This blog is an addendum of the study report on “Responsibilities of Board of Directors and Promoters towards Investors and Stakeholders” submitted to IIM Kozhikode as part of the curriculum for the course “Leadership and Corporate accountability” during the MBA program.

  • A startup raised 5 crores in their first funding round from a VC firm. The founders were serving as the directors. While raising the investment, it was stated that the money will be used for product development and marketing. However, the founders diverted a significant portion of the funds towards personal expenses and even buying a car for the company, which the founders used for personal purposes.

  • A promising AI startup was built on the skills of their founding CTO. The CTO was not happy with the way things were going and decided to leave the company and informed the other founders who were in discussion with potential investors to raise funds for the next round. However, they did not disclose the CTO’s departure plan to the investors. After the investment was made, the CTO left, and the investors felt misled as they believed the CTO’s presence was crucial for the company’s success.

  • A large family owned construction company was operating with significant leverage. The board of directors (who were family members) decided to split the company into two entities, one holding the profitable assets and the other holding the debt. The directors did not inform the creditors about this restructuring plan. After the split, the creditors found it challenging to recover their dues from the new entity holding the debt, leading to significant haircut for them.

  • A firm was not paying salaries to its employees for several months due to cash flow issues. The board of directors decided to prioritize payments to suppliers and other operational expenses over employee salaries. When employees raised concerns, the board assured them that their dues would be cleared soon, but no concrete plan was shared.

What is common in all these scenarios? Does these feel wrong to you? Yes, they do. In all these scenarios, the board of directors and promoters have failed in their fiduciary duties towards investors, stakeholders, and employees.

What is Fiduciary Duty?

Fiduciary relation arises when a party is entrusted with property, information, or power to make decisions that involve discretionary judgement for the benefit of someone other than themselves. A trustee and beneficiary, doctor and patient, lawyer and client – all these are fiduciary relationships. In a corporate environment where investors and shareholders entrust their money with a company to business expecting wealth maximization, they are entering a fiduciary relationship. The responsibilities (duties) of the promoters, directors, and executives towards the investors and other stakeholders can be called as their Fiduciary responsibilities which are as follows:

  • Candor and disclosure
  • Diligence and care
  • Loyalty and self-restraint

So who has the fiduciary duties in a company and to whom?

The board of directors and promoters have fiduciary duties towards the company, its shareholders, and stakeholders (creditors, customers, employees, etc.). The executives and employees also have fiduciary duties towards the company.

Person Role
Promoters Establish the company and may have additional responsibilities during formation. Founders in a startup company.
Board of Directors Manage company affairs and ensure compliance with laws and regulations. They are appointed by shareholders. Promoters can be board members too.
Investors / shareholders Invests their capital (money) to purchase shares, expecting wealth maximization.
Creditors A bank or a financial institution providing loans or credit to the company. Could be debenture holders too

What should they do?

The fiduciary duties of the board of directors and promoters can be broadly classified into three categories:

1. Duty of Candor and Disclosure

  • Provide accurate and complete information about the company’s financial status, operations, and risks to investors and stakeholders.
  • Disclose any conflicts of interest that may affect decision-making.
  • Inform investors about significant changes in management, strategy, or financial health.

2. Duty of Diligence and Care

  • Make informed decisions based on thorough research and analysis.
  • Regularly monitor the company’s performance and address any issues promptly.
  • Ensure compliance with legal and regulatory requirements.

3. Duty of Loyalty and Self-Restraint

  • Prioritize the interests of the company and its shareholders over personal gains.
  • Avoid engaging in activities that could create conflicts of interest.
  • Refrain from using company resources for personal benefit.