This article is written by Adv. Komal Arora and Prasenjit Singh. This article contains all the essential information about independent directors. This article will cover topics such as who the independent director is, their roles and responsibilities, relevant legal provisions, relevant case laws, and critical analysis of their roles along with suggestions, etc. 

Table of Contents

Introduction 

Independent directors are of utmost importance in corporate governance for the reason that they ensure that the company safeguards the shareholders’ interests, promotes transparent decision-making, and is accountable for their actions. An independent director’s unbiased oversight over the functioning of a company for the best interest of all shareholders is a sine qua non for the long-term success of a company. Their roles and responsibilities are disputed in the present era as even with independent directors there are many frauds in companies such as IL&FS scam, PMC Bank, Jet Airways, and Enron scam to name a few. Thus, this article will discuss the role, duties, and responsibilities of independent directors and evaluate their efficiency in combating fraud.

Concept of an independent director

An independent director is a director in a company who oversees the affairs of the company and provides unbiased guidance. He is not an employee of the company nor does he have any personal stake in the company. In simple terms has no material relationship with the company but his role is to guide the company to improve its corporate governance. 

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The concept of independent directors was first introduced through Kumar Mangalam Birla committee constituted by the Securities Exchange Board of India (‘ hereinafter ‘SEBI’) in 2000 to raise the standard of corporate governance in listed companies. Based on its recommendations, SEBI incorporated Clause 49 in the Equity Listing Agreement. This committee defined independent directors as directors who apart from receiving the director’s remuneration, do not have any other material pecuniary relationship or transactions with the company, its promoters, its management, or its subsidiaries, which in the judgement of the board may affect the independence of judgement of the director. 

Later in 2002, the Naresh Chandra committee was also constituted under SEBI which not only expanded the duties, liabilities, and remuneration of independent directors but also recommended that 50% of the total members on the board must be independent directors and be exempt from criminal and civil liabilities. Later, the Narayan Murthy committee was constituted which rejected the Naresh Chandra Committee’s recommendations of treating nominee directors of financial institutions as independent directors and also emphasised the need for evaluating the performance of non-executive directors and a limit on independent director remuneration. In 2008, SEBI further changed the listing agreement to fix the minimum age for independent directors as 21 years.

Lastly, J.J Irani committee was constituted which came up with several recommendations with respect to independent directors that were in conflict with clause 49 of the Listing Agreement and the recommendations of the Narayan Murthy Committee.  It was only after the adoption of the Companies Act, 2013 ( hereinafter ‘the Act’) that clarity to the concept of independent directors was given to a great extent. Now independent directors have been statutorily defined under Section 2 (47) of the Act which means independent directors referred to in subsection (5) of Section 149 of the Act. 

Who is an independent director

An independent director is a director who does not have any material or pecuniary relationship with the directors of the company. It means that an independent director cannot be a managing director or whole-time director or nominee director in any way. In other words, an independent director is a non-executive director of the company who brings objectivity and independence in the decision-making by the Board of Directors of the company. 

Section 2(47) of the Companies Act, 2013 defines an independent director as further given in Section 149(6). As per Section 149(6) of the Companies Act,2013 and Rule 5 of Companies (Appointment and Qualification of Directors) Rules, 2014, the following are the criteria for the appointment of independent directors:

Section 149(6) provides that an independent director means a director other than a managing or whole-time director or nominee director who fulfils this criterion:

  1. Who in the opinion of the board, is a person of integrity and has relevant expertise, 
  2. Who neither in present nor in the past was a promoter of the company, or its subsidiary or associate company or who is not in any way related to promoters or directors of the company,
  3. Who has no pecuniary relationship other than remuneration or having transactions not exceeding 10% of his income,
  4. Whose no relative: 
  • Holds any security or interest in the company or its holding, subsidiary, or associate company during the preceding two financial years or current financial years; 

Provided that it is allowed if the amount does not exceed 2% of paid up capital or Rs.50 lakh of the company or its holding, subsidiary, or associate company or such higher amount as prescribed. 

  • Is indebted to the company or its holding, subsidiary, or associate company in excess of the amount prescribed during the preceding two financial years or current financial years;
  • Has given guarantee or security related to indebtedness of a third person to company or its holding, subsidiary, or associate company for such amount prescribed during the preceding two financial years or current financial years;
  • Has any other pecuniary relationship with the company or its holding, subsidiary, or associate company amounting to 2% or more of its gross turnover or total income of Rs.50 lakh or such higher amount as prescribed during the preceding two financial years or current financial years.
  1. Who neither himself nor any of his relatives:
  • Holds key managerial position (KMP) in present or past or as an employee of a company or its holding, subsidiary, or associate company in 3 financial years immediately preceding the financial year in which he is to be appointed;
  • Is not an employee or proprietor of a firm of auditor or company secretaries, or legal, consulting firm of the company or its holding, subsidiary, or associate company amounting to 10% or more of the gross turnover of such firm;
  • Holds together with relatives, 2% or more of the total voting power of the company;
  • Is the Chief executive or director of any non-profit organisation which gets 25% or more of its recipients from the company, promoters, directors, or its holding, subsidiary, or associate company or that holds 2% or more of the total voting power.
  1. Anyone who possesses other qualifications as prescribed which is further provided under Rule 5 discussed below.

