A Critical Essay On Sections 297 And 299 Of The Companies Act, 1956

Author : Miss Shelly Ghosh

Abstract – the directors of a company holds a position of trust and to act in utmost good faith. They
hold a fiduciary position which requires them to disclose their interest, whether direct or indirect, in
any contract or any transaction they have entered into with the company. This duty of disclosure
ensures fairness in the dealings with the company and avoidance of conflicting interests between the
company and the director. The paper tries to deal with the consequences of non-disclosure, the
remedies available to a company under such circumstances by attempting a comparative study
between the Indian and the English Laws.

I. Introduction -

The position of directors in relation to the company is an amalgamation of several elements. The
director can be an agent in that he acts not on his own behalf but that of the company. He can be
said to be a trustee, in that although he does not own company assets he controls the assets and
exercises powers for the company’s benefit and not his own. As such he owes fiduciary duties to the
company. He can be an employee, in that a paid, executive director has similar rights and duties to
those of any other employee. He can also be a professional advisor, in that he renders services for
reward and must accept the burden of skill and care which falls upon independent contractors of that
type. The director does not exactly fall within any of these categories, but his duties can be derived
from these principles and can be divided into duties of good faith and duties of care and skill. 1 The
role of equity provides that no fiduciary may profit from his position as a fiduciary. No man who
stands in a position of trust towards another can in matters affected by that position, advance his
own interests for example by making a profit at that other’s expense. 2The activities of fiduciaries can
be categorized into two broad groups-

v Cases where the fiduciary has acted with proven dishonesty or has acted contrary to his
principal’s interest; and

v Cases where the fiduciary has acted honestly and in the best interests of his principal.3

As the rules of equity implicate, once a fiduciary is shown to be in breach of his duty of loyalty he
must disgorge any benefit gained even though he acted honestly and in his principal’s best interests,
even though the principal benefited as well as he from his conduct.4

The directors as fiduciaries must not place themselves in a position in which there is a conflict
between their duties to the company and their personal interests or duties to others. The courts have
adopted a severe method of ensuring that the trust and confidence reposed in a fiduciary such as a
director are not abused, and the fundamental principle was stated by Lord Herschell in Bray v
Bradford.5 It cannot however be said that a director owes a duty to the company not to make an
unauthorized profit and not to be in a position in which interest and duty, or duty to the company
and duty to another, conflict.6 The law should be analysed as if a director does make unauthorized
profits from the directorship, or is in a position of conflict of interest and duty, or conflict of duty to
the company and duty to another, then the company will be given a remedy by the courts.7 If a
transaction between a company and one of its directors profits the director or involves a conflict
between the director’s duty to the company and personal interest and duty to another, then the
transaction is voidable at the company’s option.8

This paper tries to critically examine the director’s disclosure requirements. The paper is broadly
divided into four parts. Part II deals with the director’s duty of disclosure under the English law. Part
III examines the Indian position with a detailed study of sections 297 and 299 of the Indian
Companies Act, 1956. Part IV concludes with an analysis of the slippery slope situation the directors
find themselves in.

II. The duty of disclosure of interest and the English law—

By the middle of the nineteenth century it was firmly established that the fiduciary position of the
company was liable to vitiate any contract involving transactions with the company. 9 In the absence
of express provision in the company’s articles, the only effective step for the directors was to make
full disclosure to the members of the company and to have the contract entered into or ratified by the
company in the general meeting. This provision was recognized by section 29 of the first Joint Stock
Companies Act of 1844. This section was omitted from the Act of 1856 and only an article in the
optional Table was inserted. It provided that any director, directly or indirectly interested in any
contract with the company (except an interest merely as shareholder of another company) should be
disqualified and vacate office – a provision which was taken from the Companies Clauses
Consolidation Act of 1845.10 This situation remained till the 1948 Act.

As contracts with directors became very common, such as service agreements and contracts in which
directors were interested, the disclosure requirements became common-form in the articles of
registered companies. The legislature intervened and section 149 of the 1929 Act made it mandatory
for the directors to disclose their interests in a contract or proposed contract with the company at a
meeting of the directors. This section became section 199 of the 1948 Act, and the ambit was
extended from “contracts” to “contracts, transactions or arrangements” and applied to shadow
directors. This section is now section 317 of the 1985 Act.11

