies.
In addition to the statutory rights available under the Act, investors typically enter into shareholders agreements with a company and its shareholders, setting out a wide variety of rights that they would enjoy in respect to the Company, including right to appoint observers or directors to the board and providing for affirmative voting matters.
Key Managerial Personnel
While the board of directors and the shareholders serve as the higher decision-making authorities for major decisions, the day-to-day functioning is run by the executive officers, which may include the managing director, chief executive officer (CEO), other C-suite members. The CEO, managing director, company secretary, whole-time directors and chief financial officers are classified as ‘key managerial personnel’ and hold a fiduciary responsibility to the company and its stakeholders. They are also deemed to be ‘officers in default’ for the purposes of penal provisions of the Act.
Creditors
Creditors usually do not take part in a company’s governance, but in cases of debt default, they may gain rights to oversee or even take over management, as allowed under various laws. It is the duty of a debenture trustee to appoint a nominee director on the board upon payment defaults or default in creation of security in respect of debentures under Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014]. Section 17 of the Insolvency and Bankruptcy Code, 2016 (IBC) provides that if a company undergoes a corporate insolvency resolution process, the powers of the board of directors is suspended and are taken over by the resolution professional who acts in sync the NCLT and the committee of creditors. The question that arises is, whether such nominees of creditors have any fiduciary duties towards the debtor company and its shareholders? Judicial pronouncements have shown that they indeed do, albeit to a limited context. A resolution professional has a duty to protect the assets of the corporate debtor, including its continued business operations (Section. 25 of IBC). Courts have also held that lenders have a duty to act fairly and in good faith towards borrower companies (Supreme Court of India in Mardia Chemicals Ltd. and Ors. Vs. Respondent: Union of India (UOI) and Ors., reported at AIR 2004 SC 2371).
Governance standards for listed entities
Given that significant public money is at stake, SEBI has mandated a comprehensive governance framework for listed entities under the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations 2015 and certain other regulations. The are principally based on the tenants of disclosure and transparency.
Governance related compliance requirements y mandatory for listed entities illustratively include requirements for a compliance officer, investor grievance redressal mechanisms, specific requirements for composition of directors such as mandatory inclusion of women and independent directors, mandatory independent audit committees and nomination and remuneration committees, increased compliances for related party transactions, reporting requirements for compliances with corporate governance etc.
Anti-corruption and bribery laws
The Prevention of Corruption Act, 1988, with its amendments and modifications (PCA) prohibits and punishes the use of corrupt means and bribery of public servants, including by company directors if committed on behalf of a company. Directors are responsible for preventing such misconduct. Additionally, internal corporate fraud is addressed under Section 447 of the Act, which mandates imprisonment for fraud exceeding a certain amount. Thus, directors have a responsibility to prevent the company and its officers from engaging in corrupt practices.
Penal Consequences under various statutes
The Act provides monetary penalties for breach of its provisions, which may range from a few thousand Indian rupees to as high as a few crores (see sections42, 46 and 76 of the Act), and these penalties are more often than not applicable to the company as well as its officers in default. Keeping in mind the objective of ease of doing business, the government has attempted to decriminalise certain violations of the Act over the years by providing for monetary penalties, with the exception of serious offences like fraud, impersonation of shareholders, non-compliances in financial statements, etc.,) which are punishable by imprisonment.
It is pertinent to note that while the penal provisions under the Act are stringent, the implications of non-compliance often extend far beyond statutory punishment. Orders relating to prosecution and penalties are published in the public domain, and the resulting reputational damage can be significantly more detrimental to a company and its stakeholders than the legal consequences alone. Moreover, such violations are closely scrutinized by investors and lenders, who increasingly consider compliance records when assessing financial exposure and making investment or lending decisions.
In this context, adherence to the relevant corporate governance legislations and contractual obligations is not just a legal obligation, but a vital aspect of maintaining credibility and financial stability for an organisation.
Part 3: Corporate Governance: Shareholders’ Agreement
From a corporate governance point of view, contractual protection and operational framework for shareholders are typically covered under the provisions of a shareholders’ agreement (“SHA”). The lifecycle of an investment transaction typically begins at the execution of a soft commitment from investors (term sheet / letter of intent), followed by a comprehensive check of the company’s health and viability by the investor (due diligence), followed by the relationship terms being recorded under an SHA and subscription / purchase agreements.
As explained below, shareholders can avail protective rights under law as well as under contract, under the terms of an SHA. Where a company has / may have subsidiaries, shareholders may also seek comparable rights in those subsidiaries.
