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Safeguarding Trade Secrets: Conflict With Director’s Duties

Published on Fri, Dec 05,2014 | 22:33, Updated at Fri, Dec 05 at 22:33Source : Moneycontrol.com 

By: Darshan Upadhyay - Partner & Bhavin Gada - Senior Associate, Economic Laws Practice (ELP), Advocates & Solicitors

In common parlance a ‘trade secret’ is any important confidential information related to business that is not available in the public domain. A ‘trade secret’ facilitates an edge on the competition in the market and usually includes business secrets, research data, marketing strategies and other competitively valuable information (Trade Secrets). It is fully justifiable and logical for a company to safeguard its Trade Secrets. In the usual course, a company safeguards its Trade Secrets by contractual restrictions in the nature of non-compete agreements, non-disclosure agreements or confidentiality agreements.

A company conducts business not just through its employees but also its board of directors. It is pertinent to note that certain directors and personnel of the company involved in the day to day affairs are privy to these Trade Secrets. In view of this, a pertinent question that arises is, can the company or a set of directors claim confidentially on Trade Secrets and argue that the Trade Secrets ought not to be shared with other directors who are not involved in the day to day affairs of the company.  The short answer to this question ought to be that Trade Secrets cannot be withheld from Directors, as they have a duty to act in the best interests of the company.

However, there are some instances which pose a predicament for companies where either private equity owners nominate the same director on competing companies or even instances where post the termination of a JV, a hostile director is serving the rest of his term.

To address such sticky situations, this article discusses whether (i) the Trade Secrets can be disclosed selectively to certain directors, and (ii) if yes, then whether such selective disclosure would hold good in view of provisions under the Companies Act, 2013 (Act) and the equity listing agreement.

The Act and the duties of Directors

It is often said that a director should ‘be informed’ in relation to a company to which he owes duty and liabilities. Section 166 of the Act has clearly codified the duties of directors unlike the Companies Act, 1956 and thus the law on duty of directors until the introduction of section 166 of the Act, developed only by judicial precedents.

Section 166 of the Act requires the directors to:

-         act in accordance with the articles of the company;

-         act in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of environment;

-         exercise his duties with due and reasonable care, skill and diligence and exercise independent judgment;

-         not involve in a situation in which he may have a direct or indirect interest that conflicts, or possibly may conflict, with the interest of the company;

-         not achieve or attempt to achieve any undue gain or advantage either to himself or to his relatives, partners, or associates;

-         not assign his office and any assignment so made shall be void.

As evident from the duties stated above, a director has to shoulder duties to act in good faith in order to promote the objects of the company in the best interests of the company and not involve in a situation, either directly or indirectly, which may result in conflict of interest with the company.

Information a director is entitled to seek under the Act

In order to answer the question whether a director is legally entitled to receive information in the nature of Trade Secrets is a debatable issue.

Under the Act, a director is entitled to inspect company’s books of accounts. Further, in case of a listed company, the minimum information that a director is entitled to includes information like recruitment and remuneration of senior officers just below the board level, including appointment or removal of Chief Financial Officer and the Company Secretary; show cause, demand, prosecution notices and penalty notices, which are materially important; fatal or serious accidents, dangerous occurrences, any material effluent or pollution problems; any material default in financial obligations to and by the company, or substantial non-payment for goods sold by the company; any issue, which involves possible public or product liability claims of substantial nature, including any judgement or order which, may have passed strictures on the conduct of the company or taken an adverse view regarding another enterprise that can have negative implications on the company; transactions that involve substantial payment towards goodwill, brand equity, or intellectual property; non-compliance of any regulatory, statutory or listing requirements and shareholders service such as non-payment of dividend, delay in share transfer, etc.

A careful analysis of the above-mentioned heads of minimum information reveals that none entails a director with a right to receive information in the nature of Trade Secrets. However, a pertinent question then arises is how a director is supposed to perform his duties in good faith and to the best of his abilities when he is unaware of the Trade Secrets.

Twist in the Tale: View by Judiciary

Although the Indian judiciary is yet to rule on this issue of safeguarding of Trade Secrets from certain directors, the Singapore High Court has observed the information that can be sought by a director. In this context, in a recent judgement[1] of the Singapore High Court, section 199 (3) of the Companies Act (Cap 50, 2006 Rev Ed) which is substantially similar to section 128(3) of the Act was examined. The Court held that the right to inspect was conferred on directors, whether at common law or by statute or both, to facilitate the discharge of all director's duties. The right is a "concomitant of the fiduciary duties of good faith, care, skill and diligence which a director owes to the company".

