This article is written by M.S.Bushra Tungekar from the University of Mumbai Law Academy and Ayush Tiwari, a student of Symbiosis Law School, NOIDA. The author in this article who can be an independent director highlights their roles, duties, functions, and the manner in which they are selected.
It has been published by Rachit Garg.
With the introduction of corporate governance in India, the need for independent directors in companies was realized. The Companies Act 1956, did not have the necessary provisions. In order to bridge the gap, the Ministry of Corporate Affairs amended the Act in 2013.
Independent directors play an important role in maintaining the balance between the management and the ownership in a company. Independent directors help in attaining not only profit maximization but also keep a check on shareholders’ welfare.
In simpler words, an independent director is a third party who is a member of the board of directors, having an impartial position with a company. The independent director does not participate in the daily functioning of the company neither he is a part of the executive team of the company.
Who can be an Independent Director?
Chapter XI of the Companies Act 2013, deals with the appointment and qualifications of directors. Provisions pertaining to who can be an independent director under the Companies Act 2013 are set forth under section 149 subsection (6) of the Act. The section provides that an independent director in regard to a company means a person other than the managing director, or a whole-time director, or a nominee director:
- Is a person of integrity and a person who has the relevant expertise and experience, in the opinion of the board.
- The person should not be the promoter of the company or any of its subsidiaries or any of its holding or, any of its associate companies.
- The person should neither be related to the promoters of the company nor the directors in the company. Including the directors of its holdings, any of its subsidiaries, or any of its associate companies.
- The person should not have or had any pecuniary relationship with the company (including its holdings, subsidiaries, or associate companies) during the previous two financial years. However, the pecuniary relationship mentioned in this clause means the monetary relationship should be other than the remuneration as director or transaction not going beyond ten percent of his total income.
- None of whose relative must have had or has any relationship with the company (including its holdings, subsidiaries, or associate companies) that is in the nature of pecuniary or transactional.
- None of whose relative during the current or two immediately previous financial years is:
- Holding any security or interest. Provided it must not exceed fifty lakhs or two percent of the paid-up capital;
- Is indebted; or
- has provided for a guarantee, or security for the indebtedness of a third party.
- The person neither himself nor any of his relatives:
- Holds any managerial position of importance or is employed in the company (including its holdings, subsidiaries, or associate companies) during three immediately previous financial years.
- For the three immediately previous financial years has been an employee or, proprietor or a partner in the:
- Firm of auditors,
- The firm of company secretaries,
- Cost auditors of the company (its holdings, subsidiaries, or associate companies),
- The legal firm carrying transactions on behalf of the company (its holdings, subsidiaries, or associate companies) amounting to ten percent or more of gross turnover.
- The person having the hold of two percent or more voting power in the company along with his relatives.
- Is the head of the Non-profit organization that receives twenty-five percent or more from the company (its holdings, subsidiaries, or associate companies).
- A person having the prescribed qualifications.
Which companies must or can appoint independent directors
It is obligatory for certain companies to appoint an independent director. Sub-section (4) of Section 149 of the companies Act 2013 provides that:
- Every Public listed company must have at least 1/3rd of the total number of directors.
- The Union government to prescribe for the minimum number of independent directors for other classes or classes of public companies.
Rule 4 of the Companies (Appointment & Qualification of Directors) Rules, 2014 provides for the number of independent directors. It states that the public companies falling under the below-mentioned criteria shall have at least two independent directors:-
- Having paid-up share capital of INR 10 crores or more.
- Having a turnover of INR 100 crores or more.
- Having in the aggregate, outstanding loans, debentures, borrowings, and deposits, more than INR 50 crores.
Exceptions to the following clauses:
- Joint venture.
- Wholly owned subsidy.
- A dormant company as defined under the Act.
Limit on the number of Independent Directorships?
According to section 165 of the Companies Act 2013, the maximum number of companies wherein a person can be appointed as a director shall not be more than 20 companies (including the alternate directors). For calculating the limit wherein a person can be appointed as a director in a public company, the directorship of that person in private companies (holdings, subsidiary company) shall be included.
In the case of a public company in which a person can be appointed as a director shall not be more than 10 companies. However, the Companies Act, 2013 is silent regarding any specific limit on the number of companies where a person can be appointed as an independent director.