Inspection rights: Shareholders have a legal right to inspect certain records of the company, and investors often negotiate additional rights in relation to visiting premises, consulting officers or conducting audits, often at the company’s expense. These rights help monitor investments, collaborate with other stakeholders and address misconduct making these rights crucial, especially for minority shareholders who lack board access. Unlike some jurisdictions, notably, Indian law does not require shareholders to provide reasons for exercising their inspection rights.
Information rights: To ensure transparency, investors negotiate to obtain periodic information regarding the functioning of a company, which goes well beyond the information available to shareholders under company law. Investors avail information typically through a management information system (MIS) providing periodic financial and operational reports. This may include the company’s annual budget and business plan. Where investors hold significant stakes, they may also gain approval rights over such plans, usually listed as affirmative vote rights / reserved matters (see below).
Directorship: Investors with significant stake often secure a right to appoint nominees on the board of directors of a company. In companies with many investors and fragmented shareholding patterns, this right is typically granted to institutional investors holding a minimum shareholding in the company (usually 5-15% of the share capital). These directors typically do not initiate proposals but otherwise have the right to approve / reject board actions, helping investors implement sound governance principles over the management and affairs of the company.
Board observers: Board observers are a creation of the industry (and not of statute) and refer to individuals appointed to attend and observe board meetings of a company, with no power to vote. Controlling shareholders can exert influence beyond their ownership, aligning management with their interests (M/s Subhkam Ventures (I) Private Limited v SEBI, 2010 SCC Online SAT 35). While the option of appointing 1 (one) director for minority shareholders, i.e., small shareholder director, exists in law, it is only optional [S. 265, CA 2013]. Hence, a board observer seat is crucial for minority shareholders to access real time information, and in hostile situations, seek timely remedy against oppression and mismanagement [S. 241, CA 2013].
Shareholders’ meetings: Lead investors often require that shareholders’ meetings be held with their representative being present. The company concerns are usually two-fold (a) deadlock due to differing opinions, (b) non-attendance for mandatory quorum. While the typical solution is to adjourn and reconvene as per law, such adjournments should not continue ad infinitum. In such cases, parties to the SHA often agree to a fixed number of adjournments (typically 1 or 2) post which shareholders’ meetings may be conducted in the absence of the representative. That said, affirmative voting rights / reserved matters are an exception to this rule and customarily, no reserved matter tabled for discussions can be determined without the presence of the representative.
Affirmative vote rights / reserved matters: Financial investors typically do not engage in overseeing the day-to-day functioning of a company and instead exercise discretion over key decisions termed as ‘reserved matters’ or ‘affirmative voting matters’. Such matters can be approved only if the affirmative consent of the investor has been obtained. The list of affirmative vote rights typically ranges across matters such as fresh issue of capital, amendment to charter documents, or operational matters such as substantial deviation in the company’s business, revisiting limits on expenditure, etc. In companies with multiple investors, it is typical for affirmative vote rights to be linked to a minimum shareholding threshold as well as be determined by collective wisdom of the majority. This ensures that while adequate checks and balances are instituted, neither small shareholders nor a single investor / minority of investors can block operations. Investors also insist that their affirmative vote rights are entrenched in the company’s articles, making them practically incontestable. While attempts (including by SEBI trying to lay down a bright-line test) have been made under law to define the construct of reserved matters that may amount to the holders of such rights having ‘control’ over a company, this conundrum continues to challenge legal minds and is more often than not determined on a case to case basis.
Covenants: As the name suggests, covenants are simply undertakings or forward-looking actions that obligate a company to do / not to do certain acts that relate to the affairs of the conduct business. The intent here is for investors to create perimeters within which the affairs should be run, ensuring a framework of good governance and limiting the scope of mismanagement. These covenants cover a variety of matters including business plans and budgets, audit requirements, strong anti-bribery and anti-corruption frameworks, rules for dealing with sanctioned territories nations and other industry specific ESG matters.
Non-compete and non-solicitation provisions: To protect a company’s business and its stakeholders interests, investors often impose non-compete provisions on promoters / founders, restricting them from undertaking the same / similar business activities not only during their involvement with the company but also once their engagement seizes, for a reasonable time and defined geographical territory. While common in private equity and venture capital transactions, such provisions have to be carefully crafted in India to ensure they are not considered being unreasonably restrictive of constitutional trade freedoms and Section 27 of the Indian Contract Act, 1872. While most common law jurisdictions attempt to balance company interests with promoter rights, Indian courts have largely prioritized the promoters’ right to trade.
In addition to non-compete provisions non-solicitation clauses prevent promoters / founders from self-dealing by having embargos on poaching key employees, clients and vendors from the company. They too apply for a limited period after cessation of the relationship with the company.