Further, Rule 5(1) provides that an independent director must possess skills, experience, and knowledge in any one field like finance, law, sales, management, marketing, research, corporate governance, technical operations, or other areas related to the company.

Further, Rule 5(2) states that none of the relatives of independent directors shall be indebted to the company, its holding, subsidiary or associate company, or its promoters or directors. Also, they should not have given any guarantee or security in connection with the indebtedness of a third person to the company, its holding, subsidiary, or associate company, or their promoters or directors of such holding company for the amount of Rs.50 lakhs at any time during 2 immediately preceding financial years or during the current financial year.

Number of independent directors

Section 149(4) of the Companies Act,2013 provides that every listed company shall have a minimum of one-third of the total number of directors as independent directors.  Further, as per Rule 4 of Companies (Appointment and Qualification of Directors) Rules, 2014  the following public companies shall have a minimum of two independent directors:

  1. Company with paid up share capital of Rs.10 crore or more,
  2. Company with a turnover of Rs.100 crore or more,
  3. Company which has in the aggregate, outstanding loans, debentures, and deposits of more than Rs.50 crore.

Provisions under the Companies Act, 2013

Independent directors are governed by various legislation such as the Companies Act, 2013, Companies (Appointment and Qualification of Directors) Rules, 2014, they are bound by the Securities and Exchange Board of India Act, 1992 (SEBI Act) and SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR Regulations) in case of listed companies and SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations,2003 (PFUTP regulations). The provisions in the Companies Act,2013 dealing with independent directors as are follows:

Basics on independent directors under Section 149

Section 149(6) as already discussed above gives the definition of independent director. Further subsection (7) states that every independent director shall at the first meeting of the Board where he participates as a director, give a decoration that he meets the criteria of independence whenever there is a meeting of the Board in every financial year.

Section 149(10) states that an independent director shall have a term of 5 years on the Board of the Company. He can be reappointed by passing a special resolution. Subsection (11) clarifies that an independent director cannot hold office for two consecutive terms. He shall be eligible for reappointment after the expiry of 3 years of ceasing to become an independent director.

Section 149(12) provides that an independent director or a non-executive director not being a promoter or Key managerial personnel shall be liable only for acts or omissions committed by a company done with his knowledge or consent or connivance or where he acted without diligence.

Part of the CSR committee

Section 135 deals with Corporate social responsibility. It states that every company falling in this criteria shall constitute a CSR Committee: 

  • Company which has a net worth of Rs.500 crore or more, or
  • Company with a turnover of Rs.1000 crore or, 
  • Company with a net profit of Rs.5 crore.

The CSR Committee shall consist of 2 or more directors, which shall have at least 1 independent director.

Data bank of independent directors 

Section 150 deals with the manner of selection and maintenance of a data bank of independent directors. It provides that an independent director may be selected from a data bank that contains the name, address, and qualifications of persons who are eligible to be appointed as independent directors.

An individual interested in becoming an independent director has to register themselves on this data bank and clear the online proficiency self-assessment tests within 1 year of registration. It is conducted by the Indian Institute of Corporate Affairs.

Audit committee and nomination committee

Section 177 states that the Board of directors of every listed company shall make an audit committee which shall consist of a minimum of 3 directors with independent directors forming the majority. So as a part of the Audit committee, an independent director should have the ability to read and understand the financial statements.

Further, Section 178 deals with the nomination and remuneration committee and stakeholders relationship committee. It provides that this committee shall consist of 3 or more non-executive directors out of which not less than half shall be independent directors.

Schedule IV

Then in Schedule IV, we have the code for independent directors. It is a guide to professional conduct for independent directors. Following these standards and performing their responsibilities which are given below will increase the confidence of minority shareholders, regulators, and companies. 

Guidelines for professional conduct

An independent director shall:

  • Uphold ethical standards of integrity and probity,
  • Act objectively and constructively while performing his duties,
  • Act in a bonafide manner in the interests of the company while performing his functions,
  • Gives sufficient time and attention to his professional obligations to ensure balanced and informed decision-making,
  • Not allow any extraneous consideration that vitiates his objective independent judgement in the interests of the company, while dissenting from the collective judgement of the Board,
  • Not abuse his position to the detriment of the company or its shareholders to gain direct or indirect personal advantage,
  • Refrain from any action that leads to loss of independence,
  • Assist the company in implementing the best corporate governance practices.