Appointment and Re-appointment of Independent Directors
Independent directors are directors of a company. Independent directors are subject to the same general requirements and disqualifications as any other director. The 2013 Act specifies specific qualification standards for independent directors in addition to those outlined in the Listing Agreement. An independent director must be a subject matter expert with the necessary qualifications in the domains of finance, law, management, research, and corporate governance. He must be a person of moral character, faith, honesty, and appropriate experience. Additionally, he should not be a promoter of the business or any affiliated businesses, or even a relative of any promoters or board members. In addition, he must not have any financial ties to the corporation, its holdings, subsidiaries, or promoters. He must, thus, be a person in order to be selected as an independent director. He must be qualified to serve as a director and provide assurance that he is not ineligible. In order to serve as a director, he must also submit his written approval, which must be filed with the Registrar, and declare his director identification number (DIN).
The New Act prohibits the appointee from being associated with the promoter or directors of the company, its holding, subsidiary, or associate company, whereas, the listing agreement prohibited the appointment of a person in relation to the promoters or persons possessing management positions at the board level or one level below.
The new Act does not require the appointment to be unrelated to someone holding managerial positions at the board level or one below the board, unlike the listing agreement, and it can be deduced from this. Companies must adhere to the standards under both until the regulations developed in this respect give further clarity since the new Act does not supplant or replace the listing agreement. While the Listing Agreement does not contain any strict rules about the potential appointee’s family, the new Act stipulates that neither the independent director nor any of his kin may:
- Hold a significant managerial role or had worked for the business during any of the three financial years;
- Has participated in any of the three financial years as an employee, proprietor, or partner;
- Holds 2% or more of the company’s total voting power;
- Belongs to any non-profit organisation whose chief executive officer or director obtains 25% or more of its revenues.
While the new Act stipulates that an independent director must possess honesty, the necessary knowledge, and the necessary experience, it does not specify the criteria to be used in deciding whether a person satisfies these requirements. The ultimate effect is that listed corporations eventually nominate independent directors after using their own discretion. It is important to note that, in contrast to the 2013 Act, the listing agreement does not define the term “a person with integrity and holding the necessary skills and experience” when describing the individuals eligible to be selected as independent directors. This provision is not present in the Listing Agreement. These constraints aim to ensure that independent directors do not act against the financial or pecuniary interests of the firm. There may be a need to review the selection criteria for independent directors at many listed companies.
Tenure of Independent Directors
The duration of the term of office for independent directors has been set forth under subsection (10) and subsection (11) of section 149 of the Companies Act,2013.
According to section 149(10), an independent director can be appointed for a term up to 5 consecutive years.
This was clarified by the Ministry of Corporate Affairs via its General Circular 14/ 2014, stating that the appointment of an independent director for the term of 5 years or less is permissible. Whether the appointment is for five years or less, it will be considered as one term.
The independent director under this section shall be eligible for reappointment through the passing of a special resolution and the disclosure of such information has to be made in the board report.
Furthermore, section 149(11) states that no person shall be appointed as an independent director for more than two consecutive terms. Although such independent directors shall be eligible for reappointment after the expiration of 3 years.
The person shall have to resign from the office on completion of two consecutive terms even if the aggregate number of years is less than 10, as clarified by the Ministry of Corporate Affairs via its General Circular 14/2014.
Remuneration of Independent Directors.
Subsection (9) of section 149 of the Companies Act 2013, expressly prohibits independent directors from gaining any stock options.
However, the independent director may receive remuneration in the form of a fee. The said fee shall be decided by the board of directors, and it shall be in the form of a sitting fee to an independent director for attending meetings of the Board or committees. The amount of the said fee shall however not exceed INR 1 lakh per meeting.
Retirement by Rotation
Unlike other directors, the independent directors shall not be liable to retire on rotation as provided by subsection (13) of section 149.
Section 161 of the Act provides for the appointment of alternate directors, nominee directors, and additional directors. The section states that a person shall be appointed as an alternate director for an independent director only if he has the said qualifications required to be appointed as an alternate director.
