In this blogpost, Sudhi Ranjan Bagri, Student, National Law Institute University, Bhopal, writes about position, role, responsibility, remuneration and responsibilities of independent directors in India.

Introduction

The concept of independent directors is not new. However it has turned out to be a huge matter of debate after corporate frauds like Satyam Scam, Enron scandal etc came to light. One of the factors that have been identified to be common in all these major corporate failures around the world has been the failure of the board of directors of a corporation to detect internal crisis early on & act in a timely manner to put the organization back on track before difficulties become irreversible. After witnessing various corporate failures, scandals & the ensuing crisis, attempts at every level have been made to make corporations strong & effective to counter various problems which crop up in routine dealings. It is at this point that the office of independent director draws attention as it is increasingly being felt that through them, objectivity & rational perspective can be brought on board & they can to a large extent ensure transparency & accountability of a board. They are expected to enhance the standards of corporate governance.

“Corporate governance is a key element in improving economic efficiency & growth as well as enhancing investor confidence…The corporate governance should promote transparent & efficient markets, be consistent with the rule of law & clearly articulate the division of responsibilities among different supervisory, regulatory & enforcement authorities..”[1]

Concept Of Independent Directors

The Board of Directors plays a key role in balancing the interests of managers & shareholders. The board also undertakes various other roles like keeping a check on the work of the executive team, analyzing their own performance, etc. However if we compare the workings of widely held corporations & those corporations which are owned by a small number of people (usually family owned) we realize that the roles and functions of the board change drastically between the two. In widely held corporations (eg.US & UK) the board’s role is one of “vertical governance” that entails working on behalf of the shareholders to maximize managerial opportunism & maximize shareholder wealth. Whereas in family-owned corporations the board’s role is that of “horizontal governance”, of balancing between major stockholders who are also part of the management & the minority shareholders & also protecting the latter by the former. It is while pondering on these issues that need is felt to have “independent” people on board who are free from any kind of influence or bias & can work independently harmonizing the interests of various parties involved in a corporation. The role they play in a company broadly includes improving corporate credibility, governance standards & the risk management of the company. They are also expected to contribute from their vast amount of experience & expertise to improve the overall functioning of the company. They bring a fresh perspective to the boardroom & since they have no other vested interests, their judgment isn’t clouded & they can work exclusively for the benefit of the company. In Indian scenario, this institution assumes another important role i.e. protection of minority shareholder’s rights as the majority of companies are family owned businesses, and thus they exercise strong control over the management.

Position of Independent Directors under Companies Act, 2013

In Indian corporate history, there is more than an even chance that 2013 will go down as a watershed year in terms of corporate governance reforms as it was the year a path-breaking new Companies Act, 2013 found its way into the statute book. The new Act, 2013 has brought in a lot of revolutionary changes addressing a wide variety of issues but in this project focus is on provisions relating to independent directors. The 2013 Act, for the first time, has defined the term “Independent director”. The old Act,1956 did not contain any provisions regarding this, so only listed companies had to follow this requirement as per Clause 49 of the Listing Agreement but now independent directors have been made mandatory for unlisted large public companies. The Act, 2013 differs from Clause 49 at various points, but its requirements are far more stringent than Clause 49.

Who can be Independent Director

By listing out detailed criteria regarding the appointment, the Act has brought in a significant change. Any promoter of the company or its holding, subsidiary or associate company or anyone related to them or anyone who has or had a pecuniary relationship with the company during the two immediately preceding financial years or current financial year has been excluded from being appointed as independent director[2]. All this has been done to maintain complete independence.The Act also lays down a term-based appointment for a period of five years, renewable, by special resolution for a second term, & not subject to retirement by rotation[3]. This kind of stability enables them to work fearlessly & efficiently.

Number of Independent Director

There is a specific obligation on every listed public company that at least one-third of the board of directors should comprise of independent directors & also empowers Central govt. to include other class/classes of companies within the scope of this requirement[4]. To make the process even simpler, an independent director may be selected from a data bank containing details of persons willing to be appointed maintained by some body as may be notified by the Central government[5]. But the hard fact remains that it is really difficult to find adequate amount of persons sufficiently qualified & also willing to take up this job.