The inter-relation between section 317 of the 1985 Act and the general equitable principle was
considered by the Court of Appeal in the case of Hely-Hutchinson v Brayhead Ltd12 and the House
of Lords in Guinness v. Saunders.13 Failure to comply with section 317 makes the director liable to
pay a fine. Failure to comply with the equitable duty of disclosure enables a company to rescind the
contract or claim the profits made by the director in the transaction. If a company A proposes to
contract with company B and a director of company A is a member of company B then the
membership is an interest which must be disclosed under section 317 (1).14 Disclosure of interest in a
contract must be made even if the contract is a loan or other transaction which is illegal under
s.330.15

Disclosure is not limited to contracts which are considered by the Board. This is particularly essential
in the case of a sole director of a company who is interested in a company contract. He must hold a
board meeting and record his interest in the minutes in order to comply with s.317 (1).16 An equitable
declaration of interest by a director can be qualified or excluded by the Articles of Association of a
company. A general provision in the articles may by itself prescribe that declaring an interest is a
condition for disapplying the rules: under Table A, declaration of an interest is required by Art. 84
but that article only requires disclosure of any ‘material interest’ whereas section 317 (1) requires
disclosure of any interest.

III. Disclosure of interest by directors under the Indian law –

It is essential for the proper exercise of the function of the director, that he is disinterested and free
from any conflicting interest. The Indian Companies Act, 1956, lays down certain procedures to be
followed in sections 297 and 299. Section 297 deals with requirement of the Board’s sanction to be
required for certain contracts in which the particular directors are interested. Section 299 deals with
the disclosure of interests by director.

A. Board’s sanction required when director is interested (section 297) -

The object of the section 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 subsection (1), and accord their consent to such
dealings.17 The consent contemplated is not a general consent but consent referable to each particular
or specific contract. Consent requires knowledge of the necessary facts and materials which leads to
the consent and cannot be given in a general or abstract manner.18

Scope of the section – this section does not apply to contracts between two public companies and
also is not attracted to a transaction of loan made by a director to the company because it is not a sale
or purchase of goods or a contract to render services.19 If ‘A’ is a director of X Ltd. and also a
director or a member of Y Private Ltd., then this section will apply to contracts between these two
companies, subject to the exceptions provided therein. However, if only the relatives of A are
directors or members of Y Private Ltd., and not ‘X’ himself, then the section will not apply.

Central Government approval required when directors are interested – this proviso was added by the
Companies (Amendment) Act, 1974, to check the abuse of power by the directors. As provided
under the section, for entering into such contracts, the director concerned only has to disclose his
interest in the subject matter of the contract and have it sanctioned by the Board of Directors. This is
not considered sufficient to safeguard the interests of the company, especially when directors are in a
position to take advantage of inside information for personal gain. Also, even among the directors an
understanding is created that when their turn comes they be accorded similar treatment, which is sort
of a mutual back scratching policy adopted by them for overall benefit. Hence, it is proposed to
strengthen section 297; approval of Central Government is required in case of a company with a paid
up capital of Rupees One Crore or more with the objective that the terms of the contract are at arm’s
length. 20
Nature of transactions for which approval is required – The provisions contained in sections 297 and
299 are founded on the principle that a director occupies a fiduciary position in relation to a company
and as such he must act bona fide in the interests of the company. If he makes a contract with the
company and does not disclose his interest subsequently he will be committing breach of trust.21
Contracts also include service contracts like contracts of appointment. The mere fact that a person
who is a director of one company is no impediment to his entering into a contract to serve another
company.22

Subsection (2) of section 297 provides that the provisions of subsection (1) would not affect cases
where the purchase of goods from the company is for cash at the prevailing market price or during
the regular course of trade or business. However, the value of such transaction shall not exceed five
thousand rupees in the aggregate in any year. The provisions of subsection (1) also does not apply in
the case of a banking or insurance company, where the transaction takes place during the ordinary
course of business.

Subsection (3) enables a director to enter into contracts in cases of urgent necessity without obtaining
the consent of the Board of Directors. It does not dispense with the requirement of obtaining the
consent of the Central Government, though the Government may waive such necessity by giving
general approval for certain classes or kinds of contracts. Failure to obtain such previous approval as
per the requirements of subsection (1) will render the contract illegal and void. Also, subsection 5
provides that contracts entered into in cases of emergency are voidable where the consent of the
Board of Directors has not been accorded to such contracts.23 Section 297 does not provide any
penalty for non-compliance.24