According to Rule 4 of the Companies (Appointment & Qualification of Directors) Rules, 2014, any company falling within the ambit of the said rule must appoint an independent director in case of an intermittent vacancy within 3 months or before the immediate next Board meeting.
Manner and selection of independent directors
Selection of independent directors
The main aim of appointing an independent director is that the appointed person should be impartial and help with good corporate governance. The manner in which an independent director shall be appointed has been laid down under part IV of Schedule IV of the Companies Act 2013.
Part IV clause (1) of Schedule IV states that the appointment of an independent director should be free from any company management. The board of directors shall appoint an independent director, however, the board while appointing must ensure that there is a balance between skills, knowledge, and experience in the board. Doing so will facilitate the board to administer their roles and duties efficiently as provided under section 150 (1).
Therefore the board may nominate the person to be appointed as independent directors. The board has also been given an option to select an independent director from the data bank that has been maintained. The data bank might be anybody, associate as notified by the central government. The responsibility of conducting due diligence before appointing an independent director shall be of the board.
The board nominates person(s) for the post of independent director. However, the appointment of the independent director should be approved in the shareholders meeting ad provided under Part IV clause (2) of Schedule IV.
Section 150(2) states that the appointment of an independent director must be approved in the general meeting held by the company. Additionally, an explanatory statement must be attached to the notice of the general meeting. The notice must provide the justification for selecting the said independent director.
Furthermore, Section 152(5) also requires the explanatory statement to specify that in the opinion of the board, the independent director fulfills the conditions laid down under this Act and its rules.
The appointment of the independent directors must be formalized by a letter of appointment. The letter of appointment shall mention the following things listed below (as specified by Part IV clause (4) of Schedule IV.):
- The tenure of the independent director.
- Expectations of the board and the board level committee(s) in which the independent director is expected to serve.
- The fiduciary duties and the corresponding liabilities.
- Provisions of director and officer insurance.
- The code of business ethics to be followed by its directors and employees.
- List of prohibited actions when functioning as such in the company.
- The remuneration, periodic fees, provision for reimbursement of expenses and profit related commissions; if any.
The terms and conditions of the appointment of independent directors must be posted on the company website and must be made available for inspection at the company’s registered office(during business hours) as provided under clause IV (5)(6) of Schedule IV.
Every person who has been appointed to hold an office as an independent director must give his consent to act as an independent director and the said consent must be filed with the registrar within 30 days as provided under Section 152 (5) of the Act.
Furthermore, the independent director must furnish the consent in writing on or before his appointment in Form Dir 2 in conformity with rule 8 of Companies ( Appointment and Qualification of directors) rules, 2014.
According to clause V of Schedule IV, the independent directors shall be re-appointed based on the performance evaluation report.
For various reasons, an independent director may resign from the position by giving the board written notice of his intention to do so and providing a plausible explanation for why he is unable to maintain his position. As per the Companies (Registration Office and Fees) Rules, 2014, he must also give a copy of his resignation letter and an explanation of his reasons for leaving within 30 days to the Registrar of Companies. Upon receiving a resignation notice, the board is required to take note of it and notify the applicable stock exchange, as well as the Registrar of Firms in the case of listed companies. Additionally, they must provide information on the resignation in the board report that is distributed to the company’s next annual general meeting. The resignation is effective only on the day the company receives the notice of resignation—or any later date that may be specified in the resignation letter.
When a director tenders his resignation and the Board of Directors accepts it and takes action on it, the director is no longer responsible for any liabilities the company may incur after the date of acceptance of his resignation, with the exception of the liabilities he personally incurred when he bought shares of the company. Directors who resigned and submitted their resignations to the Registrar of Companies (ROC) before the relevant time during which the alleged offences occurred should be granted relief.
However, at this time, these explanations must be specific in their resignation letter due to the increased obligations and consequent responsibilities. The resignation letter of an independent director is a public record that may be cited as prospective evidence in a lawsuit or an inquiry to establish compelling reasons for the resignation. It can serve as a useful tool for the director to reduce his exposure and justify his stance before resigning. A fresh appointment must be made as an independent director within 180 days of the resignation date.
