In this article, Prashant Gupta, of Damodaram Sanjivayya National Law University discusses the appointment of Independent Directors in a Listed Company. The class of companies which require 1/3 of the directors to be independent directors.

Prologue

Among many other amendments in the Companies Act, 2013, the Act intends to overhaul the position of independent directors in India. The present amended Act confers upon them greater power and responsibility unlike in the 1956 Act where there were no explicit provisions pertaining to independent directors. Only clause 49 of the Listing Agreement in the previous Act prescribed for the inclusion of independent directors in the Board of Directors for companies which were listed. The amended Act attempts to include independent directors on the board of listed companies to oversee corporate governance. However, it is noteworthy to mention that the amended Act fails to mention the role, duties, and responsibilities of independent directors in an eloquent manner. The independence of directors in the board is crucial for effective implementation of corporate governance. Hence, it became imperative for a comprehensive legislation pertaining to independent directors which eventually led to the overhaul of the 1956 Act.

Appointment

The amended Act obligates the listed companies to have a minimum of 1/3rd of the total board composition as independent directors. It also gives power to the Government of India to include other class of companies in the list pertaining to the appointment of independent directors. Hence, those public companies –

• Which have a paid-up capital of Rupees 100 crores; or
• Which have an annual turnover of Rupees 300 crores; or
• Which have loans/debenture borrowings in excess of Rupees 200 crores

have to appoint one-third of the total board composition as independent directors. The Government of India maintains a central database of those individuals who are express interest and are eligible to be appointed as independent directors. The listed companies which fall under the above list have the option of choosing independent directors from the above list. But the main point of contention is – Are there enough qualified individuals to fill the directorial positions? Even though the Act provides over a year to the listed companies for appointing one-third independent directors in its board, but there is a paucity of individuals with requisite skills to be qualified for this position. Hence, it becomes important that training is imparted by recognized institutions for qualified individuals so that they can develop the required skill sets that come with this position.

Prescribed Statutory Criteria

Requirements

The term ‘independent’ director’ is itself self-explanatory. The individual holding this position should not have any pecuniary interest in the company/directors concerned. Section 149(6) of the Companies Act, 2013 provides the criteria for independent directors. They are as follows –

• The individual concerned must possess high integrity and relevant industrial experience.
• The individual concerned must not have any pecuniary interest either in the company or in its subsidiaries if there are any.
• The individual or his/her relatives should not have any pecuniary interest in the company or its subsidiaries amounting to 2% or more of its total income or gross turnover or Rupees fifty lakhs, whichever is less, during two years preceding the current or previous financial years.
• The individual or its relatives should have held any key position in the company during the previous three fiscal years.
• The individual or his/her relatives should not have been an employee of the company during the previous three fiscal years.
• The individual should not be a promoter of the company concerned or its subsidiaries.
• The individual should not hold more than 2% voting rights in the company either by himself or his relatives combined together.

Responsibility

The criteria mentioned in the aforementioned requirements were put in rules so as to ensure transparency in the selection process and also safeguard the autonomy of the independent directors. The selected candidate for this position also has to sign an undertaking that they fulfill the criteria as mentioned above. The Act attaches great importance to an independent director. For example, in an event where a decision is taken by the board of directors in the absence of an independent director, the decision will have to be circulated to all the directors and at least one director will have to ratify the decision otherwise, the impugned decision would become null and void. An individual holding the position of an independent director can be removed from office if they fail to attend meetings with or without permission in the twelve month period. The term of an independent director is for five years and cannot exceed for more than two times. The independent director can seek for a second term provided that the board of directors passes a special resolution to effectuate the same. It is also important to mention that Section 149(11) specifies that the individual seeking reappointment after the expiry of its second term can do so only after the ‘cooling period’ of three years has passed. This rule has been included so that there can be transparency and people from diverse backgrounds can be appointed to this position.