The SHA has evolved as a critical instrument in corporate governance, particularly within private companies where shareholder dynamics are closely held and keenly negotiated. While public markets rely on strict regulatory oversight and disclosure norms, SHAs play a key role in defining rights, responsibilities and contractual remedies among shareholders. Such rights are folded into the articles of association of a company to ensure these are binding on such company and their enforcement is watertight. As governance norms become more defined in private companies, SHAs will continue to play a pivotal role in balancing the interests of minority and controlling shareholders, as well as reinforcing obligations and value protection in companies.
Part 4: Corporate Governance: Contractual Remedies for Breaches and Mismanagement
Shareholders agreements (SHA) are no exception to ‘ubi jus ibi remedium’. In our previous part, we described how the management of a company often owes allegiance to controlling shareholders, while other shareholders retain a right against abuse of such power. Much like ‘rights', which are made available either statutorily in the Companies Act, 2013 (Act) and/or contractually, to shareholders, the ‘remedies’ (a) against abuse of power by management/controlling shareholders, and (b) for protection of shareholder rights, are made available under statute or by contract. In this part, we highlight the contractual remedies that are typically available to shareholders of a company.
Rights to protect shareholding against dilution
Investors typically have certain contractual rights that protect against dilution in case of any new funding round taking place in the company:
Pre-emptive rights
Pre-emptive rights are meant to be the first line of defence against dilution. Pre-emptive rights / pay to play rights give a shareholder the ability to not be diluted if it is willing to participate in an upcoming funding round to maintain its shareholding as it stood immediately prior to such funding taking place. This right is typically provided to all investors who hold a certain minimum shareholding threshold typically arrived at keeping in mind the balance between access to capital, administrative convenience and having a well-diversified shareholder base.
Right of first offer (ROFO)/ Right of first refusal (ROFR) / Tag along rights
ROFR and ROFO are key contractual protections in shareholder agreements that help maintain a shareholder’s ownership structure. ROFR gives an existing shareholder the right to match any third-party offer made to a selling shareholder before shares are sold externally, whereas ROFO requires the selling shareholder to first offer their shares to existing shareholders before seeking third party buyers. When a shareholder is selling its shares, ROFR / ROFO give the existing shareholders the first rights to buy shares before an outsider can thus, allowing for existing shareholders to increase their shareholding in the company, preventing dilution from new entrants. These are powerful safeguards against secondary dilution through external share transfers.
Tag along rights allow investors / shareholders to sell their shares on the same terms as the founders that sell their stake to a third party. This ensures fair exit opportunities and prevents a situation where control shifts without giving investors a chance to monetize their investment. This prevents value erosion and preserves balance and transparency in ownership transitions.
Anti-dilution rights / Rachet protection
Anti-dilution rights or rachet protection help investors preserve the economic value of their investment in the company in case future fund raises take place at a valuation that is lower than the valuation at which such investors had invested in the company (commonly known as a ‘down-round’). In such cases, to protect against value-dilution, the number of shares that investors should hold are increased by adjusting the conversion ratio in case of convertible securities or by issuing fresh shares at a lower valuation. Such anti-dilution is typically achieved either through a full ratchet anti-dilution mechanism or through a broad based weighted average method (both being different in terms of the extent of additional shares being issued, with the former being favourable to an investor). The additional shares are issued such that the economic interest of the investor is retained as far as reasonably possible. Broad based weighted average anti-dilution is the more accepted mechanism these days to achieve any anti-dilution protection to an investor, as this is calculated on a weighted average formula basis and does not adversely impact the founders solely.
Breach or bad acts by founders
Vesting and Reverse Vesting
In order to have founders retain skin in the game, investors typically negotiate for a vesting schedule to be incorporated in the SHA. The vesting schedule typically spans across 3 to 5 years for a slow release of the shares held by the founders. Investors require founders to continue to be employed in the company until the investors exit completely (or at the minimum 4-5 years from the date of their investment), following which founders would have been vested with all their shares and effectively “earned back” their shares.
Investors further structure protections in the SHA for bad acts or worst case scenarios such as occurrence of ‘cause’ events or situations where a founder resigns from the company without consent of the investors or eventualities like death or permanent disability of a founder wherein the released shares / vested shares are clawed back by the company (either via buy-back or transfer to an employee welfare trust or a preferred individual etc. as decided by the board). This is to ensure business continuity and availability of shareholding to be reallocated to management who are likely to take on the responsibilities of the exiting founder. For obvious reasons, this is often the most negotiated provisions in an SHA.