Appointment, remuneration, and retirement 

Part IV of Schedule IV deals with the manner of appointment. It is specifically provided that the appointment of an independent director shall be done independently of the management of the company, there should be a balance of skill, experience, and knowledge. The appointment shall be approved at the meeting of shareholders. There should be an explanatory statement with the notice of meeting that the independent director fulfils the conditions under this Act in the opinion of the Board. It is made formal through a letter of appointment which gives details for the term of appointment, expectations of the Board, fiduciary duties, insurance, code of Business ethics and remuneration, etc.

The remuneration that shall be paid to the independent director is sitting fees along with entitlement to the reimbursement of expenses for participation in the Board and other Committee meetings and profits-related commissions as approved by members of the company. 

Its Part V states that the re-appointment of an independent director shall be done on the basis of a report of performance evaluation. Further, part VI provides that the resignation or removal of an independent director shall be in accordance with Sections 168 and 169 of the Act. In such cases, a new independent director shall be appointed not more than 180 days from such resignation or removal.

An independent director is not subject to the retirement of directors by rotation; rather an independent director shall hold office for 5 consecutive years on the Board of the company and is eligible for reappointment on the passing of a special resolution by the company. independent directors shall not hold office for more than two consecutive terms and shall be eligible for reappointment after a cooling-off period of 3 years. 

Meeting 

Its Part VII states that the independent director shall hold at least 1 meeting in a year without the attendance of non-independent directors and members of the management. All independent directors must try to attend this meeting where the performance of non-independent directors, the Chairman, and the Boards is reviewed and the flow of information between the management and Board is assessed.

Performance evaluation 

Its Part VIII further states that the performance of an independent director shall be evaluated by the entire Board of Directors excluding the director which is being evaluated. On this basis, it is decided whether the independent director will continue his term of appointment or not.

Provisions in LODR regulations

SEBI LODR regulations 2015 has some provisions related to independent directors:

  • Regulation 16 (1)(b) defines independent directors in the same way as the Companies Act defines it. It adds that neither the director nor his relative is a material supplier, service provider, customer, lessor, or lessee of the listed entity.
  • Regulation 17 provides that where the chairperson of the board of directors is a non-executive director then one-third of directors shall be independent. Where the listed entity does not have a regular non-executive director then half of the directors will be independent.
  • Regulation 17A states that a person shall not serve as an independent director in more than 7 listed entities. Further, any person who serves as a whole time director or managing director in a listed entity shall serve as independent director in not more than 3 listed entities.
  • Regulation 24 states that at least 1 independent director on the board of a listed entity shall be a director of an unlisted material subsidiary whether incorporated or not.
  • Further, Regulation 25 deals with obligations with respect to independent directors. It states that no person shall be appointed or continue as alternate director for an independent director of a listed entity with effect from 1 October 2018. Also, the maximum tenure of independent directors shall be as per the Companies Act. Regulation 25 (2A) provides that appointment, reappointment or removal of independent directors shall be by special resolution. They shall hold at least 1 meeting in the financial year without the presence of non-independent directors and review their performance. If any act is done with their knowledge, consent, or connivance they will be liable.

Roles and responsibilities of independent director

The role and responsibilities of the independent director are enshrined in Section 149(8) read with Schedule IV of the Companies Act, 2013. Schedule IV and SEBI (Listing Obligations and Disclosure Requirement) Regulations 2015 impose huge powers and responsibilities in the hands of independent directors. The following are the roles and responsibilities of an independent director:

  • To bring objective view and independent judgement in the evaluation of the performance of the board,
  • Ensure the integrity of financial information and financial records of the company,
  • Protect the interest of all stakeholders and balance their conflicting interests,
  • Review the performance of non-independent directors and the Board of directors as a whole, review the performance of a listed entity taking into account the views of executive directors and non-executive directors, 
  • Assess the quality, quantity, and timeliness of the flow of information between the management of the listed entity and the board of directors which is necessary for the board to effectively and reasonably perform their duties,
  • To determine appropriate levels of remuneration for executive director, key managerial personnel, and senior management, and recommend removal of such officers of the company,
  • independent directors further act as a moderator and arbitrators in the interest of the company in the situation of conflict between management and shareholder’s interest, 
  • An independent director is the final custodian of the sustainability of the company in matters  such as corporate governance, greater productivity, major efficiencies, and many more,
  • independent directors are on audit committees and such audit companies deliberate on the finances of the company such as loans taken by the company, key findings in balance sheet, the performance of companies in the financial year, and many more. Hence, the Board of Directors is a collective responsibility of the company of which the independent director is a critical part. 

