In this article, Gitanjali Balakrishnan pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, discusses The role of independent directors in a takeover transaction.
Who is an independent director?
According to NASDAQ “Independent director” means a person other than an executive officer or employee of the company or any other individual having a relationship which, in the opinion of the issuer’s board of directors would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.[1]
Independent directors form a key part of the Corporate Governance of a company. Various scandals and problems have shaken the corporate world, and the need for Independence and objectivity in corporate governance has grown. For eg. In the Satyam case, the $1.6 billion bid for two Maytas companies i.e. Maytas Infrastructure Ltd and Maytas Properties Ltd had been advised against by some independent directors who raised concerns regarding the plan. Nonetheless, the Board adopted a unanimous resolution to proceed with the proposed acquisition which was one of the most significant events in the Satyam case. The Satyam episode has brought out the failure of the present corporate governance structure that hinges on the independent directors, who are supposed to bring objectivity to the oversight function of the board and improve its effectiveness.[2] It also revealed the independent directors failure to strongly question management’s strategy and to act when it was already clear that the company was in financial distress.
What was formerly existent but only as a mere formality is seen as a necessity today. The aforesaid corporate issues The Companies Act, 1956 does not expressly provide for Independent Directors except Clause 49 which mandates the appointment of Independent Directors on the Board of every listed company.
The New Companies Act, 2013 seeks to consolidate and strengthen the role of Independent Directors. Under the Act, every listed public company must have at least one – third of its directors as independent directors. Independent directors have been made mandatory for unlisted large public companies i.e., if their Paid-up share capital exceeds 10 Crores; if their turn- over exceeds 100 crores; or if the aggregate of all the outstanding loans, debentures and deposits exceeds 50 Crores.
What is the role of an Independent Director?
It is mandatory for all Independent Directors to meet once annually without the presence of non- independent members and members of the management. They are required, during this meeting, to evaluate holistically, the Company’s position, the performance of its members and take decisions pertaining thereto in an impartial manner including the performance of the chairperson, non- independent directors and the Board as a whole.
Schedule IV of the Companies Act, 2013 lays down the Code of Conduct for Independent Directors:
Role and functions:
The independent directors shall:
- Help in bringing an independent judgment to bear on the Board’s deliberations especially on issues of strategy, performance, risk management, resources, key appointments and standards of conduct;
- Bring an objective view in the evaluation of the performance of board and management;
- Scrutinise the performance of management in meeting agreed goals and objectives and monitor the reporting of performance;
- Satisfy themselves on the integrity of financial information and that financial controls and the systems of risk management are robust and defensible;
- Safeguard the interests of all stakeholders, particularly the minority shareholders;
- Balance the conflicting interest of the stakeholders;
- Determine appropriate levels of remuneration of executive directors, key managerial personnel and senior management and have a prime role in appointing and where necessary recommend removal of executive directors, key managerial personnel and senior management;
- Moderate and arbitrate in the interest of the company as a whole, in situations of conflict between management and shareholder’s interest.[3]
Therefore, the Independent Director’s role in a Takeover transaction is also implicit in the Code which lays down that the Independent Director must bring an independent judgment even in terms of strategy. They are required to represent all the stakeholders and to balance the interests of the stakeholders.
What is a Takeover Transaction?
A takeover is the acquisition of a business by another through purchase, exchange of capital stock, or any other device. [4] Acquisition means, directly or indirectly, acquiring or agreeing to acquire shares or voting rights in, or control over, a target company[5] Acquisitions may be via an acquisition of existing shares of the target, or by subscription to new shares of the target[6].
Audit Committee
In order to understand the role of Independent Directors it is pertinent to note that 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.
The Audit Committee is one of the main pillars of the corporate governance system in public companies. The Audit Committee is entrusted with the principal oversight of financial reporting and disclosure. The Audit Committee aims to enhance the confidence in the integrity of the company’s financial reports and announcements, the internal control processes and procedures and the risk management systems.
The focus of the Audit Committee has shifted specifically on new committee dynamics, financial reporting, risk oversight, oversight and evaluation of performance and effectiveness of the audit process, rotation of the statutory auditor, interaction with the statutory auditor and the internal auditor, oversight and evaluation of internal financial controls, related party transactions, vigil mechanism, and more importantly for the first time on the monitoring of the end use of funds raised through the public offers. The natural implication of the new set of responsibilities is that investors and stakeholders would now place greater reliance on the judgment of the Audit Committee to appropriately oversee.[7]
Listing regulations
Furthermore, the key functions of the Board under the Listing Agreement by Securities Exchange Board of India states the following:
As per Clause 49 I.D.2 of Listing Agreement:
- Reviewing and guiding corporate strategy, major plans of action, risk policy, annual budgets and business plans; setting performance objectives; monitoring implementation and corporate performance; and overseeing major capital expenditures, acquisitions and divestments.
