AIBE: Companies Act
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In this article, Samvit Ganesh discusses How to improve the role of Independent Directors in Indian Law.

Introduction

  • In 2013, the Legislature identified the need to incorporate provisions in Indian Company Law to provide for the appointment of Independent Directors (ID).
  • The Satyam scam, amongst others recognized the necessity to have Independent Directors. These directors serve the purpose of maintaining checks and balances in companies and to further accountability and transparency in these companies.
  • The United States, following the Enron scam in 2000, enacted the Sarbanes-Oxley act, which serves as a precursor to India’s addition in 2013.
  • In pursuance of the goals stated in the Oxley act, the US government also asked the New York Stock Exchange to prepare guidelines under the act. The NYSE concluded that company boards must majorly consist of Independent Directors[1].
  • Much like in the US, following the Satyam Scam, India enacted the Companies Act in 2013 where Section 149(4) was added[2].
  • It expects only that atleast a third of the directors must be independent[3].
  • The stated goal of adding Independent Director’s although not found in the act is generally understood to include responsibility to ensure minority shareholders rights are protected, and that the company does not commit fraud.
  • The IDs are expected to question the decisions of the Board as an independent authority and in an impartial manner, so as to prevent an abrogation of appropriate company conduct. Despite these aims existing, there exists serious issues in implementation in the role IDs.
  • The IL&FS fiasco is one of the prime examples of this failure. Given the nature of the Indian companies market and the various failures of corporate governance highlighted, it becomes imperative to devise a method effectively implement IDs.

The problems

It is imperative that a few of the major concerns in the role of IDs are identified clearly prior to constructing an ideal format of law and implementation regarding IDs. India, unlike the US often has companies that are familial and large percentages are controlled by promoters. Wipro, for example is controlled to the extent of 76% by the promoters[4], unlike in the US where Apple is only controlled by promoters to the extent of 40%[5]. This creates unique challenges of corporate governance in respect of IDs in India.

The pertinent issue that we may identify from the IL&FS scam is that there is no real understanding of what independent directors are accountable for. The IDs in IL&FS were naturally aware of the transactions entered into by the company[6] – which were perhaps beneficial to majority shareholding interests. Despite the fact that IDs possessed this knowledge, there is no evidence that they have acknowledged it. It is their prerogative to ensure that the company does not commit illegal activity under their nose – however there is no written law to the effect determining their accountability to these matters[7]. Perhaps this lack of accountability is linked to the second problem: Independent Directors are exclusively appointed by the existing board members[8]. The only true ‘benefit’ conferred upon the operation of IDs, is that they may be paid by way of remuneration under Section 197(5) of the Companies Act[9]. The IDs are expected to not have any holding interest in the company, which makes them independent, yet their remuneration is controlled by the board. Since the appointment of the IDs also flows through the board, the IDs tend to become a show piece, and their word is only taken as lip service. The only ‘real’ incentive to their function, their pay is also wholly controlled by the board, which often renders the office of IDs infructuous.

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These two concerns read in conjunction cause the position of IDs to become a tool for corporate governance, and not a safeguard to poor corporate governance. These problems cause the position of Independent Directors to be laden with legal hypocrisy and defeats the purpose of its existence. Despite the poor legal standing of IDs, the position of IDs is essential to successful and clean corporate governance. Independent Directors also become the first to be blamed for mismanagement in the company and blamed for excessive loss suffered by the Company. This was noted in the IL&FS case[10]. In light of these circumstances, it is hard to understand why Independent Directors would wish to continue their role judiciously, and not just simply fall to the will of the rest of the Board. The question then is, how does Indian law govern the position of IDs effectively?

Fixing the infirmity

The infirmities highlighted above can be fixed in Indian law through two steps. The first step is at the level of appointment of directors, and the second would be with respect to the fixing of responsibilities. It may be so that the appointment itself may fix both infirmities.