Duties of independent director

The following are the duties of independent directors:

  • To undertake introduction  and regularly update and refresh their skills, knowledge, and familiarity with the company, 
  • To attend the general meetings and Board of directors meetings of the company,
  • To have appropriate knowledge about the company and its working,
  • To report concerns about unethical behaviour, actual or suspected fraud, or violation of the company’s code of conduct or ethics policy, and keep themselves well informed about the company and the external environment in which it operates,
  • Not to disclose any confidential information related to the company and its affairs,
  • To not obstruct the functioning of the company,
  • The liability of independent directors is very limited, unlike executive directors. The independent director is only liable in respect of such acts of omission or commission by the company which has occurred with his knowledge, attributable through Board process, and with his consent or connivance, and the independent director had not acted diligently,
  • The expertise of an independent director is required for key issues such as the choice of long-term accounting policy, the choice of implementing cyber security programs, and many more. 

Relevant case laws 

  1. Sunita Palita vs. M/s Panchmani Stone Quarry (2019)

The Supreme Court recently in this case, held that no liability can be fixed on the independent directors or non-executive directors who are not involved in the day to day working of the company.  It is an important judgement as it clarifies once again that independent directors cannot be held liable for all the wrongs committed in the company. It safeguards the rights of independent directors and saves them from being criminally answerable for every act. 

  1. In the matter of LEEL Electricals Ltd. (2024)

In this matter, SEBI questioned the responsibilities and liabilities of independent directors. A Fine of Rs.10 lakh was imposed by SEBI on two independent directors as they failed to discharge their statutory duties as a part of the Audit Committee. 

  1. In the matter of Fortis Healthcare Limited  (2023)

In this matter, the company was aiding in the routing of funds for the benefit of its promoters. It led to misrepresentation and non-disclosure of material information. The independent directors took the defence that they placed bona fide reliance on the reports received from the Audit committee and minimal knowledge of finance. All the independent directors were held liable for failing to discharge their duties and also aiding and abetting fraud.

Case studies on independent directors 

Satyam scam Case(2009)

What happened in the Satyam scam was that Ramalinga Raju, the founder and CEO of Satyam computers declared on January 7, 2009, that his company was falsifying its accounts for years and inflating profits. He famously said that ‘ It was like riding a tiger, not knowing how to get off without being eaten’. After this, he was arrested and sentenced to 7 years imprisonment. 

Role of independent directors post Satyam scam Case

The Satyam scam led to the CII, NASSCOM, ICSI, and Ministry of Corporate Affairs issuing a set of voluntary guidelines for corporate governance in 2009. It dealt with the independence of directors and the roles and responsibilities of different committees. Some of the recommendations concerning independent directors are as follows: 

  • A Nomination committee shall be formed to select independent directors. It shall comprise the majority of independent directors with a chairman.
  • The independent directors must conduct executive meetings regularly outside the management. 
  • They must have the freedom to meet managerial work periodically. The Board must provide independent directors with the procedure, resources, and information about the company’s details to let them effectively discharge their duties.
  • All independent directors must be paid adequate sitting fees. This amount must be based on the net worth of the company.

Further, in 2013 the Company law was amended and provisions regarding the responsibility and accountability of independent directors were clearly defined, independent directors have been barred from receiving stock options and are not entitled to receive remuneration for their services other than reimbursement. At least one-third of the Board shall consist of independent directors.

After the Satyam scam, there was fear instilled in the minds of independent directors in India. As per the Bombay Stock Exchange, more than 500 independent directors left their companies after the Satyam episode. This trend of leaving companies left people worried. The Ministry of Corporate Affairs then suggested some amendments in 2018. The recommendations related to the independent directors are as follows:

  • It was recommended that there should be a cap on the total pecuniary relationship with the independent directors. The proportion that the financial rewards from the company constitute the overall earnings of independent directors is very important to decide how much independently he works from the company. The fear of losing revenue might make them biased towards the promoters or majority shareholders. Therefore, it should not exceed 20% of the total income.
  • As a requirement, independent directors are mandated to fill a declaration of independence with the Registrar of Companies.
  • Independent directors can resign by giving a notice in writing to the company. They need to give detailed reasons for resignation in 7 days and it would not be effective until the 30th day from the date of receipt of such notice by the company.
  • For the removal of independent directors, a special resolution is required to be passed.
  • There was also a recommendation to disqualify an independent director based on poor performance, which will be evaluated by the government.
  • It was recommended to have mandatory e-registration for independent directors. It will be a screening mechanism for the appointment of independent directors and create their database.
  • The most stringent action was recommended by freezing the assets of independent directors of defaulting companies. In case of its breach, they were liable for criminal prosecution and contempt of court.