The question that now arises is ‘can this right be exercised for purposes unconnected to discharge of a director’s duties’.

The English Court of Appeal held that, they find it difficult to hold that a court would be required to enforce the right in circumstances in which it was demonstrated that the director was seeking inspection for some other improper purpose (not involving injury to the company). As long as the director was seeking to exercise that right, not for the purpose for which it was conferred but for some purpose unconnected with his duties as a director, there was no reason why inspection should not be refused.[2] Lord Justice Hughes further added to what was held by the English Court of Appeal in the following words: “Inspection may well not be ordered if a clear prima facie case is raised that the information sought will not be used qua director and especially if to the detriment of the company; one of many possible examples is where inspection is in effect sought for the benefit of a competitor.” This is in consonance with the decision in Scottish Co-operative Wholesale Society Ltd. v. Meyer.[3] It was held in that case that, the duty of the three directors to the textile company was to do their best to promote its business and to act with complete good faith towards it; and in consequence not to disclose their knowledge of its affairs to a competitor, and not even to work for a competitor, when to do so might operate to the disadvantage of the textile company.

The Singapore High Court judgment (supra) has also concluded that right to inspect can also be displaced if the director intends to use it for any purposes unconnected to the discharge of his director’s duties.

However, there are some jurisdictions like Delaware, USA, which recognise that a director’s right to information is “essentially unfettered in nature”.[4] The right includes “equal access to board information”.[5] A company “cannot pick and choose which directors will receive which information”.[6] The director’s right to information extends to privileged material.[7]

Conclusion

Safeguarding Trade Secrets is an important facet of conducting business by any person including a company. However, at the same time, a director may not be able to perform his duties, unless he is in know-how of such Trade Secrets. A director merely does not have the duty to avoid conflict of interest but has to also see that the interest of the company is not adversely affected. Where he is not aware of such Trade Secrets, he may not be able to perform his other duty to work towards the progress of the company.

Interestingly, it may be argued by Promoter’s directors that sharing of such Trade Secrets with Non-Promoter directors may result in breach of their good faith and trust duty towards the company as such information may be used for purposes unconnected with director’s duties. On the other hand, Non-Promoter directors may claim that they need to know such Trade Secrets in order to discharge their duties towards the Company.

Contemplation by Promoter directors that Non-Promoter director may put him in a conflicting position may not hold good as Non-Promoter directors are also subject to the same duties and liabilities as a Promoter director. However, it will be interesting to see how this issue unfolds in India, as we are yet to witness guiding principles by the judiciary on the concerned issue.

[1] Hau Tau Khang v/s Sanur Indonesian Restaurant Pte Ltd and another (Hau Tau Thong, non-party) and another matter, [2011] SGHC 97

2 The Oxford Legal Group Limited v/s Sibbasbridge Services PLC and another, [2008] EWCA Civ 387

3 Scottish Co-operative Wholesale Society Ltd. v/s Meyer, [1958] 3 All ER 66

4 Schoon v/s Troy Corp., 2006 WL 1851481, at *1 n.8 (Del. Ch. June 27, 2006) (quoting Milstein v/s  DEC Ins. Brokerage Corp., C.A. Nos. 17586, 17587, at 3 (Del. Ch. Feb. 1, 2000)

5 Moore  Bus. Forms, Inc. v/s Cordant Hldgs. Corp., 1996 WL 307444, at *5 (Del. Ch. June 4,  1996); accord Intrieri, 1998 WL 326608, at *1

6 Hall v/s Search Capital Grp., Inc.,  1996 WL 696921, at *2 (Del. Ch. Nov. 15, 1996)

7 Re: Kalisman, et al. v/s Friedman, et al., C.A. No. 8447-VCL , judgment of Court of Chancery of the State of Delaware dated April 17, 2013

Disclaimer: This article has been authored by Darshan Upadhyay, Partner and Bhavin Gada, Senior Associate, at Economic Laws Practice (ELP), Advocates & Solicitors. The information provided herein is intended for informational purposes only and does not constitute legal opinion or advice. Readers are requested to seek formal legal advice prior to acting upon any of the information provided herein.

 
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