Resignation may only be withdrawn or revoked, prior to the resignation’s effective date, which is the later of the day the firm receives the notice of resignation or the date mentioned in the resignation notice. In Union of India v. Shri Gopal Chandra Misra and Others (1978), the Supreme Court of India ruled that an incumbent’s written notification to the appropriate authority of his intention or proposal to step down from his post as of a future specified date may be withdrawn by him at any time before it becomes effective, barring any legal, contractual, or constitutional restrictions. The case of Yamaha Motors (Pvt) Ltd. v. Labour Court-II and Another (2012) also adopted a similar approach. It was emphasised that a potential resignation may always be revoked prior to going into force, although it would always be subject to the employee’s service conditions.
Since just resigning and absolving oneself of duty cannot be done, there should be some guidelines. Resignations based only on vague personal reasons cannot be accepted in order to leave one firm just to serve others.
Like any other director of the corporation, an independent director may be dismissed from the board. They can be dismissed before their term ends by passing a regular resolution that is supported by the majority of the members. The independent director must have a fair chance to be heard before being removed. However, a director chosen by proportional representation cannot be dismissed before the end of his tenure. Specific notice must be introduced at the meeting when a director is to be dismissed. The resolution voted in the Extraordinary General Meeting (EGM) to remove the directors was deemed invalid since no particular notice of the vote to remove the directors was given. To provide the concerned director with a chance to voice his views, the corporation must also submit a copy of the document to him. The concerned director may also ask for more time to send his representative or a lawyer. In the event of a time constraint, the director may address the matter at the scheduled meeting. However, if the company or another individual file a claim with the National Company Law Tribunal (NCLT) claiming that doing so would amount to securing unwarranted exposure for defamatory material, such representation may not be read out at the meeting. With a majority vote, shareholders may also dismiss a director with or without cause. However, if two-thirds of the directors were chosen by proportional representation, this option would be unavailable. If any compensation or damages are due to the dismissed director under the conditions of his appointment as director, they might have to be paid.
The independent directors of the company shall hold an exclusive meeting at least once in the financial year. The meeting shall be without the non-independent directors. All the independent directors of the companies must be present at such meetings.
The agenda of the meeting shall be as follows:
- Reviewing the performance of the board, of the non-independent directors, and the chairperson of the company.
- Assessing the structure and the flow of information between the board and the company management is required for the efficient and effective functioning of the board.
Evaluation of the performance of an independent director
Part VIII of the Code for Independent Directors provides that based on the performance evaluation report term of an independent director may be extended or he may be reappointed. The performance evaluation of the independent director is to be conducted by the entire board of directors.
Director Identification Number (DIN)
Director Identification Number is a unique 8 digit identification number that is allotted to an individual who wishes to be a director or a company or someone who already is a director of a company. This number is allotted by the central government.
Section 152 of the companies Act makes it compulsory for the directors to obtain a unique identification number. The provisions pertaining to Director Identification Number are set forth under section 153 and rule 9 of the Companies (Appointment and Qualifications of Directors) Rules, 2014.
Director identification numbers facilitate the government in maintaining a database. Every person intending to be a director or every person who is already a director in a company shall be allotted a single number irrespective of the number of directorships he holds.
To obtain a Director identification number an individual needs to apply to the Ministry of Corporate Affairs in the manner prescribed along with the prescribed fee. The central government shall allot the director identification number to the individuals within a month.
The DIN is valid for a lifetime. After receiving the DIN, the director within a month must inform about the same, to all the companies where he holds or intends to hold the position of director. The company on receiving the DIN must inform about the DIN of the director within 15 days to the Registrar of Company.
The detailed procedure and the requirements for the application of DIN are provided under rule 9 of the Companies (Appointment and Qualifications of Directors) Rules, 2014. While allotting and scrutinizing for DIN, Rule 10 of the Companies Rules 2014 (Appointment and Qualification of Director) is also considered.
Data Bank of Independent Directors
In order to strengthen good corporate governance, the ministry of corporate affairs launched Databank for independent directors. The databank maintains a database of the independent directors that are willing to take up the post of an independent director and is also eligible for the post. The data bank facilities the selection process of independent directors by the company as can select the per their requirements.
Indian Institute of Corporate Affairs has been authorized by the central government to create and to maintain a data bank for independent directors. The data bank is an online data bank displayed on the website of the institute.
