Introduction
A promoter plays a pivotal role in driving a company’s growth and significantly contributes to its overall success. They are instrumental in shaping the company’s vision, setting its culture, and defining long-term goals. Any deviation from lawful and ethical conduct by a promoter can negatively impact stakeholders, particularly investors of a company.
In recent years, however, there have been multiple instances where promoters have engaged in actions or omissions that amount to wilful misconduct or gross negligence. These developments have led parties to investment agreements to more carefully define the term ‘cause’, often including such wilful misconduct and gross negligence as grounds for material breach or events of default.
While Indian law draws on common law principles in addressing the meaning of gross negligence and wilful misconduct, these concepts have been further refined through landmark judicial decisions. This article explores the legal interpretation and distinction between ‘gross negligence’ and ‘wilful misconduct’ as established by Indian courts.
Concept of ‘Gross Negligence’ and ‘Wilful Misconduct’
Gross negligence refers to a party’s failure — whether through action or omission — to exercise reasonable care and skill in performing an obligation, demonstrating a clear disregard or serious neglect for a foreseeable risk that a reasonably prudent person would have anticipated. However, to delve further, it is important to distinguish between negligence and gross negligence. ‘Negligence’ refers to the failure to exercise the standard of care that a reasonably prudent person would apply in a given situation. ‘Gross negligence’, on the other hand, involves a more serious lapse and is a failure, whether by action or omission, to exercise reasonable care and competence in fulfilling an obligation, coupled with a disregard for an obvious and foreseeable risk.
This distinction was highlighted by the Hon’ble Supreme Court in State of U.P. through Secretary (Excise) and Ors. v. McDowell and Company Limited[1], where the Apex Court examined various forms of negligence. It was held that while negligence is a breach of the standard care expected of a prudent person, gross negligence reflects a level of carelessness that even ordinarily inattentive individuals would typically avoid to prevent harm to themselves or their property.
Similarly, in The Institute of Chartered Accountants of India v. Mukesh Gang[2], the High Court of Andhra Pradesh clarified that for negligence to escalate to gross negligence, it must involve a reckless disregard for legal duty and the potential consequences to others, or it must amount to a wilful, voluntary, or wanton omission.
‘Wilful misconduct’ on the other hand refers to an intentional act or failure to act that deviates from expected behavior, where the individual is either aware or reckless regarding the fact that their actions or omissions are contrary to, or exceed, the standard conduct that should be expected from them.
In N.M. Roshan Umar Karim and Co. v. The Madras and Southern Maharatta Railway, Co., Ltd.[3], the High Court of Madras distinguished 'wilful misconduct' from an accident, noting that it is akin to gross or culpable negligence. Also, the Patna High Court, in Jamunadas v. E.I. Ry. Co.[4], had also clarified that misconduct arises from the mere omission of a duty, but if that failure is aimed at intentionally causing harm or loss, it qualifies as ‘wilful misconduct’.
In a recent judgement, the High Court of Kerala in Indian Airlines v. Kurian Abraham[5] explained that ‘wilful misconduct’ refers to a deliberate disregard of a known duty, or one that should have been known, crucial for safety. The court also referenced Stroud's Judicial Dictionary of Words and Phrases, Volume 3, which defines ‘wilful misconduct’ as conduct where the will plays an active role, differentiating it from accident or negligence. The Hon’ble Court further emphasized that misconduct, while intended, must not be attributed to honest forgetfulness or genuine mistake to be considered ‘wilful misconduct’.
Distinction between ‘Gross Negligence’ and ‘Wilful Misconduct’
While differentiating between ‘gross negligence’ and ‘wilful misconduct’, it is pertinent to recognize that ‘misconduct’ and ‘negligence’ are distinct concepts. Such a distinction was affirmed by the High Court of Bombay in Ramkrishna Ramnath Shop v. Union of India[6], where the Court stated, “’misconduct’ and ‘negligence’ are different notions. Some kinds of negligence may amount to ‘misconduct’, while some kinds of negligence may not amount to ‘misconduct’.” Similarly, the Calcutta High Court, in Bengal Nagpur Railway Co. Ltd. v. Dhanjishah Pestonji[7], observed that “gross negligence and wilful misconduct are not convertible terms, the latter may include the former and that there are many cases in which wilful misconduct and gross negligence correspond.”
Based on the precedents discussed above, it can be inferred that gross negligence and wilful misconduct, while related, are distinct legal concepts. These two terms are not interchangeable; instead, they represent different degrees of wrongful behaviour. Therefore, while the two concepts may overlap in some instances, they represent different degrees of culpability in the eyes of the law.
Inclusion of such terms in the investment agreements
Since the promoters of a company, often serving as the public face of a company, hold substantial influence over its reputation and long-term success, when a promoter engages in misconduct or neglects to perform his/her duties, the repercussions on the company’s standing, internal operations, and future performance can be profound. Therefore, in the light of increasing instances of misconduct and negligence within companies, which have led to investor-initiated investigations, it is essential for investors to clearly define ‘gross negligence’ and ‘wilful misconduct’ as grounds for material breach under their investment agreements. Establishing detailed provisions for these events will provide the necessary safeguards for the investor.
To safeguard against the risks posed by gross negligence and wilful misconduct, investors should consider the following recommendations:
(a) Inclusion of indemnity provisions: Investment agreements should include clear indemnity provisions, holding the promoters liable for compensating investors for any losses resulting from a breach caused by gross negligence or wilful misconduct. This would ensure that investors are financially protected in the event of such breaches.
(b) Excluding limitation of liability in such instances: The investment agreements should also explicitly exclude any limitations of liability in cases of gross negligence or wilful misconduct. This provision ensures that investors are not unfairly restricted in seeking full compensation for the harm caused by such actions.
(c) Robust definition of ‘Cause’ and related provisions: The inclusion of a comprehensive definition of ‘cause’ along with detailed exit provisions, material breach terms, and linkage of the same to the event of default clauses can serve as a strong tool for investor protection. These provisions will help prevent promoters from engaging in acts of misconduct, knowing that there are clear, enforceable consequences that protect the investors' interests upon occurrence of such contingency.
In the light of these considerations, it is imperative for investors to carefully negotiate and finalize transaction documents that include wilful misconduct and gross negligence as defined ‘cause’ events. The implementation of such measures will equip investors with the requisite safeguards to mitigate the risks associated with a promoter’s failure to fulfil their duties responsibly, thereby safeguarding their investment and reducing the likelihood of substantial losses.
[The authors are Principal Associate and Associate, respectively, in Corporate and M&A practice at Lakshmikumaran & Sridharan Attorneys, New Delhi]
[1] (2022) 6 SCC 223
[2] 2016 (6) ALT 606
[3] AIR 1936 Mad 508
[4] (1933) A.I.R. Pat. 630
[5] AIR 2010 Ker 85
[7] AIR 1930 Cal 298
