This article has been written by Prasenjit Singh, pursuing the Certificate Course in Advanced Civil Litigation: Practice, Procedure and Drafting from LawSikho. The article has been edited by Prashant Baviskar (Associate, LawSikho), Zigishu Singh (Associate, LawSikho), and Indrasish Majumder (Intern at LawSikho).

This article has been published by Shoronya Banerjee.

Introduction 

In this article, the author shall address the evolution of the concept of independent directors, statutory powers of independent directors, roles, duties, and responsibilities of Independent directors, critical analysis of the functioning of independent directors, and discuss the way forward. 

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The roles and responsibilities of independent directors are the most debated topic in the present era as checks and balances of Independent Directors fail to address several frauds in companies such as IL&FS scam, PMC Bank, Enron scam to name a few. Post-Satyam scam, the government of India tried to overhaul the corporate regulatory framework and enacted new legislation i.e Companies Act, 2013. This statute was enacted aiming to keep a check on corporate frauds as one of its purposes. The Parliamentary Standing Committee on the Companies Act observed that the role of independent directors assumed greater importance after the failure of major corporations like Satyam Computers Limited. Prior thereto, there was uncertainty as neither the Companies Act, 1956 nor SEBI Listing Agreement provided any guidance about the role and responsibilities of independent directors. 

Historical background on independent directors 

The concept of independent directors was first introduced through Kumar Mangalam Birla Committee constituted by the Securities Exchange Board of India (‘ hereinafter ‘SEBI’). This has been incorporated in clause 49 of the Listing Agreement. This Committee defined independent directors as directors who apart from receiving the director’s remuneration, do not have any other material pecuniary relationship or transactions with the company, its promoters, its management, or its subsidiaries, which in the judgment of the board may affect the independence of judgment of the director. Later Naresh Chandra Committee was also constituted under SEBI which not only expanded the duties, liabilities, and remuneration of Independent Directors but also recommended that 50% of the total members on the board must be Independent Directors and be exempt from criminal and civil liabilities. Later, Narayan Murthy Committee was constituted which rejected the Naresh Chandra Committee recommendations of treating nominee directors of financial institutions as Independent Directors and also emphasized the need for evaluating the performance of non-executive directors and limit on independent director remuneration. Lastly, J.J Irani Committee was constituted which came up with several recommendations with respect to Independent Directors that were in conflict with clause 49 of the Listing Agreement and the recommendations of the Narayan Murthy Committee. 

It was only after the adoption of the Companies Act, 2013 ( hereinafter ‘the Act’) clarity to the concept of Independent Directors was given to a great extent. Now Independent Director has been statutorily defined under Section 2 (47) of the Act which means independent director referred to in subsection (5) of Section 149 of the Act. 

Who is an independent director? 

An independent director is a director other than managing director or whole-time director or nominee director. In other words, an independent director is a non-executive director of the company who brings objectivity and independence in the decision-making by the Board of Directors of the company. The Board of Directors acts as the brain of the company and when the brain functions optimally, the corporation is said to function efficiently. 

Section 149(6) of the Act highlights the criteria for independence before the appointment of a person as an independent director with respect to the relationship with promoters, holding company, subsidiary company, associate companies, transaction through relatives, shareholding in the company, appointment of a firm of auditors and many others. The appointment of independent directors of the company shall be approved at the shareholders’ meetings. Further such appointments shall be formalized through a letter of appointment highlighting terms of appointment, the expectation of the Board from the appointed director, the fiduciary duties that come with such appointment along with accompanying liabilities, and many more. Having stated the above, the provisions relating to Independent Directors have been found in Section 149, Section 150 of the Companies Act, 2013, and Schedule IV read with Rules 4 and Rule 5 of the Companies (Appointment and Qualification of Directors) Rules, 2014. 

An independent director is not subject to the retirement of directors by rotation rather independent director shall hold office for 5 consecutive years on the Board of the company and is eligible for reappointment on the passing of a special resolution by the company. Independent directors shall not hold office for more than two consecutive terms and shall be eligible for reappointment after a cooling-off period of 3 years. 

The remuneration which shall be paid to the independent director is sitting fees along with entitlement to the reimbursement of expenses for participation in the Board and other Committee meetings and profits related commission as approved by members of the company. 

