In this blog post, Ranjeet Yadav, an Ex-Commissioner of Railway Safety with the Indian Railways and a student pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, analyses the principle of proportional representation while appointing Directors.

Introduction

As per the company’s laws, appointment of directors in a company is usually done through simple majority passing a resolution in the general meeting of shareholders. As such, a simple majority is in a position to elect all the directors and a significant minority as large as 49 percent may not succeed in appointing even a single director. This may jeopardise the interests of minority shareholders in a company. To mitigate this disadvantage of the minority shareholders, section 265 of the erstwhile Company Act, 1956 had provided that the minority shareholders could have an opportunity of placing their representatives on the Board of Directors where the concerned company adopted the system of proportional representation by providing in its ‘articles of association’.  

These provisions relating to proportional representation for appointment of directors in a company are now included in the section 163 of the Companies Act, 2013 which reads as under:

“Notwithstanding anything contained in this Act, the articles of a company may provide for the appointment of not less than two thirds of the total number of the directors of a company in accordance with the principle of proportional representation, whether by the single transferable vote or by a system of cumulative voting or otherwise and such appointments may be made once in every three years and casual vacancies of such directors shall be filled as provided in sub-section (4) of section 161.”

Salient Features of Principle of Proportional Representation for Appointment of Directors in a Company

Overriding authority:  The section 163 of the Companies Act, 2013 begins with ‘Notwithstanding anything contained in this Act ————-‘. Thus, the provisions of this section override all other sections of the entire Companies Act, 2013. Should a company adopt provisions of this section in appointing directors in accordance with the principle of proportional representation, it can enjoy overriding authority of this section.

The section 162 of the Companies Act, 2013 provides for appointment of directors to be voted individually and as such provisions of section 162 are contrary to those of section 163. But, due to overriding authority of section 163, the provisions of section 162 get excluded.

Optional in nature: The provisions of the section 163 say ‘the articles of the company may provide for the appointment———‘and thus they are optional in nature. They will apply only if the articles of association of the company provide for such appointment provision i.e. the articles of association of a company may provide for appointment of directors of the company on proportional representation basis if they choose so. It is not obligatory for a company to adopt the provision i.e. a company may decide not to have appointment of its director following the proportional representation system. This means that the requirements of provisions in the articles is authoritative for invoking section 163.  

Intention of law: This system of appointment of directors in a company based on proportional representation ensures a fair representation of the minority interest of the shareholders group. In normal course, it may not be always possible for minority shareholders to place their nominee directors in the board to safeguard their interests keeping them always apprehensive about the functioning of the company in a fair manner as far as their perspective is concerned. Intention of law to incorporate this provision of appointment of company’s directors on the basis of proportional representation is basically to look after the interests of minority shareholders.    

Applicability: The provisions of this section of the Companies Act, 2013 are made applicable to both public and private companies, unlike the old Act of 1956 which was applicable only for public company or a private company which was subsidiary of a public company. Thus the present provisions provide a wider scope in favour of the minority shareholders  

Tenure of directors: The appointment of directors by way of proportional representation may be made once in every three years. Use of the verb ‘may’ indicates the stipulation of three year tenures is not mandatory.

Number of directors that can be appointed: The section stipulates that the articles of association of a company may provide for the appointment of not less than two thirds of the total number of the directors. Thus, it mandates that where a company adopts proportional representation, it shall appoint at least 2/3rd of its directors by this method. There is no cap however on the maximum number of directors which can be appointed through this system of proportional representation.

Casual vacancies of directors appointed under the system of proportional representation: Casual vacancies vice such directors shall be filled up as provided in sub-section (4) of section 161 of the Company Act, 2013. It stipulates that the resulting casual vacancy, in default of and subject to any regulations in the articles of the company, be filled by the Board of Directors at the meeting of the Board. It is imperative that such appointment of directors will not be effected through circulatory resolution of the board.

It is further provided that any person so appointed shall hold office only up to the date up to which the director in whose place he is appointed would have held office if it had not been vacated.

Method Of Appointment Of Directors Under The System Of Proportional Representation

There are two methods of appointment, viz a) single transferable voting and b) cumulative voting are usually followed for appointment of directors under the system of proportional representation. Their detailed methodology is set forth hereunder:

• Single Transferable Voting – Under this system, each shareholder irrespective of his shareholding is entitled for one vote per post of directors to be appointed.  For example, let us take a situation where there are five posts of directors to be appointed in a company out of a total of eight candidates. Here each shareholder irrespective of number of shares he holds can cast one vote each in favour of up to five candidates. Five candidates getting the highest number of votes in order will get elected.

Minority shareholders can work to a strategy of casting their votes only in favour of their nominated candidate skipping others. This could ensure winnable number of votes for their nominated candidate as other shareholder’s votes may get distributed amongst numerous candidates. This way minority shareholders will be in a position to place their nominee director in the Board.

• Cumulative Voting – Under this system, each shareholder is entitled to have number of votes as per his shareholding. For example, let us take a situation where a shareholder has 500 number of shares in a company and there are 05 number of directors to be elected out of a total of 08 candidates. Here he is eligible to cast 500*5=2500 number of votes. He can use all these votes for a single candidate or he can divide his votes amongst all the candidates.

If a group of minority shareholders decide to cast all their votes to their nominated candidate, there is a good chance of their nominated candidate getting adequate number of votes to enable him to get elected as votes of other shareholders may be distributed in favour of other candidates to fill up remaining vacancies of directors.

Thereby under both the methods, the minority interests are protected in the company.

• Other methods– The company may adopt methods other than the above two, as provisioned in its articles of association and approved by majority shareholders in the general meeting, to appoint directors under the system of proportional representation.

Exemption

The central government vide notification issued on 5th June 2015, has granted exemption for applicability of the section 163 to certain government companies. In such companies, minority shareholders will have no scope of choosing their nominee directors based on the principle of proportional representation.

Removal of Directors

Section 169(1) of the Company Act, 2013 provides for the ways to remove a director of a company with the condition that nothing contained in this sub-section shall apply where the company has availed itself of the option given to it under section 163 to appoint not less than two third of the total number of directors according to the principle of proportional representation.

Therefore, any director appointed in terms of section 163 cannot be removed as per section 169(1). The method of removal of directors appointed through the system of proportional representation is not clear

Conclusion

The concept of ‘Proportional representation for appointment of directors in a company’ is very noble towards safeguarding the interests of minority shareholders, but prospect of its implementation through section 163 of the Company Act, 2013 has serious infirmities due to the provisions being kept optional for the companies. It is left to the choice of a company whether to adopt the provisions of the said section in this regard. There is no clear picture in regard to its acceptability or otherwise by the corporate entities in our country and as such its contribution in taking care of interests of minority shareholders is not well known.