Remuneration

Another significant step taken is that the Act also places a limit on the amount of shares that can be held in the company by a relative of such a director[6]. The Act also expressly disallows them from obtaining stock options[7]. Profit related commission may be paid to them, but subject to the approval of the shareholders[8]. The concern which arises here is a wide disparity between the remunerations & the responsibilities given to perform.

Responsibilities

The Act has imposed manifold responsibilities on independent directors. The Act requires the individuals to submit a self-declaration confirming that they have satisfied the criteria prescribed for the position[9]. It is also stated that any board meeting held at shorter notice (to transact urgent business) requires the presence of at least one independent director & if such is not present, the matter discussed at the board will be considered approved only once an independent director ratifies it[10]. Further, they can be removed if they fail to attend any board meeting for 12 months period with or without permission from the Board[11].

Separate meetings

The Act makes it mandatory for all the independent directors to hold at least one meeting annually, without the presence of non-independent directors & members of management[12]. Here they are expected to review the performance of the Chairperson, non-independent directors & the Board as a whole.

Committees

The Act has made it mandatory for independent directors to be a part of certain committees.

• Corporate Social Responsibility Committee– The Act provides that every company having net worth of rupees five hundred crore or turnover of rupees one thousand crores or more or a net profit of rupees five crores or more during any financial year shall constitute a CSR Committee of the Board consisting of three or more directors, out of which at least one director shall be an independent director. This provision has been included so that independent directors can keep a check on the workings of the CSR committee.
• Audit Committee- The Act requires that the Board of every listed company & such other companies as may be prescribed shall constitute an Audit committee which shall consist of a minimum of three directors with independent ones forming a majority[13].
• Nomination & Remuneration Committee (NRC) – The Act requires that the Board of every listed company & such other companies as may be prescribed shall constitute an NRC consisting of three or more non-executive directors out of which not less than one-half shall be independent directors.

The role of NRC is to:

(a) identify persons qualified to become directors

(b) recommend to the Board their appointment & removal

(c) evaluate directors performance

(d) recommend to the Board a policy relating to the remunerations for the directors etc.

Independent Director’s Liability

To provide an atmosphere where independent directors feel free to function to their full capabilities the Companies Act 2013 protects them from liability to a certain extent. It is provided that they are liable only if any fraudulent act has been committed with the consent of such a director or where such director has not acted diligently & if such act is attributable to the board process.

Conclusion

The institution of independent directors has come a long way & has evolved over the years. In the Indian context, Companies Act, 2013 has become a turning point for independent directors. They have been assigned wide powers & responsibilities. The major reason behind this is that it is sincerely hoped that independent directors would be successful in implementing high standards of corporate governance & ensure that the companies are run in a transparent & efficient manner. They also carry with them the expectation that they would act as the protector of minority shareholder’s interests which is very important at least in the Indian context. However the kind of roles & responsibilities that have been assigned to them under Act, 2013 appear to be numerous & at certain times, overwhelming. It remains to be seen as to how many people would be willing to take so many responsibilities especially when remunerations are not at all attractive. It also remains to be seen whether independent directors, in reality, are able to carry out so many functions as been assigned to them in an efficient manner. But at the same time, it is too early to analyze whether these provisions would be successful in implementation or not.

To conclude, the researcher feels that all the desired regulations, provisions, etc have been put in place to ensure the office of independent directors is able to contribute in corporate governance. All that remains to be seen is whether independent directors are able to break away from their old mould of merely acting as a rubber stamp & actually contribute to the growth of the company rather than simply playing an ornamental role.

[1] Preamble,OECD Principles of Corporate Governance,2004

[2]  S. 149(6) Companies Act 2013

[3] S. 149(10) and (11) Companies Act, 2013

[4] S. 149(4) Companies Act, 2013

[5] S. 150(1) Companies Act, 2013

[6]  S.149 (6) (e)( iii) Companies Act 2013

[7] S. 149(9) Companies Act 2013

[8] S. 197(7) Companies Act 2013

[9] S. 149(7) Companies Act 2013

[10]  S.173(3) Companies Act 2013

[11] S. 167Companies Act 2013

[12] Companies Act 2013, Schedule IV

[13]  S. 135(1) Companies Act 2013