The provision relating to the details required by the databank is provided under the companies (creation and maintenance of databank of independent directors ) Rules 2019. Accordingly, the following details of individual are required by the databank:
- Director identification number (DIN)
- Full name
- Income tax PAN
- Fathers name
- Date of birth
- Present and permanent full address along with PIN code
- Phone number
- Email id
- The educational qualifications and professional qualifications
- Details of experience or expertise (if any)
- If any pending criminal proceedings
- Details of the limited liability partnership which he is a part of:
- List of the limited liability partnerships,
- The names,
- Nature of the industry of the limited liability partnership,
- The duration along with the dates,
- Details of the companies he is part of:
- The Name of the companies.
- The nature of the industry.
- The duration along with dates.
- The nature of directorship i.e whether he serves as an independent director or an executive director, or nominee director, or a managing director.
The data shall be provided by the institute on payment of a prescribed fee by the company. Indian Institute of Corporate Affairs shall not be held responsible for the lack of accuracy of any information. As mentioned earlier it is the responsibility of the company to conduct due diligence on the prospective independent directors.
The individual whose name has been included in the databank in the event of any change must inform the institute within 15 days.
Further, in respect of any person who has been appointed as an independent director or who intends to hold the position of an independent director, the institute shall comply with the following:
- Conduct a competency self-assessment test with the curriculum covering subjects such as basic accountancy, company law, securities law, and other areas relevant to the functioning. The test would be conducted online.
- Assemble the required study material for individuals appearing for the above-mentioned assessment. The study material will be in the form of online lessons or audiovisuals.
- Provision for individuals to take an advance test for the areas specified above and prepare the study material for the same.
Code for directors
The standards and professional conduct that is expected by the directors have been laid down under Schedule IV of the Companies Act,2013. The code for independent director includes guidelines for professional conduct, the duties of the independent directors, their roles and functions. These are discussed below:
The independent director according to the part I of the schedule IV must:-
- Sustain ethical standards.
- To be impartial while discharging his duties.
- Perform his responsibilities in the interest of the company.
- Allocate the necessary time to fulfil his professional obligations so as to facilitate him in an informed decision making.
- Not allow any unnecessary considerations that will hamper his independent judgment, while taking decisions for the benefit of the company.
- Not to abuse his position.
- Abstain from actions that would cause him to lose his independence.
- Assist the company in incorporating good corporate governance.
Duties of Directors
The independent director according to part II of schedule IV has the following roles and functions:
- In case of issues relating to strategic risk management, resources, key appointments, standard of conduct, and performance, the independent director must facilitate in bringing an independent judgment.
- The independent director must be impartial when considering the evaluation of the performance of the management and the board of the company
- He must ensure the financial controls and risk management systems are efficient and effective.
- An independent director must always make sure that he is safeguarding the interest of all stakeholders especially the minority shareholders.
- In case of conflicting interests of all stakeholders, the independent director must try to maintain a balance.
- The independent director must facilitate in determining remuneration for different levels of:
- The Executive directors.
- Key managerial personnel.
- Senior management and wherever necessary.
- While adjudicating matters, the independent director must adjudicate keeping in mind the interest of the company as a whole.
Duties of the independent directors
- Independent director must update and enhance their skills knowledge and familiarity with the company regularly.
- An independent director must aim to attend all the board meetings and the meetings conducted by the board committee is of which he is a member.
- The independent director must try to keep himself updated about the company the external environment under which it operates.
- Before approving any related party transactions the independent director must ensure death the transaction is in the interest of the company and has been duly considered.
- An independent director must report the matters concerning unethical behavior whether it is actual or suspected fraud of the companies ethics policy for code of conduct.
- The independent director must never disclose confidential information except if such disclosure is required by law.
- In order to discharge his duties or in order to take any decision independent director may seek expert opinion or clarifications of the information
- Must be active and an impartial member of the committees of the board that they are part of.
- In case of any concerns regarding a proposed plan of action or scheme, the independent director must convey his concern to the board and make sure that they are duly addressed and resolve.
- Independent directors are prohibited from unjustly obstructing the functioning of the board or committee of the board.
- Independent directors must make sure that there is a proper and efficient vigil mechanism in place in the company.