Cause events
Most Indian companies tend to be founder led, with founders occupying key positions in the executive management or C-suite. While the terms of employment of the individual founder(s) and other key individuals are set out in employment agreements, it is not uncommon to see ‘cause’ events and other analogous terms in shareholder agreements, outlining actions or occurrences which would give rise to a cause for penalising the concerned founder.
What constitutes ‘cause’ is heavily negotiated and it typically includes events such as charges for criminal offences, fraud, embezzlement, wilful misconduct, charges of sexual harassment at the workplace, abandonment / resignation without investor approval, material breaches of the SHA and employment terms. Occurrence of a cause event by a founder in a company is of major concern to investors on account of being operationally challenging (as founders are the face of a company) and could damage the reputation and prospects of a company. Investors contractually build remedial protections for these scenarios ranging from termination of the founder’s employment and clawback of shares held by the founders.
The extent of shares to be clawed back is also a debatable topic during deal making, considering founders have earned those shares with their time and effort and want to maximise on what they can retain; and investors having to manage a new executive being appointed in place of the defaulting founder to salvage the operations of the company in the best manner possible.
In cases of a ‘cause’ event occurring, given the grave nature of the occurrence, the ask is often that 100% of the vested and unvested shares are taken away from the defaulting founder and repurposed in the best manner the board determines. Founders are also provided with an opportunity to be heard in such situations, and any discussions would follow the principals of natural justice to ensure it is fair trial before an event of cause is concluded. Clawback of founder shares however is still one of the strongest deterrents in an SHA, ensuring that equity is earned, not entitled and misconduct has real, enforceable consequences.
Breach by the company
So far, we have looked at the rights available to investors against the company, other shareholders and founders. Below are the contractual protections for investors in case the company, other shareholders or founders breach any of their contractual obligations.
Events of default
A breach of affirmative vote matters and covenants / representations and warranties or occurrence of a share transfer in violation of the provisions of the SHA, or in some situations the occurrence of a ‘cause’ event (as discussed above) inter alia, fall under the umbrella of an ‘event of default’. An ‘event of default’ may also include insolvency proceedings against the Company or fraud, wilful misconduct etc. by a Company (as typically determined by an acceptable third-party).
Upon the occurrence of an ‘event of default’, share transfer restrictions applicable to investors fall away (including restriction on transferring shares to a competitor of the company) and investors are entitled to (a) accelerated exit rights and step-in rights to take over operational control of the company (by appointment or dismissal of directors), retain the right to transfer their shares to defined competitors of the company, and / or (b) indemnity, should investors suffer losses.
From a governance standpoint, EOD provisions are crucial as it protects the interests of minority shareholders, acts as a deterrent to encourage compliance and prevents abuse of power in founder-led companies where checks and balances can be maintained to avoid governance failures.
In essence, while SHAs safeguard against unforeseen circumstances, these are not triggered as frequently as, investors also understand that building a company ground up is a herculean task and do not trigger ‘cause’ events unless it is grave or irreparably damaging to the company. Triggering a ‘cause’ event by an investor often marks the end of the road for the company’s leadership, signalling a breakdown in trust and governance. Yet, such clauses set a high bar for integrity serving as a powerful reminder that accountability is non-negotiable in serious, investor-backed enterprises.
Part 5: Corporate Governance: Statutory Framework for Addressing Mismanagement
While it has become the norm in the PE/VC ecosystem to include elaborate provisions in shareholders’ agreements to deal with violations of agreed governance principles, statutory remedies under Companies Act, 2013 (the Act) continue to be highly relevant, particularly because of their enforceability. In this part, we provide an overview of key statutory remedies available to stakeholders and their interplay with contractual arrangements.
The National Company Law Tribunal (NCLT) is the principle statutory body under the Act for adjudicating company law matters. The National Company Law Appellate Tribunal (NCLAT) is the appellate authority for orders passed by the NCLT. Notably, Section 430 of the Act bars the jurisdiction of civil courts from entertaining any proceedings in matters for which the NCLT or the NCLAT are empowered to determine under the Act. Both the bodies have powers, akin to a civil court, including the power to initiate contempt proceedings under the Contempt of Courts Act, 1971.
Oppression and Mismanagement
Section 241 of the Act permits members of a company to approach NCLT for relief in cases where (a) the affairs of the company are being conducted in a manner prejudicial to the interests of the company / its members or against public interest; or (b) a material change in the management of the company is likely to result in the affairs of the company being conducted prejudicially to the interests of its members or a particular class of members. Pertinently and as an anti-abuse provision, this right is available to members who meet a certain threshold, being at least 100 members or 10% of the total number of members (whichever is lesser), or 10% of the issued share capital of the company. Interestingly, the NCLT does have the power to waive these thresholds if it deems fit. Further, the Central Government may also apply to the NCLT in respect of mismanagement, if it is of the opinion that a company’s affairs are contrary to public interest, or where any person involved in the management of a company has been found guilty of fraud, misfeasance, persistent negligence, etc.