Role, duties and liabilities of independent director 

The role and responsibilities of the independent director are enshrined in Section 149(8) read with Schedule IV of the Companies Act, 2013. Schedule IV and SEBI (Listing Obligations and Disclosure Requirement) Regulations 2015 impose huge powers and responsibilities in the hands of Independent Directors. Independent directors review the performance of non-independent directors and the Board of directors as a whole, review the performance of a listed entity taking into account the views of executive directors and non-executive directors, and assess the quality, quantity, and timeliness of the flow of information between the management of the listed entity and the board of directors which is necessary for the board to effectively and reasonably perform their duties. There are instances where Independent Directors have asked the board for massive changes in the company including the change of promoter chairman of the company. Hence the powers and responsibilities are widespread. India seems to be the only country to have this kind of extraordinary importance and role definition for an independent director under the law. 

One of the major roles and functions of an Independent Director is to determine appropriate levels of remuneration of executive director, key managerial personnel, and senior management, and recommend removal of such officers of the company. Independent directors further act as a moderator and arbitrators in the interest of the company in the situation of conflict between management and shareholder’s interest. One of the key duties of an independent director is to report concerns about unethical behavior, actual or suspected fraud or violation of the company’s code of conduct or ethics policy, and keep themselves well informed about the company and the external environment in which it operates. The liability of independent directors is very limited unlike executive directors. The independent director is only liable in respect of such acts of omission or commission by the company which has occurred with his knowledge, attributable through Board process, and with his consent or connivance, and the independent director had not acted diligently. Further, the expertise of an independent director is required for key issues such as choice of long term accounting policy, choice of implementing cyber security program and many more. 

An independent director is the final custodian of the sustainability of the company in matters  such as corporate governance, greater productivity, major efficiencies, and many more.  Independent directors are on audit committees and such audit companies deliberates on finances of the company such as loans taken by the company, key findings in balance sheet, performance of companies in the financial year, and many more. Hence, the Board of Director is a collective responsibility of the company of which independent director is a critical part of it. 

Critical analysis of the role and responsibilities of independent director

The above mentioned discussion highlights the theoretical aspect of the role and responsibilities of independent directors which is completely divorced from the practical realities. In the real world, the independent directors are subdued due to various factors. The author shall highlight the problems and solutions to address submissive behavior of independent directors in Board meetings. 

The roles and responsibilities of independent directors have enhanced multifold and at the same time liability has become more severe.  Hence, overall risks are high for independent directors. Laws are getting complex and there is fear in the mind of professionals and experts to take the position of independent director. A major point to ponder is whether the seat of independent director is onerous and there are more risks than reward in position.  Usually, independent directors are found under the clout and influence of promoter(s) of the company as independent directors are appointed by promoters who control the affairs of the company. Thereafter, independent directors become integral part of the Board as a non-executive director and the burning issue that arises is how independent is independent director in discharging his responsibilities and duties. 

In some instances, the independent directors take an independent view of the board which results in promoters turning unhappy with independent directors, thereafter reappointment of those independent directors becomes uncertain and they are not generally reappointed. This happened in the very famous case where Nusli Wadia was sacked as independent director as he was not ready to work according to the promoters’ lines. It is opined that the concept of independent director has taken a fall from grace as the independent director usually takes its decision for the majority shareholders and minority shareholders are at the receiving end of the stick. The minority shareholders literally have no voice in such situations.  

Another major reason for subdued behavior of independent directors in Board meetings is the performance evaluation mechanism of independent directors. The performance evaluation of an independent director shall be done by the entire Board of Directors excluding the Director being evaluated. On the basis of the report of performance evaluation, it shall be determined whether to extend or continue the term of appointment of the independent director. Thus the onus of reappointment of independent directors are at the whims of the Board and the major motivation for independent directors is to remain in good books of the Board and enjoy the perks. This has led to the situation of “Puppet Independent Directors” who shall be unable to perform his/ her duties diligently. 

It is also found that independent directors are prime witness to swindling of money by the promoters, independent directors are also consenting party to conflict of interest, and independent directors lack behavioral skills inside boardrooms. If independent directors are not independent in their working, then independent directors’ responsibilities and liabilities would be identical to those of promoters’ and other directors.

Suggestions to improve the functioning of Independent Directors in the Board 

The Independent Director needs to boldly put up his point in the board meeting and ask the right questions to the board. Expectation from an Independent Director is to have fierce independent stand on issues in the board meeting, and should also feel free to ask the right questions to the board which has become the biggest limit of an Independent Director. 

  1. There should be no interlocking directorate. 
  2. An independent director should protect minority shareholders of the company.
  3. Independent directors need to ensure that the most appropriate course is adopted considering all information and relevant data with respect to the company.

It is further suggested that the independent director should maintain corporate integrity, transparency, and safeguard the interest of minority shareholders. The independent director plays a significant role in all possible aspects such as review of audit reports, appointment of Key Managerial Personnel (KMP), strategic decisions, risk management, internal controls to protect the interest of minority shareholders.  

It is suggested that Independent directors have a moral capital based relationship with executives of the company and ask questions directly from KMP and not only focus on information provided in board meetings. For example: scheduling a visit to the plant/ facility/ interaction with counsels to get insight into overall issues which are complex and fraught with multiple interpretations. Independent directors need to exercise their powers in a diligent manner; however, such powers and freedom should be at the consent of the Chairman of the Board. In essence, independent director interaction with all board members is important to understand key issues in the company. Hence, a trust based interaction with board members is key to exercise of powers by independent directors and ultimately by the board. Such trust based interaction cumulating into a relationship based flow amongst the board members ensures that the independent directors get to know the company. 

Further, the digitalisation of various reports is one of the effective methods to ensure a fault free compliance in the company. Hence, independent directors should not confine themselves to board rooms, as there is more to do like interaction with the executives, in depth look into businesses and several other things outside the boardroom to analyse the functioning of the company. This will ensure that the independent directors are fully equipped to handle board meetings and minimize fraud in a well-managed company. However, there is no perfect system for an independent director to assess the functioning of the company. Independent directors need to be diligent and empowered and exercise that empowerment, which helps in minimising chances of fraud. 

The dissenting views of the independent director needs to be recorded in minutes of the board meeting; however, if the independent director views are not recorded, then the independent director needs to write to other directors highlighting the means and mechanism to be followed by the company to ensure proper compliance. As per Section 166 of the Act, the interest of the company is of paramount importance. Further, it is not the interest of the promoters which is to be protected but the interest of minority shareholders, public shareholders, banks, etc by the independent director. Hence a balance between promoters’ interest and other stakeholders’ interest needs to be maintained. Hence, independent directors are watch dogs as to the proper functioning of the company.

The independent directors need not be influenced by the power of the suggestion of the heavyweight board members. It is also found that independent directors pay the price of cowardice where independent directors resign one after the another from the board of the company on disclosure of frauds without realising that the ultimate losers are shareholders, lenders, suppliers, banks, etc. Rather, independent directors should act as whistle blowers on failure to provide important and key information by the executives and Board members of the company and bringing the notice of possible fraud upfront to the regulator or the Court. 

A large-scale resignation of independent directors from 2018 is a wrong precedent reflecting cowardice and fear of criminal prosecution and civil prosecution on the part of independent directors. The Government of India has addressed the rampant resignation of independent directors from Boards of several companies, and the Ministry of Corporate Affairs has published a circular vide dated 02-03-2020 that no civil or criminal proceedings should be initiated against the independent directors, non-executive directors without adequate evidence on acts of omission or commission by the company which has occurred with such directors knowledge, attributable to the Board process, and with such directors’ consent or connivance, and that such directors had not acted diligently. In short, civil or criminal prosecution shall commence on such directors if such directors have not acted diligently, such directors connived with the promoters, such directors failed to ask relevant and key information from the board.

It is also suggested that the independent directors shall be appointed on merits and not on the basis of personal relationship with the promoters as close proximity between the independent directors and the promoters do not ensure compliance of proper corporate governance. Such close relationships result in failure to address various corporate crimes with the company. 

The SEBI consultation paper on review of regulatory provisions related to independent directors mandated appointment and reappointment of independent directors through a dual process route, i.e approval of shareholders and approval by majority of minority shareholders, and if either of the approval threshold are not met, the person would have failed to get appointed or reappointed as independent directors. Such proposed measures may be adequate to some extent in distancing independent directors from their alleged relationship with the promoter and promoter group. 

Conclusion 

The Indian corporate sector has matured with time and experience as it has not only clearly spelt the terms of independent directors but also expanded the rights and duties of independent directors. Time is appropriate to address the pitfalls in performing the roles and duties of independent directors to address increasing corporate frauds and scandals. It is also important to highlight the protection provided to independent directors so that such directors perform their duties diligently. Increasing the effectiveness of their role is significant to achieving high governance standards as independent directors are the backbone of corporate governance.  

References

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