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Directors’ Responsibility Statement obligation of directors and associated issues

Date | Version September 17, 2022| 1.0
Keywords ‘Director’, ‘Director Responsibility Statement’, ‘Financial Statement’, ‘Reserve Matters’, ‘Shareholder Approval’, ‘Corporate Governance’
List of Legislation Referred.
  • Companies Act, 2013
Jurisdiction India

 

Abstract: This write-up examines the responsibility of directors in relation to the disclosures under the directors’ responsibility statement, consequent obligations cast on the directors under the Companies legislation, and the role of shareholders in relation thereto.

Introduction

The financial statements, in respect of a financial year, of a company, are required to give a true and fair view of the Company’s state. Accounting standards have been notified, which must be complied with in preparing such financial statements. The financial statements, together with the auditors’ report and report by its Board of Directors, are laid before the Company’s shareholders for adoption.

The Companies Act, 2013 (‘Act’), the primary legislation governing the management of companies established in India, envisages the directors to bear responsibility for the Company’s financial statements. Thus, the board of directors’ report must be attached to the financial statements. Such a report, among other things, is required to include a Directors’ Responsibility Statement.

Directors’ Responsibility Statement

The origin of the directors’ responsibility statement is found in the 1992 Cadbury Report. The Cadbury Report recommended that the director’s report and accounts of a company should include a formal statement by its directors to the effect that responsibility for preparing the accounts rests with the board of directors and that this should be positioned alongside a statement by the auditors in the auditors’ report. The objective of the statement is to set forth the area of responsibility of the directors as distinct and independent from the responsibilities of the auditors of the Company.

The Directors’ Responsibility Statement is required under Section 134(5) of the Act to state as under:

  • In preparing the annual accounts, the applicable accounting standards and proper explanations relating to material departures were followed.
  • The directors had selected such accounting policies and applied them consistently and made judgments and estimates that were reasonable and prudent to give a true and fair view of the state of affairs of the Company at the end of the financial year and of the profit and loss of the Company for that period.
  • The directors had taken proper and sufficient care for the maintenance of adequate accounting records in accordance with the Act’s provisions for safeguarding the Company’s assets and for preventing and detecting fraud and other irregularities.
  • The directors had prepared the annual accounts on a going concern basis.
  • In the case of a listed company, the directors had laid down internal financial controls to be followed by the Company and that such internal financial controls are adequate and operating effectively.
  • The directors had devised a proper system to ensure compliance with all applicable laws and that such systems are adequate and operating effectively.

Obligations cast on directors

The Directors’ Responsibility Statement, as the nomenclature suggests, is an affirmative statement from the directors with respect to the subject matter. In this regard, the directors have a collective responsibility, among other things, to;

  • Apply their judgement and select accounting policies
  • Apply their judgement for having in place SOPs for the prevention and detection of fraud and other irregularities in the management of the Company.
  • Apply their judgement for having in place SOPs safeguarding the assets of the Company.
  • Apply their judgment for selecting internal financial controls (in the case of listed companies).
  • Apply their judgement for devising a proper system to ensure compliance by the Company with all applicable laws. (collectively called ‘Statutory Obligations’).

 

The obligation of directors v. right of shareholders

The obligation of the directors with respect to the Directors’ Responsibility Statement is unconditional and absolute. The shareholders do not have a say in this regard. The shareholders are at liberty to not adopt the accounts when laid before it during an annual general meeting, but they have no right to in any manner to restrict the directors from discharging their statutory obligation.

At this juncture, it is important to note that the above is a list of matters where an obligation has been cast on the directors to take decisions with respect to certain matters as distinct from the ‘powers’ of directors, which is enabling and may be curtailed by provisions contained in the charter document, i.e., articles of association of the Company.

It is common practice for shareholders to agree to a whole host of matters, in respect of which their affirmative vote would be required for passing a resolution in relation thereto – typically called ‘reserved matters. There is no issue with the concept of ‘reserved matters. However, to the extent any reserved matter impinges on the Statutory Obligations, arguably, it would not be valid.

To illustrate, ‘change in accounting policies’ is typically covered under ‘reserved matters. Arguably, it is the obligation of the directors to use their judgement and select accounting policies; therefore, the shareholders should not have any veto rights in respect thereof.

The directors bear important responsibility under the Company’s legislation, and there is a reason for the distinction between ‘management’ and ‘ownership’. The directors are responsible for the management of the Company, while the shareholders, as owners of the Company, do wield ultimate authority – they appoint the very directors who are enjoined with the management of the Company. However, this does not give the shareholders the right to intervene in the directors’ performance of the role and responsibilities.

Disclaimer: The content of this article is intended to provide a general guide to the subject matter. Specialist professional advice should be sought about your specific circumstances. The views expressed in this article are solely of the authors of this article.