Infrastructure leasing and financial services crisis (2018)

In this case, independent directors were questioned as they did not exercise due diligence in safeguarding and overseeing the financial health of the company. Independent directors were expected to have a basic understanding of financial transactions, possess sufficient industry knowledge, and act like prudent persons. Here, independent directors failed to fulfil their role which led to this crisis. This increased the scrutiny of independent directors and their accountability and responsibility were recommended to be increased.

Punjab National Bank scam (2018)

The scam involved PNB and misuse of the letters of Undertaking by jewellery firms owned by Nirav Modi and Mehul Choksi to take loans. It also raised questions regarding the role of independent directors in preventing fraud. It was claimed that many independent directors on the Board failed to exercise due diligence and perform their duties effectively. They overlooked potential red flags in the transaction of the company and basically failed to detect crimes. This case also highlights that there is a need to make stringent provisions about the role of independent directors. 

Jet Airways (2019)

It was one of the leading airlines in India and it faced severe financial distress in 2019. In this matter, again independent directors were criticised for poor financial management of the company. The independent directors have a specific duty to protect the interests of minority shareholders. The promoter-led companies need to find the balance otherwise they are thrown out of the board. In this case, there were 2 independent directors who resigned when Jet Airways was in talks with Tatas to be acquired owing to huge losses for the company. It is said that the independent directors suggested taking the offer to revive the company but it was not taken into consideration, after which they resigned. 

PMC Bank (2019)

Three independent directors of the PMC Bank were arrested in 2019. The Bank had extended loans without proper collateral and turned them into huge losses. These independent directors were blamed as they failed to prevent fraud and they could not effectively oversee the lending practices of banks. It was once again pointed doubt that independent directors are responsible for safeguarding the interests of all stakeholders. They are expected to act diligently and bring an element of objectivity.

Yes Bank (2020)

Yes Bank faced a financial crisis due to poor corporate governance and loans. It was bailed out by the RBI. The independent directors were criticised for their failure to oversee the risk management practices of the company. They failed miserably by not raising concerns about exposure to stressed sectors and poor asset quality. This episode also led to analysing the importance of independent directors and the need to make it more robust.

Critical analysis of the position of independent director 

The above mentioned discussion highlights the theoretical aspect of the role and responsibilities of independent directors which is completely divorced from the practical realities. In the real world, the independent directors are subdued due to various factors. This article shall highlight the problems and solutions to address the submissive behaviour of independent directors in Board meetings. 

Increased liability 

Independent directors play two important roles, one is to monitor the working of the company as a watchdog and the second is to act as a strategic advisor. If an independent director in any way does not fulfil his responsibilities it is an offence, there is no scope for error or mistake and he cannot escape this liability. The roles and responsibilities of independent directors thus have enhanced multifold and at the same time liability has become more severe. The overall risks are high for independent directors. Laws are getting complex and there is fear in the minds of professionals and experts to take the position of independent director. A major point to ponder is whether the seat of independent director is onerous and there are more risks than rewards in position. 

In the case of the Satyam computer scam, the court imposed a fine of Rs.26.6 million on Krishna Palepu who was an independent director and also provided consultancy services during it, and a fine of Rs.20,000 on other independent directors. It is said that the collapse of this tech giant was due to the ineffectiveness of independent directors. There are other instances such as Enron Power, Dewan Housing Finance, and Worldcom where fraud happened due to independent directors which has led to increased scrutiny of the role of independent directors. The Ministry of Corporate Affairs froze the assets of independent directors of companies that belonged to Nirav Modi and Mehul Choksi in connection with the PNB fraud case. independent directors argued against it as they were independent from day to day working of the company and it is unfair to place the entire onus on them.

It is important to understand here that an individual independent director cannot play an effective role in isolation. They can only do much to prevent any wrong from being committed, and there is a growing tendency of companies to point all the wrongdoings on the negligence and lack of due diligence of independent directors. Therefore, the effectiveness of an independent director depends on the independence and effectiveness of other stakeholders as well. If independent directors are held liable for every corporate fraud, it will pose a difficulty of finding the best people for the role of independent directors.

Suggestions 

There are cases showing that independent directors opt to escape from the companies when there is any sign of fraud. Vikram Mehta resigned from Jet Airways without citing any cogent reason, then Anil Umesh Haldipur resigned from Gitanjali Gems during the PNB scam after the fraud was suspected. R. Chandrashekhar resigned from YES Bank and Analjit Singh left TATA Global Beverages when they were not happy with the governance in the company. It means that we need to provide protection and incentives to independent directors to prevent them from resigning in fear of being punished for the wrongs of the company.

Section 149(12) of the Companies Act clarifies that independent directors will be liable only for such omission or commission by the company of which he has knowledge, or he consented to it or did not act with due diligence. It is made clear by the Ministry of Corporate Affairs time and again that independent directors should not be prosecuted unless there is enough evidence to prove it. Recently in the matter of Raghukul Shares India pvt ltd, SEBI disposed of show cause notice as they are against the independent directors who were not involved in the day to day affairs of the company. Thus, independent directors are slowly becoming powerful against the companies. The fundamental question here is what should be the incentive that motivates independent directors to commit to the company and fulfil their responsibilities. There are two suggestions for it:

  1. Monetary incentive /compensation 
  2. Reputation or social stature. 

Independence of independent directors

The independence of independent directors is not limited to pecuniary interest in the company but it also includes independence from the association of the company. It means that independent directors should not let their ties in any way affect their judgement and decision-making.

Usually, independent directors are found under the clout and influence of the promoters of the company as independent directors are appointed by promoters who control the affairs of the company. Thereafter, independent directors become an integral part of the Board as a non-executive director and the burning issue that arises is how independent is independent director in discharging his responsibilities and duties. In some instances, the independent directors take an independent view of the board which results in promoters becoming unhappy with independent directors, thereafter reappointment of those independent directors becomes uncertain and they are not generally reappointed. This happened in the very famous case of TATA group where Nusli Wadia who was the independent director was sacked as he was not ready to work according to the promoters’ lines and he raised voice in favour of the minority shareholders. 

Another instance of it is when former SEBI Chairman UK Sinha was appointed as an independent director in the Vedanta board even when it was objected to by the minority shareholders because the promoter group passed a special resolution for his appointment. Even in the Satyam scandal, the independent directors neglected the misrepresentation that the promoters made to let it be acquired by Maytas which was owned by another promoter. These cases highlight that the whole purpose of appointing independent directors is being defeated.  It is opined that the concept of independent director has taken a fall from grace as the independent director usually takes its decision for the majority shareholders and minority shareholders are at the receiving end of the stick. The minority shareholders literally have no voice in such situations.  

Suggestions 

The only way to ensure that the independence of independent directors is maintained is to prevent the management and shareholders of the company from trying to influence the independent directors. For this, SEBI had proposed a dual approval model for the appointment and removal of independent directors. According to it,  independent directors first need the approval of the majority of all shareholders and then subsequently the approval of the majority of minority shareholders. It was objected to by the companies, after which SEBI decided to not add this to the regulations. 

The following suggestions can be incorporated for this issue:

  1. Deciding the minimum level of qualification and experience for independent directors,
  2. There should be strict norms about the appointment and removal of  independent directors and it should not be in the sole hands of the promoters
  3. SEBI to nominate independent directors from its database,
  4. Independent supervisors should be appointed which are different from the company,
  5. Decide a minimum remuneration amount which is deemed reasonable
  6. Making a national-level supervisory board of  independent directors,
  7. Training sessions for independent directors, clarify their duties, etc.

Performance evaluation 

Another major reason for the subdued behaviour of independent directors in Board meetings is the performance evaluation mechanism of independent directors. The performance evaluation of an independent director shall be done by the entire Board of Directors excluding the Director being evaluated. On the basis of the report of performance evaluation, it shall be determined whether to extend or continue the term of appointment of the independent director. Thus the onus of reappointment of independent directors is at the whims of the Board and the major motivation for independent directors is to remain in the good books of the Board and enjoy the perks. This has led to the situation of “Puppet independent directors” who shall be unable to perform his/ her duties diligently. 

It is also found that independent directors are prime witnesses to the swindling of money by the promoters, independent directors are also consenting parties to the conflict of interest, and independent directors lack behavioural skills inside boardrooms. If independent directors are not independent in their work, then independent directors’ responsibilities and liabilities would be identical to those of promoters and other directors.

Suggestions

Evaluation should be done by an external independent agency. The criteria for assessment of the working of independent directors should be openly discussed and duly disclosed in the Annual Reports of the company. They shall be evaluated on the factors such as:

  1. How well the independent director had upheld ethical standards and integrity, 
  2. Whether the independent director has consecutively performed its duties, 
  3. Whether an independent director acts bona fide in the interest of the company,
  4. Whether independent director understands their roles and responsibilities in the company,
  5. How well does the independent director engage with other stakeholders, etc.        

Suggestions to improve the functioning of independent directors on the Board 

Every company requires independent directors for the reason that it leads to enhanced governance and strategic guidance. Having efficient independent directors on the Board of Directors contributes to informed decision-making, long-term growth of the company, transparency, and accountability. independent directors are more likely to initiate critical discussions, improve the strategies of the company, and be the link between the management and shareholders. But with the above-stated issues, their role is suppressed and is merely left on the papers. The following are some suggestions to improve the functioning of independent directors on the board:

  • The independent directors need to boldly put up their point in the board meeting and ask the right questions to the board. Expectation from an independent director is to have a fierce independent stand on issues in the board meeting, and should also feel free to ask the right questions to the board which has become the biggest limit of an independent director. 
  1. There should be no interlocking directorate. 
  2. An independent director should protect the minority shareholders of the company.
  3. independent directors need to ensure that the most appropriate course is adopted considering all information and relevant data with respect to the company.
  • It is further suggested that the independent director should maintain corporate integrity, and transparency, and safeguard the interest of minority shareholders. The independent director plays a significant role in all possible aspects such as review of audit reports, appointment of Key Managerial Personnel (KMP), strategic decisions, risk management, and internal controls to protect the interest of minority shareholders.  
  • It is suggested that independent directors have a moral capital-based relationship with executives of the company and ask questions directly from KMP and not only focus on the information provided in board meetings. For example: scheduling a visit to the plant/ facility/ interaction with counsels to get insight into overall issues which are complex and fraught with multiple interpretations.
  • independent directors need to exercise their powers in a diligent manner; however, such powers and freedom should be at the consent of the Chairman of the Board. In essence, independent director interaction with all board members is important to understand key issues in the company. Hence, a trust-based interaction with board members is key to the exercise of powers by independent directors and ultimately by the board. Such trust-based interaction cumulating into a relationship-based flow amongst the board members ensures that the independent directors get to know the company. 
  • Further, the digitalisation of various reports is one of the effective methods to ensure fault-free compliance in the company. Hence, independent directors should not confine themselves to board rooms, as there is more to do like interaction with the executives, in-depth look into businesses and several other things outside the boardroom to analyse the functioning of the company. This will ensure that the independent directors are fully equipped to handle board meetings and minimise fraud in a well-managed company. However, there is no perfect system for an independent director to assess the functioning of the company. independent directors need to be diligent and empowered and exercise that empowerment, which helps in minimising chances of fraud. 
  • The dissenting views of the independent director need to be recorded in minutes of the board meeting; however, if the independent director’s views are not recorded, then the independent director needs to write to other directors highlighting the means and mechanism to be followed by the company to ensure proper compliance. As per Section 166 of the Act, the interest of the company is of paramount importance. Further, it is not the interest of the promoters that is to be protected but the interest of minority shareholders, public shareholders, banks, etc by the independent director. Hence a balance between promoters’ interests and other stakeholders’ interests needs to be maintained. Hence, independent directors are watchdogs as to the proper functioning of the company.
  • The independent directors need not be influenced by the power of the suggestion of the heavyweight board members. It is also found that independent directors pay the price of cowardice where independent directors resign one after the another from the board of the company on disclosure of frauds without realising that the ultimate losers are shareholders, lenders, suppliers, banks, etc. Rather, independent directors should act as whistleblowers on failure to provide important and key information by the executives and Board members of the company and bringing the notice of possible fraud upfront to the regulator or the Court. 

A large-scale resignation of independent directors in 2018 is a wrong precedent reflecting cowardice and fear of criminal prosecution and civil prosecution on the part of independent directors. The Government of India has addressed the rampant resignation of independent directors from Boards of several companies, and the Ministry of Corporate Affairs has published a circular vide dated 02-03-2020 that no civil or criminal proceedings should be initiated against the independent directors, non-executive directors without adequate evidence on acts of omission or commission by the company which has occurred with such directors knowledge, attributable to the Board process, and with such directors’ consent or connivance, and that such directors had not acted diligently. In short, civil or criminal prosecution shall commence on such directors if such directors have not acted diligently, such directors connived with the promoters, and such directors failed to ask relevant and key information from the board.

  • It is also suggested that the independent directors shall be appointed on merits and not on the basis of a personal relationship with the promoters as close proximity between the independent directors and the promoters does not ensure compliance with proper corporate governance. Such close relationships result in failure to address various corporate crimes with the company. The SEBI consultation paper on review of regulatory provisions related to independent directors mandated appointment and reappointment of independent directors through a dual process route, i.e approval of shareholders and approval by the majority of minority shareholders, and if either of the approval thresholds is not met, the person would have failed to get appointed or reappointed as independent directors. Such proposed measures may be adequate to some extent in distancing independent directors from their alleged relationship with the promoter and promoter group. 
  • All the agenda items to be discussed in the meetings need to be made available to the independent directors before the set time to ensure that everything is communicated to them for transparency and accountability. 
  • Independent directors should have a deep understanding of the functional area of the company so they can ensure proper working in the company and call out in case of its failure. They should also be well versed with financial knowledge as pleading ignorance or lack of financial information is not taken as a defence by courts.
  • Independent directors have the responsibility to make sure that internal and statutory audits of a company are done independently, free from any pressure. They need to act promptly if there is any sign of financial irregularity. 
  • Independent directors need to be vigilant. They should be cognizant of the transactions in the company, understand the details of agreements entered into, and be aware of the general affairs of the company.

Conclusion 

In conclusion, independent directors play an indispensable role in the corporate governance regime in India by ensuring transparency, accountability, and management of the company. Their role in a company is critical for its proper functioning. The Indian corporate sector has matured with time and experience as it has not only clearly spelled the terms of independent directors but also expanded the rights and duties of independent directors.  To be able to make the most out of the potential of independent directors, it is essential to provide them with legal protections and incentives to motivate them. We must adopt corporate governance models that are fit for independent directors in India. We need a system where independent directors can work without fear of undue liability and promote sustainable growth of the company. Time is appropriate to address the pitfalls in performing the roles and duties of independent directors to address increasing corporate frauds and scandals. It is also important to highlight the protection provided to independent directors so that such directors perform their duties diligently. Increasing the effectiveness of their role is significant to achieving high governance standards as independent directors are the backbone of corporate governance.  

Frequently Asked Questions (FAQs)

Who is an independent director?

An independent director is a non-executive director who has no material or pecuniary relationship with the company, its promoters, or members of the management.

What are the key qualifications of an independent director?

An independent director must fulfil the following qualifications:

  • Relevant expertise in his field,
  • Appropriate skills and knowledge, 
  • Impartial and unbiased, 
  • Professional reputation,
  • Objective decision-making power. 

How is an independent director appointed and removed?

An independent director is appointed by the Board of Directors and confirmed by a general meeting. For their removal, a special resolution is passed by shareholders.

What is the tenure of an independent director and can they be re-appointed?

An independent director can hold the office for a maximum of two consecutive terms, each of 5 years. After completing these two terms,  an independent director is eligible for re-appointment only after a cooling off period of three years during which they should not be associated with the company in any other capacity.

What are the primary responsibilities of an independent director?

An independent director performs the following functions:

  • Ensuring good corporate governance practices,
  • Protecting the interests of minority shareholders,
  • Monitor the performance of executive management, 
  • Oversee the integrity of the financial information and financial control systems
  • Review the effectiveness of internal control systems and risk management.

How does an independent director contribute to the Board?

The independent director brings an objective and unbiased view to the Boardroom, they participate in decision-making strategies and ensure that the interests of all stakeholders are considered while making any decision.

Can an independent director be made liable for the actions of a company?

As a general rule, independent directors are not liable for the acts of the company unless there is evidence to support the claim that they were involved in fraud, negligence, or any other type of misconduct with their knowledge, consent, or connivance. 

What committees is an independent director a part of?

independent directors are a part of the Audit committees where a minimum 3 directors would be independent directors, the Corporate Social Responsibility committee with 1 independent director, the Nomination and Remuneration Committee, and the Stakeholders Relationship committee which shall consist of 3 or more non-executive directors out of which not less than half shall be independent directors.

Which companies are required to appoint independent directors? 

All the listed companies must have one-third independent directors. In the case of public companies, the companies with paid-up share capital of Rs.10 crore or more, companies with turnover of Rs.100 crore or more, or companies that have in aggregate, outstanding loans, debentures, and deposits of more than Rs.50 crore, are required to have a minimum of two independent directors.

Which companies need not appoint independent directors?

The following class of unlisted public companies are not required to appoint independent directors:  

  • A joint venture, 
  • A wholly owned subsidiary, and
  • A dormant company as defined under Section 455 of the Act.

What is the data bank of independent directors?

The Ministry of Corporate Affairs introduced the data bank for independent directors. It is an important development to ensure their independence. This database can be used by companies while making appointments.  It registers all the independent directors and individuals who aspire to become independent directors. The companies register search and select independent directors based on their choice. It is a first of its kind initiative where many important topics for independent directors are also covered. There is also an independent director test which needs a mandatory score of 60% to pass.

How can independent directors prevent fraud?

independent directors can perform their duties effectively and assist in detecting and preventing fraudulent activities in the following ways:

  • They have to be vigilant and review all the financial statements,
  • They need to ensure the credibility and accuracy of financial reporting, 
  • They should actively participate in all the committees,
  • They should also ensure that the company has effective risk management and mitigation strategies, 
  • They must be independent from the promoters and management and provide unbiased decisions, 
  • They must prevent conflict of interest and pursue all transactions fairly and transparently,
  •  They must advocate for stronger whistleblower policies,
  • They should be continuously trained and educated on fraud prevention and detection techniques.

References 

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