With respect to appointment, an impartial solution is to require the confirmation of an Independent Director by non-controlling shareholders[11]. The election may still be by the controlling share-holders, but this method may effectively ensure that the minority rights are protected. In addition, it will force the controlling shareholders to act judiciously such as to ensure the appointment of an ID isn’t for a ‘token’ purpose. The non-controlling shareholders will hold a veto to ensure the effectiveness in appointment of a new ID. Further, given India’s peculiar situation regarding familial ownership, it may be important to begin increasing the number of IDs that large public companies appoint[12]. The NYSE as previously suggested, recommends a 50% appointment of IDs in any given Board of a public company[13]. India would benefit greatly from this, as large familial groups tend to undermine the will of shareholders and mismanage companies. Indeed, a greater number of IDs will help keep the company’s interest in mind and not the interest of an XYZ family.  To further solidify the position of IDs, the law on removal of IDs should also become more stringent. Currently, an ID may be removed by 50% of the shareholders consent[14] but appointed by 75% of Consent[15]. The removal should also be held at the 75% margin, and the confirmation of removal left to the non-controlling shareholders. This will ensure that there is accountability with respect to the removal of IDs and will ensure that it is only done for cogent reasons, and not for the purpose of maintaining promoters’ interest.

IDs (as highlighted before) aren’t interest holders in a given company, and truly have nothing to lose by being IDs of a company. It is a voluntary responsibility that they confer upon themselves, for a specific remuneration. It is argued that higher remuneration to IDs leads to them being more in favor of the promoters, as the promoters control the payment of remuneration. In light of this, the responsibilities of an ID need to be more clearly defined. For example, the guidance of the IDs is most important when the company is suffering a financial crisis. In Hong Kong, it has been found that an active responsibility of the IDs is activated during such situations, and a failure to give cogent advice will lead to them being held accountable[16][17]. In Indian Law, no statute has defined ID roles, and neither has the Court. The IDs roles are confined to the same realm as normal Directors, and when a crisis happens, such as in IL&FS the promoters are quick to point their fingers at the IDs[18]. By statutorily defining certain roles of the IDs, clarity will be given to persons in the position, and they will be forced to take their responsibilities seriously. In addition, they are also protected from arbitrary allegations against them, as long as they duly discharge their responsibility of giving cogent advice. Balancing the remuneration with sufficient responsibility would duly address this problem.

Conclusion

In light of the severe corporate failures like IL&FS, Satyam and Cyrus Mistry, the Indian Legislature has seemingly done just the bare minimum in addressing the problem of IDs. The implementation of the IDs and their extremely important roles lack the clarity and precision required for a position of that importance. Perhaps in due time these solutions, coupled with IDs in India honing their skills will lead to better corporate governance overall, but the change must begin at the level of the legislature. IDs present a glimmer of hope in dire straits for all companies, and it is of utmost importance that the sanctity of their position in corporate governance is realized.

[1] “NYSE Guidelines on Corporate Governance.” NYSE, The New York Stock Exchange , 2014.

[2] Indian Companies Act, 2013.

[3] Ibid.

[4] Kota, Hima Bindu. “Independent Director: An Oxymoron.” The Pioneer, 10 Jan. 2018, www.dailypioneer.com/2018/columnists/independent-director-an-oxymoron.html.

[5] Ibid.

[6] Rebello, Joel, and Kala Vijayaraghavan. “RBI Audit of IL&FS Group Makes Independent Directors Jittery.” The Economic Times, 1 Oct. 2018, economictimes.indiatimes.com/markets/stocks/news/rbi-audit-of-ilfs-group-makes-independent-directors-jittery/articleshow/66022060.cms.

[7] Supra n. 2.

[8] Ibid.

[9] Ibid, ss. 197.

[10] Prasad, Gireesh Chandra. “Sacked IL&FS Directors Face Questions on Diversion of Funds, Negligence.” Https://Www.livemint.com/, Livemint, 2 Oct. 2018, www.livemint.com/Companies/0uZR4zD1HSO6wta8oFd4BO/Sacked-ILFS-directors-face-questionson-diversion-of-funds.html.

[11] Balasubramanian, Bala N., and Jaideep Singh Panwar. “The Spirit of Independence Remains Unaddressed.” Https://Www.livemint.com/, Livemint, 10 Oct. 2017, www.livemint.com/Opinion/ho4MGVdTn25UN8HptNWU5H/The-spirit-of-independence-remains-unaddressed.html.

[12] Supra n. 4

[13] Supra n. 1

[14] Supra n. 2, ss 169.

[15] Ibid, ss. 149.

[16] Whitehead, Kate. “All Hail the Independent Non-Executive Director.” ACCA Global, 2017, www.accaglobal.com/in/en/member/discover/cpd-articles/governance-risk-control/ineds-jul17.html.

[17]  Empowerment of Independent Non-Executive Directors (INEDs) in the Banking Industry in Hong Kong .” Empowerment of Independent Non-Executive Directors (INEDs) in the Banking Industry in Hong Kong , Hong Kong Monetary Authority, 14 Dec. 2016.

[18] Supra n. 6

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