In this article, Parth Sarthy Kaushik discusses rules governing the removal of Independent Directors and the need for reform.
The role and significance of independent directors has been formally recognized by the Companies Act, 2013. The law, with the aim to strengthen the corporate governance norms, details the obligations of independent directors which includes, inter alia, the duty to look after the interests of minority shareholders and scrutinizing the performance of management by providing an objective opinion on the strategy and functioning of the company.
JJ Irani Committee on Company Law (2005) observed that independence of the board of directors from external influences is critical for effective corporate governance and an independent director would play a key role to balance the interests of various stakeholders. The rationale behind formalising the institution of independent directors arises from the fact that non-independent directors (who are appointed by majority shareholders/promoters) represent the interests of majority shareholders and their approach is dictated by such interests. Therefore, independent directors are considered quint-essential in bringing objectivity to the governance process in the larger interests of the company by taking into account the interests of all stakeholders, particularly the minority shareholders. Thus, the Companies Act, 2013 casts an onerous burden on independent directors to discharge their fiduciary duties in addition to the obligations mandated by the statue.
However, in light of the on-going Tata boardroom battle, which has resulted in the ouster of a number of independent directors, serious concerns have been raised on the vulnerability of the institution of independent director and the need for their protection against a vindictive management. In the present context, it is very crucial to ensure that independent directors are treated fairly so that they can perform their duties without the fear of repercussions from the majority shareholders.
Duties and Obligations of Independent Directors
Section 149 (8) of CA, 2013 lays down that the independent directors are required to follow the professional code of conduct as specified in Schedule IV of the Act. The Schedule dictates that independent directors shall discharge their responsibilities in a professional and faithful manner. It also lays down the duties and obligations of independent directors to promote investor confidence, secure the interests of minority shareholders and ensure compliance with applicable laws.
Section 149(7) casts a duty on an independent director to make a self-declaration, prior to their appointment stating that he/she meets the criteria prescribed for the position on which they are being appointed. Further, Section 173(3) provides that any decision taken by the board in the absence of independent directors is required to be circulated to all directors and cannot be implemented without the approval of at least one independent director.
Therefore, the Companies Act, 2013 makes certain that any person appointed as an independent director is qualified to identify any mismanagement in the company, making the role of independent directors very critical in safeguarding the interests of a company. This mandates independent directors to exercise a high level of commitment and due-diligence in the discharge of their statutory obligations.
Present Framework for Removal of Independent Directors
The process of removal (and appointment) of independent directors is in the hands of majority shareholders. Section 169 of the Companies Act, 2013 lays down that an independent director can be removed by way of an ordinary resolution requiring a simple majority (at least 50%). This essentially means that independent directors can be removed on the whims of controlling shareholder (promoters), and thus makes it untenable for independent directors to perform their duties in an independent and honest manner which resultantly defeats the purpose of their appointment in the first place.
Although CA, 2013 provides that the Independent director sought to be removed, shall be given a reasonable opportunity of being heard. The absence of any rule requiring a sufficient cause for removal effectively makes this requirement redundant. It is also interesting to note that in the case of re-appointment of an independent director, the shareholders are required to move a special resolution requiring a special majority (at least 75%).These lacunae in the framework governing the functioning of independent directors call for urgent reforms in order to mitigate the influence exercised by the majority shareholders in the process of appointment/removal/re-appointment of independent directors.
TATA Boardroom Battle and Case of Nusli Wadia
Mr. Nusli Wadia, who had been an independent director (in some of Tata Group Companies) was removed by Tata Sons (which is a dominant shareholder) after Mr. Wadia voiced his support for Mr. Cyrus Mistry, who had been thwarted from the position of Chairman of Tata Group. Under the present framework, Tata Sons has every right to seek removal of any director on board including an independent director. But the manner and surrounding circumstances which lead to the ouster of Mr. Wadia raise a very important question i.e. whether independent directors be able to discharge their duties while questioning management and ensuring good governance in the company? The emphatic answer is, No.
Although, in the case of Tata Group, the cause for the ouster of independent director is the support shown for the ousted chairman who does not enjoy the support of majority shareholders but the larger concern is that, If independent directors can be removed at whims and fancies of controlling shareholders, then their role will be reduced to that of ‘yes men’ which would prove counterproductive to the objective sought to be achieved by the formalisation of the role of independent directors under the Companies Act, 2013.
Suggestions for Reforms
The role of an independent director is that of vigilant gatekeeper of the company activities. In addition to their obligation to monitor the actions of company management, they also have a fiduciary duty towards all the stakeholders (including employees, and minority shareholders). Therefore, independent directors must be truly independent of management.
The following suggestions are to ensure that independent directors remain outside the influence of controlling shareholders and are able to perform their duties without any bias:
- Appointment of some of the independent directors shall be made by minority shareholders and majority shareholders shall not be allowed to vote in the election of such independent directors. Furthermore, on approval of appointment by minority shareholders, the majority shareholders shall be precluded from the process of removal of such independent directors for a specified time period;
- Both majority shareholders as well as minority shareholders shall elect the rest of independent directors based on the system of proportionate voting in the proportion of their respective shareholding in the concerned company; and
Sufficient cause must be shown for the removal of an independent director which should be explicitly defined by the company in its bye-laws and removal should be approved by a special majority (at least 75%).
Conclusion
The Companies Act, 2013 imposes a high level of responsibility on independent directors and makes them liable in cases of failure. Further, independent directors are expected to be independent of the management and act as the trustees of minority shareholders. This essentially requires independent directors to be fully aware of the decisions taken by the company management and raise red flags wherever any mismanagement is detected. But the scheme of the Act fails to protect independent directors if they fall out of favours with the majority shareholders.
Therefore, in order to mitigate the influence of majority shareholders, a stricter regime governing appointment/removal of independent directors needs to be introduced that creates a fair balance between the interests of a diversified shareholder group and protects the sanctity institution of independent directors.
