In this blog post, Ankit Sahoo, an Associate with Hammurabi and Solomon, Delhi, who is currently pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, writes about the roles and responsibilities of Independent Directors.
In India, the importance of the Independent Directors (from now on referred to as “ID’s”) was realized after the introduction of corporate governance. The Companies Act, 1956 did not have any direct provisions concerning ID’s, plus there was no mandate to appoint ID’s on the Board. However, Clause 49 of the Listing Agreement compulsorily requires all listed companies to appoint independent directors to the Board. With all the discrepancies and growing importance of corporate governance, the Companies Act, 2013 (hereinafter referred as “The Act, 2013”) vide Section 149 made it a statutory mandate for listed companies to appoint ID’s on the Board.
The need for ID’s stimulated due to the need for a robust framework for corporate governance in the functioning of a company. The Act, 2013 makes the role of ID’s different from that of the executive directors. An ID is vested with multiple roles and responsibilities for good corporate governance in a company. The main purpose of introducing the idea of ID’s in the Act, 2013 is to improve corporate credibility, governance standards and risk management of the company. The ID’s by taking unbiased decisions and checking the judgments of the management bring accountability and credibility to the board’s process.
Who is an Independent Director? How is he appointed?
“Independent director” means a person other than an executive officer or employee of the company or any other individual having a relationship which, in the opinion of the issuer’s board of directors would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.[1]
According to Clause 49 of the Listing Agreement, an ID is a non-executive director or director other than a managing director or whole-time director, who apart from receiving director’s remuneration, doesn’t have any material pecuniary relationship or transactions with the company, its promoters, its directors, its senior management or its holding company, its subsidiaries or associates which might affect its independence.[2]
The appointed ID should not be related to the promoters or any person occupying management position in the board level or the immediate level below. In addition to it, he shouldn’t be an executive of the company or a partner or an executive in a statutory audit firm or internal audit firm of the company in the immediately three preceding financial years. He also has to declare to the board that he is not a material supplier, service provider or customer or a lessor or lessee of the company and also where there is a change that may affect his independence. According to the Act, 2013, the selection of an ID shall be made from a Data Bank maintained by anybody, institute or association, as may be notified by the Central Government, containing names, addresses and qualifications of persons who are eligible and willing to act as IDs. It further provides that the appointed ID shall be then approved at a shareholders’ meeting wherein the board shall present an explanatory statement for approving the ID and a declaration that the ID has fulfilled all the conditions laid down under the Act, 2013.[3]
The tenure of an ID must not exceed beyond two consecutive periods of five years and the period can be extended beyond the second tenure only by passing a special resolution by the Board.[4] But Section 149(11) further mandates that the reappointment or extension of the term of the ID beyond the two consecutive term of five years can only be done after a cooling period of three years.
Roles and Responsibilities of an Independent Director
The roles of an ID are deliberated to be of great implication. Schedule IV of the Act, 2013 provides a code which lays down the roles and responsibilities of an ID.
An ID plays a vital role in analyzing the Board’s deliberations, especially on issues of strategy, performance, risk management, resources, key appointments and standards of conduct. There are various other roles that an ID plays, like bringing an objective view in the evaluation of the performance of the board, scrutinizing the performance of management in meeting agreed goals and objectives and monitor the reporting of performance, safeguarding the interests of all the stakeholders particularly the minority shareholders, balancing the conflicting interest of the stakeholders, determining the appropriate level of remuneration of executive directors, key managerial personnel and senior management and finally moderating or arbitrating in the interest of the company as a whole, in situations of conflict between the management and shareholders’ interest.[5]
The code also provides the responsibilities that the ID is obligated to fulfill. The ID is placed with a special responsibility to ensure that all the decisions arrived at are in the best interest of the company and shareholders. Apart from this, ID’s are vested with various other responsibilities like undertaking appropriate induction and regularly updating and refreshing skills, knowledge and familiarity with the company; seeking appropriate clarification and amplification of information and take and follow appropriate professional advice; striving to attend all Board meetings and Board committees of which he is member; participating constructively and actively in committees in which they are chairpersons or members; striving to attend general meetings of the company; keeping themselves well informed about the company and the external environment in which the company operates; paying sufficient attention and ensuring that adequate deliberations are held before approving related party transactions; ascertaining and ensuring that the company has an adequate and functional vigil mechanism and subsequently ensure that the interest of the persons using such mechanism is not prejudicially affected; reporting concerns about unethical behavior, actual or suspected fraud or violation of company’s code of conduct; assisting in protecting the legitimate interests of the company, its shareholders and employees while acting within his authority; and finally not disclosing the confidential information including commercial secrets, technologies, advertising and sales promotion plans, unpublished price sensitive information unless such disclosure is approved by the Board or is required by law.[6]
The demand for vigil mechanism has enormously increased after various corporate scandals in India, and this is the sole reason why the Act, 2013 has set such high standards. The Act, 2013 also increased the ID’s participation in the Board’s decision-making process to enhance the monitoring of the management and to protect the interest of the shareholders.
The Act, 2013 also mandates the ID’s to meet at least once annually and conduct a meeting without the presence of non-independent directors and other Board members. The ID’s in such meetings are required to evaluate the performance of the company’s chairperson, non-independent directors and the Board as a whole.[7] Similarly, the Act, 2013 provides the Board with the mandate to convene a similar meeting without the presence of ID’s to evaluate its performance and whether to continue their term. These provisions act as a check and ensure that the powers of the ID’s are utilized in a proper and rational manner.[8]
Conclusion
The introduction of ID has been a welcome step towards effective corporate governance in India. The Act, 2013 has conferred upon the ID’s a great deal of empowerment to ensure that the management and affairs of the company are carried out fairly and smoothly, but at the same time, greater accountability is bestowed upon them.
However, it is essential to point out that, the effective selection and functioning of the ID’s is not the only criteria for good governance. Every director whether independent or non-independent, executive or non-executive has a distinct role in the working of a company. Only when the Board as a whole functions effectively and efficiently, it results in good corporate governance and benefits the minority as well as majority shareholders.
Footnotes:
[1] NASDAQ Rule 4200 a (15)
[2]Clause 49(I)(A)(iii) of the Listing Agreement
[3] Section 149 and 150 of the Act, 2013
[4] Section 149 (10) of the Act, 2013
[5] Schedule IV(II) of the Act, 2013
[6] Schedule IV(III) of the Act, 2013
[7] Schedule IV code VII of the Act, 2013
[8] Schedule IV code VIII of the Act, 2013
