Good Faith Vs Proper Purpose: Re- Examining Judicial Review Of Directors’ Powers Under Indian Company Law
Muskkan Talreja, O.P. Jindal Global University
I. Introduction
Directors often exercise powers such as issuing shares or restricting shareholder rights stating that they acted in the company’s best interests. When these decisions are questioned, courts encounter the issue, whether it’s enough that a director acted in good faith or must they have also acted in for the right reasons for the exercise of power to be valid?
Company law is thus faced with a doctrinal divide between the subjective standard of “good faith” and the objective constraint imposed by the Proper Purpose Rule.
Section 166 of the Companies Act, 2013, codifies directors’ fiduciary duties and expressly requires them to act in good faith. However, it does not explicitly mention the requirement that powers must be exercised only for their proper purposes. Although the Proper Purpose Rule is a well- established principle of fiduciary law in common law countries, its application on its own in the Indian legal system is unclear and underdeveloped. Consequently, courts tend to focus on the good faith of the directors than on the lawfulness of the purpose behind such decisions.
This paper holds that the Proper Purpose Rule is an application of the fiduciary duty in Section 166 but that Indian courts do not use it as a separate criterion but rather merge it with the subjective criterion of good faith. The confusion of the two standards undermines the way courts examine the decisions made by directors and permits the court to condone a decision actually made improperly.
II. Section 166: Codification without Doctrinal Clarity
A directors’ fiduciary duties are encompassed in Section 166 of the Companies Act, 2013, which are largely drawn from principles developed under common law and equity. Section 166(2) requires directors to act in good faith in order to promote the objects of the company and to act in its best interests, along with those of its members, employees, shareholders and the broader community. This provision reflects a fiduciary standard grounded in loyalty but articulated through the language of subjective belief. Complementing this, Section 166(3) introduces an objective element by requiring directors to exercise due and reasonable care, skill and diligence. Section 166(4) prohibits directors from allowing personal interests to conflict with those of the company.