- Independent directors should never overstep their authority. Protecting the interest of the company, its shareholders, and its employees are the primary duty of an independent director.
Position of independent directors in various committees
The companies Act 2013, requires the independent directors to be a part of certain committees such as the:
According to Rule 6 of the Companies (Meetings of Board and its Powers):
Rules, 2014, the following classes of companies shall constitute an audit committee:-
- Every public listed company
- A public company having paid-up share capital of INR 10 crores or more
- A public company having a turnover of INR 100 crores or more
- A public company having in the aggregate, outstanding loans, debentures, borrowings, and deposits, more than INR 50 crores.
Section 177 of the Companies Act,2013 provides that the audit committee would consist of at least three directors. The majority of directors in the audit committee must be independent directors.
Nomination Committee and Remuneration committee
According to Rule 6 of the Companies (Meetings of Board and its Powers):
Rules, 2014, the following classes of companies shall constitute a remuneration committee:
- Every public listed company.,,
- A public company having paid-up share capital of INR 10 crores or more,
- A public company having a turnover of INR 100 crores or more,
- A public company having in the aggregate, outstanding loans, debentures, borrowings, and deposits, more than INR 50 crores.
According to section 178 of the Companies Act, the nomination committee and the remuneration committee shall consist of at least three or more non-executive directors. One half of the committee shall comprise of independent directors.
The chairman of the company cannot chair the remuneration committee or the nomination committee, irrespective of whether he is an executive or non-executive director. The chairman of the nomination committee or remuneration committee must be an independent director.
Corporate social responsibility committee
According to section 135 of the Companies Act 2013, a company having a net worth of INR 500 crores or net profit of INR 5 crore or turnover of INR 1000 crore shall constitute a Corporate Social Responsibility Committee.
Corporate Social Responsibility Committee shall consist of three or more directors out of which one has to be an independent director.
Advantages of appointing independent directors
Instead of a board made up of dependent directors, a board with a majority of independent directors would be more capable of overseeing the CEO. Also, adding additional independent directors typically leads to more outside counsel and knowledge (due to the executives’ coming from different backgrounds). The directors are not vulnerable to excessive influence from the management group because they, by definition, have no material link to the firm. So we can say that independent directors are essential to effective corporate governance and are typically preferred for appointment to the Board of Directors.
Disadvantages to appointing independent directors
Appointing independent directors has a number of disadvantages as well. Some of which are:
- There is a danger of knowledge asymmetry because independent directors often know less about the firm than the management team.
- Despite the fact that a director may be independent by definition, this does not guarantee that the director is working with complete impartiality;
- Independent directors are susceptible to management pressure.
- Additionally, they might not possess the knowledge and abilities needed to serve as the Board of Directors effectively.
Frequently Asked Questions (FAQs)
Who has the authority to appoint independent directors?
The company’s general meeting must authorise the nomination of an independent director.
What if the company later failed to uphold the conditions of the appointment?
If a corporation fails to meet one of the aforementioned standards for three years in a row, it is not required to follow the rules until it meets the conditions once more.
How long may a name be stored in the data bank?
By paying the appropriate fee, a name’s inclusion in the data bank might be for a duration of one year, five years, or for life.
Is a DIN required to enter a name into a data bank?
Yes, it is mandatory, and anyone without a DIN may freely apply to the institute to have their name included in the data bank.
An independent director bridges the gap between the management and its shareholders. They promote the principles of corporate governance by facilitating disclosures, transparency, and accountability of the company to its stakeholders.
They help the company in inculcating the best corporate governance practices. The independent directors make sure that the company is functioning in such a way that it keeps in mind the best interest of its stakeholders, customers, minority shareholders, workers, its own interest, and the interest of the public at large.
An independent director brings an impartial and independent judgment to the company. It acts as a watchdog. The inclusion of Independent directors will ensure that the companies are not doing any fraud. Independent directors in corporate governance will have a positive impact on the corporate environment in India.
Students of Lawsikho courses regularly produce writing assignments and work on practical exercises as a part of their coursework and develop themselves in real-life practical skills.
LawSikho has created a telegram group for exchanging legal knowledge, referrals, and various opportunities. You can click on this link and join: