This article is written by Niyati Shah, pursuing a Diploma in Companies Act, Corporate Governance and SEBI Regulations from Lawsikho.com.
Every company, whether a private company or a public company, whether a listed company or an unlisted company needs a board of directors. A company is a legal entity, meaning it is an artificial person separate from its members. Some of the relevant features of a company are that i) a company has an independent corporate existence, ii) it has a common seal, iii) it enjoys a perpetual succession, iv) it is capable of owning properties in its own name, v) has the capacity to sue and be sued. Since it is not a natural person, a company, therefore, acts through an agency of human beings. A board of directors serves the purpose of this “agency” for the company, its objectives, management, mission and vision, operations, and so on and so forth. The board of directors act as agents of the company.
What is a board of directors, you ask? A board of directors is a collective body of the directors of a company. This is also well defined under Section 2 (10) of the Companies Act, 2013 as amended till date. The corporate board, or board of directors, is elected by the shareholders of the company; some directors are appointed by financial institutions providing long-term loans and advances to the company; and some directors are appointed by the government to safeguard its interests. The board of directors, in turn, elect a managing director, i.e. a chief executive officer.
Legal position of directors/ board of directors
As stated above, the true legal relationship between a director and / or board of directors, and the company, is that of a principal and an agent. In India, this agency is governed by the Indian Contract Act 1872. To some extent, not in the strictest legal sense, directors are also trustees for the properties of the company and of rights which are conferred upon them by law and conventions.
Types of directors
Basis the powers and authority conferred upon them; the directors are classified into the following types:
- Managing directors;
- Executive directors;
- Technical directors;
- Whole-time directors;
- Independent directors;
- Small shareholders’ directors;
Together, these appointed directors form the board of directors, or a corporate board (“Board”).
Roles and responsibility of the board
It is a well settled law that the Board has fiduciary obligations towards the company’s stakeholders as well as it has a duty to act responsibly in the best interest of the company and its vision and goals. The duties apply to each director of the Board individually and more importantly, towards the company, whereas the powers conferred upon them are enjoyed jointly.
Responsibilities of the board
- Fiduciary responsibility
The Board has a fiduciary responsibility to care for the financial and legal requirements of the company. The Board jointly, and its directors severally, must act in good faith and with a reasonable degree of care, and must not have any conflict of interest; that is, the interests of the company take precedence over their personal interests.
- Mission and vision
The Board is responsible for setting and designing a vision and mission for the company and assuring that all actions are in furtherance and pursuance of that mission.
As seen above, the Board is a trustee of the company, its properties and welfare of the company. The Board acts as a trustee with reference to their power of applying funds of the company. Any misuse of such power could hold the Directors jointly and severally liable. Upon the death of such directors, and since the company enjoys a perpetual succession, the cause of action survives against such deceased directors’ legal representatives.
This trusteeship is also extended to trade secrets and other intellectual property of the company.
- Designing organisational structure
The Board designs and sets up the structure of the company, its policies, objectives, expectation of employees, degree of competition, environmental-financial-technical-legal factors, etc. Based thereon, the Board exercises an oversight function, reviewing the actions of managers and other employees.
- Financial sanctions/ policies
All important financial decisions of the company are taken by the Board, keeping the company’s best interests in mind. Financial decisions like sanctioning of finances to different projects and teams, distribution of profits to shareholders (dividend policies), repayment of loans, reserves, etc. are all taken by the Board.
- Link between the company and external factors
The Board acts as a vital and perpetual/ continuous link between external factors and environment like government, shareholders, other companies, vendors, social and financial institutions, and the company.
- Management roles
The board also has certain managerial duties/ responsibilities, which are set out briefly hereunder:
- Appointment, role, remuneration of top executives (key management personnel);
- Election, evaluation, role of the chief executive officer (CEO);
- Monitor, review, and appraise management such as outside legal counsel, succession of CEO, limitations and duties of the CEO;
- Selection and compensation of all officers;
- Advisory to the managing director;
- Monitor, review, and approve employee relations;
- Monitor company’s performance;
- Compliance and regulatory role
The Board is also responsible for ensuring that the company and its operations are compliant with all applicable laws, regulations, orders, notifications, in the appropriate jurisdiction, that affect the business of the company. In an organisation, the concept of compliance manifests in many ways and forms. These include the organisation’s internal rules and standards such as its vision and values, internal rules of conduct, ethics policy, quality checks and balances, and external rules and regulations, such as legal obligations, corporate reporting, data protection, taxation, audit, HR policies, as well as international business standards which the organisation may have gotten certified in.
Having a clear, effective compliance program makes it clear to the stakeholders that compliance is the top priority of the organisation. It speaks of the ethos of the organisation and that the organisation intends to hold itself to highest transparent standards, ethical or operational.
At the outset, the following areas have been identified, that are prima facie influenced by compliance. Each area within an organisation, stated below, functions on the credo of compliance and regulation:
The above sectors of an organisation have been ascertained in the order of the level of direct influence good directorship has thereon. A director or a board of directors’ primary duty is towards its stakeholders. Such stakeholders include promoters, other directors, employees, investors, shareholders, customers, etc. A director is bound to act in the best interest of such beneficiaries. Many case studies suggest directors should take the “stakeholder-oriented” approach to corporate governance. Thereafter comes the duty towards business strategies of the organisation, subsequently over finances and so on and so forth. One must be clear that the duties of a Board towards each sector are not mutually exclusive of each other but rather convoluted and labyrinthian.
I have explained hereinbelow, in detail, the duties of a Board towards each such sector:
An organisation’s primary duty is towards its stakeholders, i.e. investors, employees, and customers. In a socio-economic climate as ours, customers and investors alike seek out and want to do business with organisations/ services who share their ethos, principles, vision. Gaining reputation as an organization that fails to meet its compliance obligations can jeopardise customer trust and loyalty, and will have a cascading effect across all business functions and profitability. Reputational risk is the primary driver for regulatory compliance, in any organisation. An efficient compliance policy provides for regular and clear reporting on systematic risk and control related trends arising across organization to key stakeholders. Moreover, in addition to building a reputation as a good corporate citizen, having a well-documented and effective compliance program demonstrates the organisation’s expertise related to its relevant industry, product, laws, etc.
A legendary and infamous example of failure to bring comfort to stakeholders is that of Jet Airways. Until recently, Jet Airways was an industry leader in the private aviation sector. However, in the year 2019, reportedly, the middle-eastern commercial carrier and parent corporation i.e. Etihad Airways refused to increase its stake in Jet Airways presumably because Naresh Goyal (i.e. the founder chairman of Jet Airways) was calling the shots. In 2018, the Tatas wanted control of Jet Airways which Naresh Goyal was unwilling to part ways with. Naresh Goyal acted in personal interest and did not want to dilute his shareholding even when Tatas were willing to infuse more capital. It is believed that the flamboyance of Naresh Goyal and the compulsive ego of not letting go of the Board drove the “plane into choppy waters”. The media and industry often reported this case as a “death by poor corporate governance”. The Board of directors, primarily, were held accountable as it is the Board that is tasked with the performance and management. This is a case of corporate failure. It was the liability of Jet Airways of having a promoter led board. The Goyal family owned the majority share in the airline and Naresh Goyal was the Chairman of the board. A promoter-led board is often at the danger of creating a spineless board, often serving at the wish and command of the promoter-chairman. Another concern that this decision raised was that of the Board’s duty towards another category of stakeholders – its employees, all 20,000 of them. Did the Board consider this stakeholder when it made the decision to not accept the offer of the Tatas or any other suitor?
Being able to say that an organisation is in strategic compliance is by itself a fundamental business strategy. It means that there is transparency and an increasing degree of management maturity. Being in compliance shows that management and teams are in control of the processes and procedures, implemented and executed with effective political, commercial, labour, contractual and behavioural compliance. It is necessary to reflect and change management styles, adjust the way company information is handled and how people behave on a day-to-day basis, in order to achieve a level of excellence in compliance regardless of the business sector and size of the organisation.
Not being in compliance means being unnecessarily high risk, which can lead to financial, equity and market losses, among many others.
Business finances are complex, and adding government compliances can make it even more so. After all, financial reports and documents are not just that, but they basically act as transcripts for an organisation. Financial records and reports demonstrate tax liabilities, operational and capital expenditures, revenues, profitability, feasibility, so on and so forth. Financial compliances with external rules such as the applicable law, governmental requirements, etc. hedges an organisation from a lot of unfavourable outcomes such as dissolution, winding up, bankruptcy, foreclosure, tax evasions, etc. Compliant taxation and audit mechanisms also reduce the risks of liabilities, penalties, fines, etc. that could be hefty in some cases.
Information and documentation such as budget information, financial records, annual reports, risks/ liabilities/ opportunities of an organisation, all together translate into the wellness and health of the organisation, which in turn translates to profitability of the said organisation. An effective financial compliance mechanism also safeguards an organisation from mistakes, financial frauds, thefts, etc. provides full visibility and management of the currency effect on business operations including direct cash flows and indirect exposures, provides a widespread understanding throughout the business cycle of risks around foreign exchange, credit, profits, etc.
Moreover, an effective compliance program provides a platform to the organisation to devise robust risk management policies with measurable objectives and evaluate the effectiveness of internal audits and controls.
Legal compliances are an integral part of any business. They ensure that the business runs smoothly, avoids penalties and legal actions that could hamper the operations, and in some cases, the future of the business. Legal compliance is also necessary if the organisation has entered into agreements, understandings, binding paperwork with other parties. Absence of compliances and adherence to the agreement as well as applicable laws, can invite expensive legal action/ litigation. Such expenses are usually also accompanied with damages, losses, and compensations incurred. With proper and effective compliance, an organisation can avoid these risks. Another significant part of legal compliance is procuring necessary licenses, registrations, permissions, sanctions, etc. Not obtaining the same could invite law enforcement from authorities or other parties, as the case may be, and that could in turn jeopardise the continuance of the organisation. Having an effective and well devised legal compliance mechanism can also open up the possibilities of monetisation and/ or protection of a company’s assets. An example of legal compliances and the impact of failure thereof is that of Ranbaxy, a leading pharmaceutical company. Mavinder Singh and Shivinder Singh, i.e. Singh Brothers owned Ranbaxy. In 2008, the Singh Brothers sold their stake in Ranbaxy to a Japanese company, Daiichi Sankyo. However, the Singh Brothers concealed information and did not disclose critical information such as that American regulatory agency FDA was investigating Ranbaxy over allegations of manufacture of spurious drugs. The Japanese company Daiichi Sankyo sued the Singh Brothers over such non-compliance and concealment of information in international court as well as separate proceedings in the Apex court of India, i.e. Supreme Court. The Singh Brothers were later convicted and were ordered by Singapore tribunal to pay 500 million dollars, whereas the Supreme Court thereafter also ordered imprisonment in the event of failure to pay the imposed fine.
Needless to say, undefined business processes or badly managed operations increases the risks of violating law and regulations, and generally impacts the profitability of the organisation or its product. Having an efficient compliance program to meet the operational needs of the organisation promotes transparency with consistent documentation of the various technical and managerial business processes involved. An effective compliance program also automates the business processes and decisions relating thereto, thereby reducing workload and tasks on a day-to-day basis.
Another implication of operational compliance is that many manufacturing organisations require various certifications and permissions at different stages in their production cycle. An effective compliance program would reduce the jeopardy of lapsing such permissions and certifications and on the other hand, help establish an internal quality assurance programme.
In conclusion, as seen above, it can be said that unforced errors are the most common risks to organisational performance and a robust compliance system helps prevent such unforced errors. A healthy compliance function can help make organisational waste tangible by tracking core metrics that evidence areas of underperformance or friction.
These are just some of the responsibilities of the Board towards the company and its stakeholders. The end and intent of a Board’s role is to act in pursuance of the company’s mission and objectives, keeping the company’s best interest in mind. A good board of directors is one that brings in expertise from strategy, finance, legal, operations, marketing, and specialised industry related skills.
Having a good board of directors underpins a good and efficient corporate governance structure of a company. A strong and effective Board of Directors is an invaluable asset, one that is a key to success in achieving its goals, by the company.
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