Class Actions
Class Actions: Section 245 of the Act allows members and depositors (i.e., a class of creditors) of a company (in representative capacity on behalf of the larger group) to approach the NCLT to seek restraining orders or claiming damages for specified instances of mismanagement. Instances where class action claims can be sought include inter alia, restraining a company from committing an act which is ultra vires of the charter documents of the company or in breach of any law; restraining a company from taking action contrary to any resolution passed by its members; etc. A class action suit can be initiated by 100 members of a company or 5% of the total number of its members (whichever is less), or at least 5% of the issued share capital of the company for unlisted companies and 2% for listed companies.
While adjudicating oppressive mismanagement and class action claims, the NCLT is empowered to take actions not just against a company but also persons involved in such default including any persons involved in preparing improper statements in the audit report or who acted in a fraudulent, unlawful or wrongful manner.
Investigations and SFIO Probes
Preliminary Investigations: Section 206 to 209 of the Act empower the Registrar of Companies (ROC) and certain other regulatory authorities to conduct preliminary inquiries, inspections and examinations into the affairs of a company. Upon reason to believe that a company is non complaint with the Act, the ROC can call for information and basis the same proceed with an inspection of records. During such inspections, the ROC can examine documents and question officers. Basis findings, reports are submitted to the Central Government, wherein further investigation may be triggered.
The Central Government is also empowered to direct an inquiry in specified situations including cases where public interest is involved or inter alia, if there’s suspicion of serious misconduct / fraud / abuse of governance mechanisms. NCLT may also order an investigation upon application by shareholders (representing prescribed thresholds), if it is satisfied that a company’s affairs are being conducted in a fraudulent, unlawful or oppressive manner.
Investigations by SFIO: The Central Government may assign cases to the Serious Fraud Investigation Office (SFIO), a specialized fraud investigation agency formed under the Ministry of Corporate Affairs (MCA), where it considers a matter to involve complex financial fraud, to be in public interest or based on recommendations of the ROC. The SFIO possesses powers to arrest individuals and conduct searches, summon and examine persons associated with the company. The report filed by the SFIO shall be deemed to be a police report filed by a police officer under the provisions of the civil procedure code. Some examples of SFIO probes include the Satyam scandal and the Nirav Modi - Punjab National bank case. These enforcement provisions also act as powerful deterrents against fraud and empower minority shareholders to act against any major wrongdoings.
Whistleblowers (Section 177 of the Act)
The Act requires listed companies and certain prescribed public companies to establish a vigil mechanism, popularly known as a whistle blower policy, for directors and employees to report genuine concerns about unethical behaviour, fraud, violation of company’s code of conduct etc. This creates a formal channel for employees to raise concerns against the company on any wrongdoings, especially in an anonymous manner. The audit committee is responsible for overseeing the functioning of this mechanism, ensuring that concerns are investigated and addressed in a fair manner, with adequate safeguards against victimisation of persons.
Financial statements, removal of directors
The Act lays down the framework for preparation, disclosure and audit of financial statements, forming the backbone of corporate governance through financial transparency. Section 129 of the Act mandates companies to prepare financial statements that give a true and fair view of the financials of a company. These statements must be approved by the board and filed with the ROC within prescribed timelines.
Auditors also play a critical role in the governance of a company, with auditors being mandated to report fraud by officers or employees failing which it can lead to penalties or disqualification. Similarly, directors are disqualified if, inter alia, they have been convicted of an offense involving moral turpitude or are undischarged insolvents or have not filed their financial statements / annual returns for 3 consecutive years. From a corporate governance perspective, these provisions ensure that individuals have fiduciary duties towards a company and its shareholders and maintain ethical standards that ensures shareholder confidence in the organisation.
Interplay between exercise of contractual remedies and statutory remedies
Under Indian corporate law, the statutory governance remedies set out above are designed to uphold fiduciary standards enabling transparency and stakeholder protection in a company. These are imposed by law on all companies and their officers, as non-negotiable governance requirements to be followed by organisations. In contrast, contractual remedies, set out in shareholders agreements provide for rights and obligations between shareholders such as pre-emptive rights, ROFO, ROFR, Tag, drag, exit rights, information rights, etc. These ensure pre-agreed privately enforceable measures that protect an investor and ring fences shareholders in companies.
The two frameworks operate in tandem, as for instance a minority shareholder may invoke statutory remedies for oppression, while also relying on contractual protections such as inspection rights to investigate the affairs of a company. However, it must be noted that contractual rights cannot override statutory provisions and courts are likely to uphold statutory protections in case of conflicts with the shareholders agreement. Hence, effective corporate governance often requires harmonising both statutory compliance and well drafted contractual protection frameworks, especially in closely held companies and companies with PE / VC investors.
Part 6: Who observes the observer?
Corporate governance in Indian companies has come under scrutiny in the recent past, for various reasons. Several high-profile issues have come to light in the last couple of years- inaccurate financial reporting, allegations of fraud, and misconduct by the management in companies pursuing disproportionate growth. This has heightened the focus on how governance structures in companies are managed, particularly given the founders' broad roles within their companies.
Investors, especially institutional investors (financial and strategic) are crucial in guiding companies towards better corporate governance. Seeking representation on the board is a key manner in which the investors seek to implement corporate governance measures, along with maintaining oversight on the company operations. However, this right is not always exercised due to significant liabilities that a director may be exposed to, especially in the early phases of a company when processes and compliances are still evolving. However, investors want insight into key matters that are typically discussed at the board level. This is usually achieved by investors appointing an "observer" to the board. An observer is entitled to attend board meetings, permitted to speak at such meetings, represent the investor’s interests, and access all the same information as a full board member. However, they do not have voting rights. Legally, observers are not considered board members, and as such, they are not bound by the fiduciary duties and liabilities that are associated with a director under the Companies Act, 2013[1].
The role of an observer is contractual, its primary purpose being to provide investors with visibility into the company’s operations and financial health without the full responsibilities or legal risks associated with being a director. The observer’s involvement in board discussions allows an investor to stay informed about key decisions and to offer advice where necessary, without becoming legally responsible for those decisions. In practice, this means that observers can participate in board meetings and discussions, but their influence is not legally recognized unless they are appointed as directors.
Until recently the observer model had been universally accepted without regulators seeming particularly concerned about its implications of the observer role. However, there are increasing concerns about the possibility of observers exercising influence over the decisions of the company. If founders are consistently acting on the advice or suggestions of an observer, questions may arise as to whether the observer, in effect, has the same influence as a director—without being subject to the same legal and fiduciary responsibilities.
Recently, the Reserve Bank of India (RBI) has expressed discomfort with investors in Non-Banking Financial Companies (NBFCs) appointing observers in regulated entities. While the RBI is yet to issue an official notification on this matter, such a move would bring investor nominees under the statutory liabilities outlined in the Companies Act, 2013, as well as in the Master Direction – Reserve Bank of India (Non-Banking Financial Company – Scale-Based Regulation) Directions, 2023 ("NBFC-SBR"). The RBI’s potential move aims to address concerns that an observer’s influence over company decisions could undermine the regulatory framework for NBFC governance.
In addition to the processes set out under the Companies Act, 2013 to appoint a director, the NBFC-SBR guidelines impose additional requirements for the appointment, removal, and responsibilities of directors in NBFCs. These include compliance with the Fair Practices Code and a "Fit and Proper" criteria, under which the RBI evaluates the qualifications and suitability of directors before they can be registered. These additional checks help to ensure that directors in NBFCs have the necessary technical skills and integrity to fulfil their duties and responsibilities.
Why the ‘Observer’ Controversy?
The main issue with the observer role revolves around the fact that, while directors are subject to fiduciary duties and need to satisfy certain criteria for appointment in case of regulated entities, observers are not. Directors are held to high legal standards, including obligations related to corporate governance, financial reporting, and decision-making. If a director is involved in any criminal activity or misconduct related to the company, they can be prosecuted, particularly if the offense occurred with their knowledge or consent[2]. This is not the case for observers. Despite their involvement in the company’s strategic discussions, observers are not liable for the decisions made by the board.
Some argue that this lack of accountability creates a grey area. If an observer's advice is followed consistently by the board, it may be difficult to argue that they do not exert any influence over the company’s governance and strategic direction. In this light, there is growing concern about whether the current structure adequately protects shareholders and stakeholders from any undue influence. A similar view is also taken by the anti-trust regulator, Competition Commission of India, where anti-trust regulations consider an observer at par with a director in terms of exercising influence over the board.
At the same time, others argue that imposing legal obligations on observers would amount to over-regulation, especially when the observer role has been functioning without issue for many years. Overregulating contractual positions could stifle the dynamic nature of businesses, potentially hindering their growth.
While there is no question that corporate governance in companies could be improved, it is crucial that regulatory efforts do not overreach by codifying contractual arrangements that have existed for decades. Instead, the focus should be on fostering an environment that encourages self-regulation and innovation. Companies can still improve their governance structures by adopting measures that strengthen internal controls and transparency.
RBI’s potential move to regulate the observer role reflects its ongoing efforts to streamline governance in the financial sector, particularly for NBFCs. However, the investor community, especially institutional investors, need time to assess the impact of these changes on their governance strategies.
Until then, self-regulation remains the ideal balance between the absence of corporate governance and overbearing compliance requirements. By focusing on responsible growth and internal controls, companies can navigate the complex regulatory landscape while continuing to innovate.
Part 7: Corporate Governance– Fiduciary Duties of Executive and Non-executive Directors
We have so far delved into governance protections available to shareholders under law and contract. In this part we focus on directors and their pivotal role in companies as well as a brief analysis of the statutory obligations bestowed on directors (including nominee directors) under the Companies Act, 2013 (the “Act”). Directors are the custodians of a company’s vision and serve as a representative of shareholders’ interests. They are responsible for making key strategic decisions in a company, overseeing management and safeguarding shareholder interests within the contours of the law, in an ethical and accountable manner thereby ensuring business decisions align with the company’s values.
Fiduciary duties of directors
In addition to the obligation to comply with a company’s constitutional documents and the law, directors have been bestowed with fiduciary duties under the Act (Section 166) requiring them to act in good faith in the best interests of the company, its employees, shareholders, community and for the protection of the environment. These fiduciary obligations form the backbone of ethical corporate governance, ensuring that directors place a company’s long-term sustainability and shareholder trust above their personal interests.
Directors are also required to exercise their duties with reasonable care, skill, diligence, and independent judgement. The expected degree of skill and diligence required is to exercise reasonable care which an ordinary man might be expected to take in the circumstances. Several instances of ‘reasonable care, skill and diligence’ have been tested in courts to uphold the expectation of oversight and prudence required by directors in different scenarios.
The Delhi High Court in one instance observed that obtaining legal opinions by directors of a company to support the applicability of specific legal provisions displayed reasonable care and diligence on their part (Ashok Bhatia and Ors. Vs. Registrar of Companies, Delhi & Haryana and Ors. 1992 (23) DRJ527). Notably also, where a director was being prosecuted for signing financial statements which incorrectly recorded deposits as secured loans, the High Court of Punjab and Haryana opined that the director ought to have exercised his duties with reasonable care and independent judgement, irrespective of the intricacies involved in preparing the financial statements, and that the blame cannot be shifted on the advisor, whose statement the said director had allegedly relied upon (Vijay Shukla vs Serious Fraud Investigation Officer AIRONLINE 2021 P AND H 792).
Ensuring undue advantages for themselves or others is a key principle that directors must follow by avoiding situations where their interest conflict with those of the company. They must not, in any manner, achieve personal gain at the company’s expense. In a situation where a director had set up a competing business and diverted employees and customers from the concerned company to the newly set up business, the Delhi High Court (Rajeev Saumitra vs Neetu Singh & Ors ((2016) 198 Comp Cas 359)) ordered the director to pay up the undue gains. The Court also opined that such conflict of interest is liable to be set aside by the court of law.
Another case concerning a conflicted director involved a managing director who, by virtue of his position, had incurred undue gains by utilizing the goodwill of the company. This resulted in the concerned company losing revenue and jeopardized the interests of its employees, who were deprived of their statutory benefits. The National Company Law Tribunal (NCLT), emphasising the necessity of adhering to the provisions of corporate governance and acting in the interest of the stakeholders, allowed for the removal of the managing director in question (Dispur Policlinic and Hospital Private Limited and Ors v/s Dr. Nilim Kr. Deka and Anr IA/Comp. Act/6/GB/2022 in CP/18/GB/2021).
Non-executive directors: Role and statutory framework
While the general principles set out above apply to all directors, it’s imperative to focus on the liability of non-executive directors. Executive directors are those who are in charge of the business and day-to-day affairs of a company and designated as whole-time directors / managing directors; whereas non-executive directors, to the contrary, are not in charge of the affairs or operations of the company.
Investors often acquire the right to appoint their nominees on board of companies. While such non-executive directors participate in key strategic decisions, the positions of investors has always been that they are not involved in the day-to-day operations of the company and hence cannot be held to be officers of the company. The Act supports this intent and provides for a non-obstante provision (Section 149 (12) of the Act) that a non-executive director (not being a promoter or key managerial personnel) is only to be held liable in respect of any acts of omission or commission by a company where such acts had occurred with his knowledge, attributable through board process and with his consent or connivance or where he had not acted diligently.
In furtherance of the above, the Ministry of Corporate Affairs (the “MCA”) has clarified through operating procedures that non-executive directors should not be portrayed in any criminal or civil proceedings under the Act, unless the criteria (under Section 149 (12)) are met. The nature of default must be set out as crucial for arraigning officers of the company as defaulters. Instances of general compliance such as filing of information with the registry, maintenance of statutory registers or minutes of meetings, or compliance with orders issued by statutory authorities under the Act are not the responsibility of non-executive directors unless provided under the Act. That said, the responsibility of non-executive directors should ordinarily arise only in cases where there are no whole-time directors or key managerial personnel involved. Where lapses are attributable to board decisions, reliance is initially placed on records available with the Registrar of Companies (“ROC”), including e-forms, to ascertain the presence of a director or key managerial personnel in the company as on the date of default.
Pertinently, vague averments against non-executive directors, without detailing their specific roles in relation to the concerned company, were rejected after taking into consideration the records of the ROC, which indicated that such directors were non-executive directors (Kiran Chintamani Vaidya vs Dilbagh Singh Rohilla 2024:PHHC:058612).
Therefore, while courts have assumed liability with respect to managing directors/whole-time directors, owing to the executive nature of their office, the law and courts necessitate corroboration of averments against non-executive directors, as officers of the company who are in default for the acts or omissions on part of the company that occurred with their knowledge or active participation (Shailyamanyu Singh vs The State of Maharashtra 2025 INSC 995). Courts have also held in the case of Dayle De’Sourza v. Union of India ((2021) 20 SCC 135), that the primary responsibility is upon the complainant to make specific averments to make the accused vicariously liable for the offence committed by the company and that while fastening the criminal liability, there is no presumption that every director knows about all transactions of the company and that criminal liability can only be fastened upon those directors or persons, who at the time of commission of the offence, were in charge of and were responsible for the day-to-day business of the company.
In a case, where prosecution was initiated against non-executive directors under the Negotiable Instruments Act, 1881 for dishonour of cheques issued by a company, the Supreme Court held that participation by directors in a meeting cannot be construed as control over financial decisions or operational management. The Court rejected the prosecution’s contention that attendance of board meetings by non-executive directors established knowledge on their part of issuance of the dishonoured cheques, thereby reiterating that it is no presumption “that every Director knows about the transaction” (K.S. Mehta v/s Morgan Securities and Credits Private Limited 2025 INSC 315).
However, while there are safe harbours for non-executive directors under the law, it is imperative to note that where intent or adverse findings have been established in relation to an investor director, there is no escaping the consequences of law. Courts have held that merely because a director has been appointed by an investor, it cannot be said that such a director is a nominee or non-executive director of the company so as to seek the quashing of an FIR (first information report). The aspect of involvement of such a director in the offence can only be ascertained after investigation is completed (Shantanu Rastogi and Ors. v/s. The State of Karnataka and Ors 2021:KHC:3136). Given that the contours of an officer in default are broad, the benefit of doubt must be extended to non-executive directors, considering they are not involved in the day-to-day conduct of the business; however, he/she may not be completely absolved of liability where there is an actual intent or where any contraventions have occurred with the director’s consent or connivance.
From a contractual standpoint however, investee companies are typically required to maintain a directors and officers’ insurance to ensure directors (including specifically, non-executive directors) are covered for monetary losses and are not held liable for defaults by a company under the Act or other laws applicable to the company. Further, Shareholders’ agreements include provisions for indemnification of non-executive directors appointed by investors, against all losses incurred or suffered by them. Provisions are often also included to ensure that such investor representatives are not made party to any suit or proceedings, whether civil or criminal in nature.
Legal jurisprudence time and again reminds us that even though there are statutory protections in place, the law will not differentiate if there is active involvement by a party in the violation of law. It is important for investors to limit their involvement in companies, so that their representatives are not designated as ‘compliance officers’ or ‘officers in default’. For key strategic matters, investors may consider having a limited list of reserved / veto matters, exercisable by the investor and not their nominee directors. To remain in the know of things, investors should also consider having observer seats instead of board nominations. As companies continue to accept investments for growth, a fine balance needs to be achieved between investor involvement, value addition and investment protection.
Disclaimer: The article is intended solely for general informational purposes only and does not constitute legal advice. It should not be acted upon without seeking specific professional counsel. No attorney-client relationship is created by reading this article.
[1] Section 166 of the Companies Act, 2013.
[2] Shantanu Rastogi and Ors. Vs. The State of Karnataka and Ors., Karnataka High Court, 21.01.2021.
23 March 2026