B. Procedure for disclosure of interests by director (section 299) –

The provisions of this section are analogous to section 317 of the English Act, 1985. Subsection (1)
of this section states that every director of a company who is interested or concerned in a contract or
arrangement, or proposed contract or arrangement, whether directly or indirectly, and is entered into
or to be entered into on behalf of the company, requires the disclosure of the nature of interest such
director has at a meeting of the Board of Directors. This section to some extent overlaps section 297,
but is wider in scope and covers all kinds of contracts and arrangements. The term ‘arrangement’
having wider significance. The section is not confined to transactions which are sanctioned by the
Broad of Directors but also to petty transactions which come before the Board. 25 The section applies
to all private companies as well as public companies.26 This section does not prohibit the director
from contracting with the company, thereby, restricting his right to contract which every individual
possess by virtue of the Contract Act. The only purpose of regulation is to ensure fairness as the
position of a director is always on a slippery slope.27

Subsection (3) provides that a general notice has to be given to the Board of Directors, by the
concerned director, to the effect that he is a director or a member of a specified body corporate or a
firm and hence he 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 and such notice
shall be deemed to be sufficient disclosure for the purpose of subsections (1) and (2). 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.28

C. Interested directors cannot participate or vote in the Board’s proceedings –

An interested director in a public limited company or a private company which is a holding company
or subsidiary of a public company, cannot vote or participate in the discussion of the Board Meeting,
in relation to a contract or arrangement in which he is concerned. He can nevertheless attend the
Board Meeting. However, the position as regards judicial decisions is quite murky. In Shailesh Harilal
v Matushree Textiles Limited,29 the director voted on the appointment of his brother for the post of
director. The Court held the appointment to be valid. But, in the case of Madras Tube Co. Pvt. Ltd. v
Hari Kishon Somani,30 the quorum for appointment of additional directors consisted of directors
who were related to the additional directors. The Court ruled that interested directors could not form
the quorum and the resolution passed with the vote of such directors was void. 31 Where there are
two or more directors interested in a particular transaction it is not possible to split the resolution on
the transaction into parts and enable interested directors to vote on parts of the resolution, in which
they are disinterested.32
D. Effect of failure to disclose an interest –

Failure to comply with the requirements of this section will cause vacation of the office of the
Director under section 283 (1) (i) and will also subject him to the penalty under subsection (4). Every
director who fails to comply with section 299 (1) or (2) as respects disclosure of interest or concern
in the company will be punishable with fine which may extend to Rs.50, 000. The offence is
compoundable under s. 621A. It may be noted that the section 299 does not prohibit a director from
being interested in any contract with the company. The only duty cast upon him is 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, void or unenforceable.33

Section 633 empowers the Court to provide relief under certain circumstances. In the case of M.O.
Varghese v Thomas Stephen & Co. Ltd.,34 the Kerala High Court listed the consequences of the
contravention of this section.35 It has been observed that in several companies with excellent
administration the Chairman himself takes upon himself to draw the attention of the directors at
every Board Meeting the requirements of section 299, in disclosing their interest or proposed interest
in any contract or arrangements. This should be a regular practice with all the companies in order to
prevent a director from disqualification under section 283 (1) (i) and also save embarrassment. An
exception to this procedure is provided in subsection (6) of section 299, which provided that the
usual procedure has not to be followed where the contract is between two companies and a director
does not hold more than two percent of the paid up share capital.

IV. Conclusion –

Every director who has a direct or indirect interest in any contract with the company is required to
disclose his interest at the Board Meeting in accordance with section 299. Also the Board should have
the knowledge of the extent of interest of a director in any contractual dealings with the company, or
any person connected with the director in any of the ways mentioned in section 297. Since a director
owes a fiduciary duty towards the company, a contract made by a director with the company is in
principle voidable by it in equity even though the director makes proper disclosure of his interest to
the Board of Directors, and even though the company stands to benefit from such transaction. This
is quite a dicey situation where the directors who are there to serve the best purpose of the company,
cannot personally involve in any contract with the company, even if that is for the company’s well
being.36 This requirement also seems justified with the increase in common directorship and interest
arising there from. The register of directors and secretaries shows what other directorships its own
directors hold,37 but there is no similar means by which it will also indicate an interest arising from
one of its own members being a director of the first company. Also, a director’s fiduciary does not
come to an end after his cessation of directorship. A director is precluded from diverting to himself a
maturing business opportunity which his company was pursuing after his resignation. A company can
avoid a contract with its director if it can restore to him what he has given under him or the thing can
be restored back to him, but the mere fact the director has transferred property to the company will
not prevent it from rescinding the contract. If the director has earned an improper profit without
there being any breach of duty on its part, the company cannot waive its right to rescind and at the
same time compel him to account for the profit he has obtained under the contract.

