This article has been written by Arbaz Zain Shariff pursuing Diploma in Corporate Litigation and edited by Oishika Banerji (Team Lawsikho).
This article has been published by Sneha Mahawar.
Corporate governance is important as it helps in the smooth functioning of any company through the use of a system of rules, practices and processes by which said the company is directed and controlled. This is done to protect the interests of the stakeholders, like shareholders, management, customers, suppliers and financiers and to achieve economic and social goals. For the purposes of conducting corporate governance smoothly, a corporation can appoint a ‘Gatekeeper of Governance’ who are professionally responsible to look into and prevent corporate misconduct. They are usually third parties and can be Lawyers, auditors, shareholders, directors and management. However, in this article, we will be discussing ‘independent directors’ as gatekeepers.
History of independent directors
The concept of an independent director originated from the United States as well as the United Kingdom and was adopted by other countries later on. To get a better understanding we must look at the circumstances which lead to its development in both these countries.
Before the 1950s many corporates were mainly comprised of ‘insiders’ (people who had some personal or pecuniary relationship with the company) they mainly held essential roles and were responsible for managing the company or to advise other members for the purposes of conducting business smoothly, though one of the problems was that there was very little or no surveillance on corporate misconduct which would ruin the company’s reputation.
However, this all changed in the 1950s when boards started to hire outsiders as directors but the majority was still held by insiders. It was during the 1970s that the concept of an ‘independent director’ really started to be considered as a part of corporate governance as there needed to be a monitoring board that would make sure that all the members of the company were treated equally, to maintain corporate standards and to prevent any wrongdoings from taking place. By the 1990s appointing an independent director was essential for a company, it was at this point of time that insider-dominated boards were considered a thing of the past. Further in the 2000s most directors of public companies in the United States and the United Kingdom were independent.
According to the definition given under Section 149(6) of the Companies Act, 2013 we can understand that an independent director is one who is appointed to help improve a company’s integrity and working by offering advice and guidance rather than making decisions relating to the corporation. They also make sure that not one individual or special interest group holds all the power in a company. The position an independent director holds is non-executive and they share no pecuniary relationship with the company.
Role of an independent director as a gatekeeper in governance
It is interesting to note that independent directors are vested with a plethora of responsibilities upon various committees of the Board, namely, the Audit Committee and the Nomination and Remuneration Committee (NRC). Relevant aspects such as the related party transactions that can be approved only by the hands of independent directors, may not even be placed before the larger Board. It is the SEBI (PIT) Regulations, 2015 which have placed several responsibilities on the independent directors in relation to compliance with insider trading norms thereby carrying out maintenance of structured digital databases by the companies for UPSI sharing. Schedule IV of the Companies Act, 2013 lists out the responsibilities and duties of an independent director. The same has been listed hereunder:
- The primary role of an independent director is to offer guidance and mentor a company to improve corporate image and governing standards by looking into the decisions which are being made by the Board of Directors on many factors relating to the company and offering suggestions to either include or exclude such decisions with the aim of improving the standards of the company and to prevent them from taking unnecessary risks.
- They also play an integral role in protecting the interest of the minority shareholders by not solely focusing on the interests of promoters. They are paid by the company to act independently and are required to not side with any one specific individual or group in the company when it comes to offering advice. This means that they cannot make suggestions that only benefit certain groups as this would not be fair and would ruin corporate integrity.
- Independent directors must objectively assess the performance of the management making sure that they are meeting the goals of the company and to report on the same to all members of the Board.
- They can decide the appropriate amount of remuneration to executive directors, key managerial personnel and senior management and even appoint or recommend removal of the same.
Appointment of independent directors
Now that we have an understanding of what is the role of an independent director let us look into how to appoint one. According to Section 149(4) of the Companies Act, 2013 any company whose shares are publicly traded on the stock market shall have at least one-third of the total number of the directors as independent directors. The following steps are to be complied with when appointing an independent director:
Choosing of independent director
The process by which an individual is selected to be an independent director is given under Section 150 (1) of the Companies Act, 2013. It states that such individuals must be selected from a data bank containing all their basic details, this data bank is compiled by the Indian Institute of Corporate Affairs.
However, it is the company’s responsibility to exercise due diligence when selecting an individual to be their independent director. The person selected by the board must also be agreed to be selected by the shareholders through a meeting.