Clause 49 I.D.3 of the revised Listing Agreement sets out the “other responsibilities” of the board, which is a mixed list of duties as well as powers. This list has the following items, among others:
- The Board should provide the strategic guidance to the company;
- the Board should have ability to ‘step back’ to assist executive management by challenging the assumptions underlying: strategy, strategic initiatives (such as acquisitions), risk appetite, exposures and the key areas of the company’s focus.[8] As Independent Directors have the same general legal responsibilities to the company as any other Director, the aforesaid duties apply to them.
Therefore, the role of an independent director as a critical evaluator of strategy and management plans is clearly defined. As seen in the case of Satyam, it becomes imperative that the affairs of a company are not handled in an autocratic manner as that is harmful to the long term sustainability of the business, the company, and the stakeholders.
Takeover code
Although the aforesaid provisions provide a general understanding of the duties of the Independent Directors in a Takeover Transaction, their duties have been specifically embodied in SEBI’s Takeover Code, i.e., SECURITIES AND EXCHANGE BOARD OF INDIA (SUBSTANTIAL ACQUISITION OF SHARES AND TAKEOVERS) REGULATIONS, 2011 which applies to listed public companies.
Under the Chapter on the Obligations of the Target Company:
As per Regulation 26 (6) & (7): Upon receipt of the detailed public statement, the board of directors of the target company shall constitute a committee of independent directors to provide reasoned recommendations on such open offer, and the target company shall publish such recommendations: Provided that such committee shall be entitled to seek external professional advice at the expense of the target company. The committee of independent directors shall provide its written reasoned recommendations on the open offer to the shareholders of the target company and such recommendations shall be published in such form as may be specified, at least two working days before the commencement of the tendering period, in the same newspapers where the public announcement of the open offer was published, and simultaneously, a copy of the same shall be sent to,— (i) the Board; (ii) all the stock exchanges on which the shares of the target company are listed, and the stock exchanges shall forthwith disseminate such information to the public; and (iii) to the manager to the open offer, and where there are competing offers, to the manager to the open offer for every competing offer.[9]
It is one of the primary duties of any Independent Director to safeguard the interests of all stakeholders especially the minority stakeholders, and to balance the interests of the stakeholders. It is his duty to see that any transfer of shares takes place in conformity with the articles of association and that the interests of all parties are represented adequately and taken into consideration. In its recommendations, it may question the basis of such an offer and challenge the presumptions underlying such a strategic initiative.
Conclusion
The role of Independent Directors has evolved in the Indian context, and it is paramount that in all cases, the interest of the minority stakeholders be represented.
[1] NASDAQ RULE 4200 A(15)
[2] HTTP://SHODHGANGA.INFLIBNET.AC.IN/BITSTREAM/10603/43939/11/11_CHAPTER%206.PDF; CHAPTER 6 EMERGING ROLE OF INDEPENDENT DIRECTORS IN INDIA
[3] SCHEDULE IV- CODE FOR INDEPENDENT DIRECTORS, COMPANIES ACT, 2013
[4] RAMANATHA AIYER, CONCISE LAW DICTIONARY, FOURTH EDITION 2012
[5] SECURITIES AND EXCHANGE BOARD OF INDIA (SUBSTANTIAL ACQUISITION OF SHARES AND TAKEOVERS) REGULATIONS, 2011
[6]HTTP://WWW.NISHITHDESAI.COM/FILEADMIN/USER_UPLOAD/PDFS/RESEARCH%20PAPERS/MERGERS___ACQUISITIONS_IN_INDIA.PDF
[7]HTTPS://WWW2.DELOITTE.COM/CONTENT/DAM/DELOITTE/IN/DOCUMENTS/RISK/CORPORATE%20GOVERNANCE/IN-CG-ROLES-AND-RESPONSIBILITIES-OF-AUDIT-COMMITTEE-NOEXP.PDF
[8]INDEPENDENT DIRECTORS- A HANDBOOK HTTPS://WWW.ICSI.EDU/WEBMODULES/COMPANIESACT2013/INDEPENDENT%20DIRECTOR.PDF-
[9] SECURITIES AND EXCHANGE BOARD OF INDIA (SUBSTANTIAL ACQUISITION OF SHARES AND TAKEOVERS) REGULATIONS, 2011