Liability

To safeguard the independent directors from the ramifications of a non-independent directors activities, Section 149(12) provides that they can be made liable for offenses committed with their connivance, knowledge or negligence. This rule ensures that the individual can take honest decisions and instill in them a sense of confidence.

Remuneration

The Companies Act 2013 expressly prohibits the independent directors from availing stock options in the company. Also, they are not allowed to seek remuneration other than travel expenses for attending board meetings. They can be paid profit related commission but that is subject to the shareholder\’s approval. This is done so as to restrict any financial relationship of the company with the independent director. But then, such a restriction also becomes less attractive for the potential candidates fit for this position.

Committees

The independent directors are required to be there on the committees mentioned below, as per the Companies Act 2013.

Corporate Social Responsibility Committee

The Companies Act 2013 specifies that any company which has annual turnover amounting to Rs. 1,000 crores or more or a net worth of Rs. 500 crores or more or the company having a net profit of Rs. 5 crores or more during any financial year will have to form a CSR committee consisting of at least three directors out of which one director must be an independent director. CSR is mandatory in nature and commits to the social, economic causes such as poverty alleviation, eradication of hunger, promotion of education, empowerment of women among other things. The committee will have to formulate CSR policy and recommend activities that have to be done in a particular financial year. It is mandatory for the companies to spend at least two percent of the average net profits in Corporate Social Responsibility related activities.

The Act proposes that every company with a net worth of INR 5 billion (approximately US$ 80 million) or more, or turnover of INR 100 billion (approximately US$ 161 million) or more, or net profit of INR 50 million (approximately US$ 806,451) during any financial year must constitute a CSR committee with 3 or more directors out of which at least one director must be an independent director. CSR is a mandatory commitment for the company to contribute for the social, economic or environmental development activities, which includes promotion of education, promotion of gender equality and empowerment of women, eradication of hunger or poverty, contribution to Prime Minister\’s national relief fund. The designated committee has to formulate the CSR policy and recommend proposed activities in each financial year. It is mandatory for qualifying companies (as outlined above) to spend at least 2% of their average net profits on CSR activities.

Nomination and Remuneration Committee

The amended Act obligates on part of every public company to appoint at least three directors in the Nomination and Remuneration Committee out of which half should be independent directors. The Chairman of the board cannot chair NRC but can definitely be its member. The main functions of NRC are listed herein below –

• To identify suitable individuals fit to become directors in the company;
• To evaluate a director’s performance;
• To formulate remuneration policies and also the qualification, attributes, and independence of directors;
• To recommend appointment/removal of director(s).

Audit Committees

The Act stipulates that every public company must have an Audit committee in place which should consist of at least three directors out of which independent directors should be in majority. The Audit Committees have an important role of assisting the board of directors in the appointment of auditors, evaluate their performance, evaluating the internal financial control, examining financial statements provided by auditors, monitoring the utilization of funds raised through public offers. The committee also has the function of conducting the investigation into any contentious issue so as to prevent fraud.

Code of Conduct, Functions and Duties

The amended Act of 2013 provides for a ‘Code of Conduct’, functions, duties, responsibilities which raises the bar of standards and performance of independent directors. The duties of such class of directors include – attending all board/general meetings that require attendance, report unethical practices, fraud, violation of the law(s), non-disclosure of a confidential information, placing before the board concerns of the management and recording the minutes of the meeting. There is a huge responsibility on part of the independent directors in safeguarding the interests of the company without compromising on ethics. Hence, it is important that such directors possess requisite skill sets to perform their duties in a diligent manner.

Conclusion

The amended Act pertaining to independent directors has proper checks and balances so that the powers are not exercised in an arbitrary manner. The independent directors have a responsibility to act in a rational manner coupled with accountability. The amended changes are a step in the right direction and aim to better corporate governance and ensure the management of the company is conducted in a company that is in the interest of the shareholders. Such changes also aim to stop scandals in future and protect the shareholders’ interest.