___________________________________

1. Peter Loose, et al, The Company Director Powers, Duties and Liabilities 127 (Bristol: Jordan
Publishing Ltd, 2002)

2. Gareth Jones, “Unjust Enrichment and the Fiduciary’s Duty of Loyalty”, 84 The Law Quarterly
Review 472 (1968)

3. Ibid at 475

4. As Lord Chancellor King said, in Keech v. Sanford (1726), of a trustee who had taken a lease after
the lessor’s refusal to grant a new term to the beneficiary: “for I very well see, if a trustee, on the
refusal to renew, might have a lease to himself, few trust estates would be renewed to cestui que use;
though I do not say there is a fraud in this case, yet he should rather have let it run out, than to have
had the lease to himself. This may seem hard, that the trustee is the only person of all mankind who
might not have the lease: but it is very proper that the rule should be strictly pursued, and not in the
least relaxed; for it is very obvious what would be the consequence of letting trustees have the lease,
on refusal to renew to cestui que use”

5. [1896] AC 44. It was held “it is an inflexible rule of a court of equity that a person in a fiduciary
position…is not, unless otherwise expressly provided, entitled to make a profit; he is not allowed to
put himself in a position where his interest and duty conflict. It does not appear to me that this rule
is, as has been said, founded upon principles of morality. I regard it rather as based on the
consideration that, human nature being what it is, there is danger, in such circumstances, of the
person holding a fiduciary position being swayed by interest rather than by duty, and thus, prejudicing
those whom he was bound to protect. It was therefore deemed expedient to lay down this positive
rule.

6. Stephen Mayson et al.,Mayson, French & Ryan on Company Law 533 (United States: Oxford
University Press, 2003)

7. Movitex Ltd v Bulfield (1986) 2 BCC 99, 403 at p. 99, 432.

8. Hely-Hutchinson v Brayhead Ltd [1968] 1 QB 549.

9. Aberdeen Ry v Blaikie (1854) 1 Macq.H.L. 461. In this case the respondents, Blaikie Bros, had
agreed to manufacture iron chairs for the railway company, and sued to enforce the contract. The
railway company pleaded that it was not bound by the contract because, at the time when it was made,
the chairman of its board of directors was managing partner of the respondents. This plea was
upheld by the House of Lords. Lord Cranworth L.C. held that: “a corporate body can only act by
agents, and it is, of course, the duty of those agents so as to act as best to promote the interests of
the corporation whose affairs they are conducting. Such agents have duties to discharge of a fiduciary
nature towards their principal. And it is a rule of universal application that no one, having such duties
to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal
interest conflicting, or which possibly may conflict, with the interests of those whom he is bound to
protect.

10. L.C.B.Gower; Principles of Modern Company Law 611 (London: Sweet & Maxwell,1997)

11. Section 317 (1) provides that it is the duty of a director, who is in any way, whether directly or
indirectly, interested in a contract or proposed contract with the company, to declare the nature of his
interest at a meeting of the directors of the company. Subsection (2) provides that in the case of a
proposed transaction the declaration shall be made at the meeting of the directors at which the
question of entering into the transaction is first taken into consideration or, if the director was not at
that meeting, at the next meeting held after he became so interested. Subsection (3) provides that a
general notice given to the directors of the company by a director to the effect:

a) That he is a member of a specified company or firm and is to be regarded as interested in

any transaction after the date of notice with that company or firm, or;

b) That he is to be regarded as interested in any transaction after the date of the notice with a
specified person who is “connected” with him within the meaning of section 346, is deemed
to be sufficient declaration of interest.

12. [1968] 1 Q.B. 549, C.A.

13. [1990] 2 A.C. 663. H.L.

14. Re British America Corporation Ltd (1903) 19 TLR 662.

15. Runciman v Walter Runciman plc [1992] BCLC 1084.

16. Neptune (Vehicle Washing Equipment) Ltd v Fitzgerald [1996] Ch 274. In this case Lightman J
said, “ where a director is interested in a contract, the section secures that three things happen at a
directors’ meeting: first, all the directors should know or be reminded of the interest; second, the
making of the declaration should be the occasion for a statutory pause for thought about the
existence of the conflict of interest and of the duty to prefer the interests of the company to their
own; third, the disclosure or reminder must be a distinct happening at the meeting which therefore
must be recorded in the minutes of the meeting.

17. Subsection (1) of section 297 provides that except with the consent of the Board of Directors of
a company, a director of the company or his relative, a firm in which the such a director or relative is
a partner, any other partner in such a firm, or a private company of which the director is a member
or director, shall not enter into any contract with the company for the sale, purchase or supply of any
goods, materials or services; or after the commencement of this Act, for underwriting the
subscription of any shares in, or debentures of, the company.