Written consent and declarations for appointment of independent director
Before appointing someone as an independent director, the company must make sure that the selected individual is in accordance with the provisions given under Section 149(6) and (7) of the Companies Act, 2013 read with Rule 5 of the Companies (Appointment and Qualification of Directors) Rules, 2014 and ensure the conditions of the Companies Act, 2013 and SEBI (LODR) Regulations, 2015.
A written declaration must be obtained stating that the person who is being appointed is indeed independent from the board of directors and is competent to hold the position in accordance with SEBI (LODR) Regulations, 2015. Written consent is to be obtained from the person who is to be appointed by filling out Form DIR-2 in accordance with Rule 8 of the Companies (Appointment and Qualification of Directors) Rules, 2014. Furthermore, a declaration must be obtained from the person being appointed stating that he is not barred from being a director under the Act which shall be done through From- DIR-8. The disclosure also must be obtained from the proposed independent director which shall be done in Form MBP-1.
Nomination and remuneration committee
Under Section 178, a corporation is required to constitute a Nomination and Remuneration Committee, the same Committee under Clause 3 shall decide the necessary qualifications which are to be held by an independent director and also recommend to the Board of Directors the amount of remuneration which is to be given to said independent director.
Meeting for appointment of independent director
According to Section 150(2), the company shall conduct a general meeting for the purpose of appointing an independent director after obtaining the approval of its shareholders. During such meetings, the term of the independent director shall be set and it shall not be for more than 5 years. The company secretary and chief financial officer or any other director must also be authorised to file a requisite form and return the same to the registrars of the company. The appointing company must submit a disclosure to the appropriate stock exchange within 24 hours from the date of completion of the board meeting, the same must be posted on the company website within 2 days.
Issuing appointment letter
An appointment letter containing the term of appointment, expectations of the board, fiduciary duties, code of business ethics, list of actions to be performed, remuneration, etc. shall be handed to the independent director and the same shall be published on the company’s website. The disclosure must also be obtained from the proposed independent director in Form B within 7 days.
Period of filing forms and documents
Within 30 days from the date of appointment, the independent director shall give his consent along with all the necessary documents and fees to the registrar of the company under Form DIR-12.
Re-appointment of an independent director
An independent director may be re-appointed in accordance with Clause V of Schedule IV based on the performance evaluation report.
Liability of independent directors
Alongside the Companies Act, 2013, it is also the Code of Independent Directors that provides with the roles and responsibilities of independent directors The duties of independent directors have been listed hereunder:
- Undertaking induction that is a requirement for the company alongside updating their skills, knowledge and familiarity with that of the company;
- The independent directors are supposed to seek necessary clarification or knowledge concerning required information and, wherever necessary, take and follow professional advice and experts opinion, at the company’s expense,
- Attending all meetings of the Board of Directors and of the Board committees of which the director is a member to, including general meetings thereby addressing requisite concerns that come along,
- It is necessary for independent directors to keep themselves well-informed about the external environment in which the company operates,
- Restrict themselves from obstructing the Board or its committees from proper functioning, in an unfair manner.
- Reporting concerns about unethical behaviour within the company is also a need.
- Preventing disclosure of confidential information, including information about commercial secrets, technologies, advertising and sales promotion plans, price sensitive information that are still unpublished, unless approved by the Board.
In a recent case of Satvinder Jeet Singh Sodhi and Anr. v. State of Maharashtra (2022), the Bombay High Court was seen to evaluate the day-to-day role of independent non-executive directors. The Court had observed that just because a person is holding the position of a director of a company, the same ipso facto does not make him liable under the Negotiable Instruments Act, 1888. Those individuals who are vested with the responsibility of conducting the company’s business affairs and are said to have committed an offence under the Act of 1888, will be considered as liable under the Act. A director, therefore, not being responsible for such offensive conduct of business, cannot be held liable under Section 141 of the Act of 1888.
Independent directors play an integral role when it comes to corporate governance not only do they offer sound and valuable advice which helps the company work smoothly but they also make sure that all the shareholders and members of management can effectively communicate with each other and that the said shareholders are treated as well as promoters. An independent director is the guardian of the company, it is because of his unbiased and independent judgement that they are able to prevent corporate misconduct.
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