18. Walchandnagar Industries Ltd. v Ratanchand Khimchand Motishaw (1953) 23 Com Cases 343.

19. A. Ramaiya, Guide to Companies Act 2967 (Nagpur: Wadhwa & Co, 2004)

20. Ibid at 2968

21. Yashovardhan Saboo v Groz-Beckert Saboo Ltd. (1995) 83 Com Cases 371 at 413 (CLB)

22. Catherine Lee v Lee’s Air Farming Ltd. (1961) 31 Com Cases 233.

23. Supra note 19 at 2971. the relevant documents required to check whether the Board’s sanction for
contracts has been acquired are minutes of Board Meeting, Form 24 A, approval letter from the
Central Government, and register of contracts in which directors are interested.

24. For any default under this section penalty can be imposed under s. 629A and the same is
compoundable under s. 621A. [Otto Burlington Mail Orders P. Ltd. Re, (1999) 96 Com Cases 525]
While compounding the offence, the nature of the offence and the financial position of the company
as well as the continuing default should be taken into account while quantifying the fee to be
recovered. The default should be stopped and also made good.

25. Rabindra Nath Mitra v Emperor,(1938) 8 Com Cases 176 (Cal). The section was held applicable
to transactions involving a meager sum of Rs. 55.

26. This section is applicable even if contracts between two public companies fall outside the purview
of section 297. The provisions of subsection (6) would be relevant when there are one or more
common directors who individually or collectively hold, in either of the two public companies, more
than two percent of the paid up capital of the company.

27. In Ramaswami Iyer v Madras Times Printing and Publishing Company Ltd., AIR 1915 Mad 1179,
the Madras Court observed that “the directors of the company are agents of the company and
trustees for the shareholders of the powers committed to them as such trustees, the general rule
applies that no one who has a duty to perform shall place himself in a situation in which his interest
conflicts with his duty and he must not make profit by the trust. The company is entitled to the
unbiased advice of every director upon matters which are brought before the Board for
consideration, and a contract made by a director with the company for profit to himself is invalid.

28. This section was introduced following a recommendation of the Company Law Committee. It
held that the director concerned to should take reasonable steps to ensure that the notice is read in
the Board Meeting. Otherwise the general notice or notice of renewal may well remain unnoticed by
the other director/s of the company and the object of giving such notice may be easily defeated. The
Company Law Committee also referred to Millin Comission in South Africa; which observed: “under
the present provisions, new directors joining the Board cannot know of it unless they take the trouble
to read the minutes, it may be for years past, and it would be convenient for auditors if they were in a
position to confine their research for such a notice to cover any particular transaction to the minutes
of the year in which the transaction occurred; as cited in supra note 19 at 2977.

29. AIR 1994 Bombay 20.

30. (1985) 1 Comp LJ 195.

31. The Company Law Board gave a clarification as to whether a director can vote on the
appointment of his relative. The Board held that irrespective of the strict legal position it is sound
company practice if a director, whose near relative is proposed to be appointed to the Board, to
abstain from voting and participation in the discussion of the Board; as cited in supra note 19 at
2707.

32. North Eastern Insurance Co., Re., (1919) 1 Ch 198.

33. Amritsar Rayon & Silk Mills Ltd. v Amirchand Saideh, (1988) 64 Com Cases 762 (P&H). The
contract also does not violate section 23 of the Contract Act, 1872, as neither the consideration nor
the object of such contract is unlawful.

34. (1970) 40 Com Cases 1131 (Ker).

35. The consequences are a) liability to be prosecuted under s. 299 (4); b) cessation of office of
directorship under s. 283 (1) (i); c) liability to be prosecuted under s. 283 (2A); and d) liability to
refund to the company all remuneration received by the petitioner as director after the cessation of
his directorship. The court can relieve petitioner only in respect of penalties, liabilities and
disqualification. However, the court has no power to prevent the cessation of directorship because
that is automatic and cannot be undone.

36. Cook v Deeks (1916-17) All ER Rep 285; Regal (Hastings) Ltd. v Gulliver (1967) 2 AC 134, 137
(HL). In the latter case Lord Russel of Killowen held that: “ the rule of equity which insists on those,
who by use of a fiduciary position make a profit, being liable to account for that profit, n no way
depends on fraud, or absence of bona fides; or upon such questions or considerations as whether the
profit would or should otherwise have gone to the plaintiff, or whether the profiteer was under a duty
to obtain the source of profit for the plaintiff, or whether he took a risk or acted as he did for the
plaintiff, or whether the plaintiff has in fact been damaged or benefited by his action. The liability
arises from the mere fact of a profit having, in the stated circumstances, been made.’

37. Companies Act 1985, s 289 (1)