Independent Directors: Role, Responsibilities, Effectiveness

  1. Independent Directors: Role in Corporate Governance

Today, Indian corporate law regime seems to be clouded by a plethora of scandals, right from the universally infamous Satyam fiasco a decade back to the recent Nirav Modi scam. Post-Satyam, the Government of India tried to overhaul the corporate regulatory framework a bit (among other efforts) and enacted new legislation i.e. the Companies Act, 2013.[1] The statute was formulated, inter alia, with the objective of improving the standards of corporate governance in India to ensure that such a scandal is not repeated.

The Parliamentary Standing Committee on the Companies Act, 2009 observed that the role of independent directors assumed great significance after the failure of a major corporation like Satyam Computer Services.[2] Therefore, one of the salient features of the Companies Act, 2013 was that it brought clarity on the functions, liabilities and duties of independent directors.[3] Prior thereto, there was uncertainty because neither the Companies Act, 1956 nor the Securities and Exchange Board of India (SEBI) Listing Agreement provided any guidance about the role of independent directors.[4]

At present, the role and functions of independent directors are primarily governed by the Companies Act, 2013 and the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. In case of a listed company, where the Chairperson of the Board of Directors is a non-executive director, at least one-third of the Board of Directors shall comprise of independent directors and where the listed entity does not have a regular non-executive Chairperson, at least half of the Board of Directors shall comprise of independent directors.[5] Recently, through the SEBI (Listing Obligations and Disclosure Requirements) (Amendment) Regulations, 2018, SEBI has mandated that the Board of Directors of the top 500 listed entities shall have at least one independent woman director by 1-4-2019 and the Board of Directors of the top 1000 listed entities shall have at least one independent woman director by 1-4-2020 .[6]

(i) Appointment and Qualifications of Independent Directors

It is widely recognised that appointment of independent directors ensures an effective and balanced composition of the Boards.[7] Section 149(6) of the Companies Act, 2013 lays down the following pre-requisites for being appointed as an independent director:

(a)?Qualitative Requirements: The person should be of integrity with relevant expertise and experience.[8] Further, he should also possess an appropriate balance of skills, experience and knowledge in one or more fields of finance, law, management, sales, marketing, administration, research, corporate governance, technical operations or other disciplines related to the company’s business.[9]

(b)?Restriction on Professional Relationships: The person should neither be a promoter nor related to the promoters or directors of the company, its holding, subsidiary or associate company.[10] Neither the person nor his relatives should be key managerial personnel (KMP) or employee in the company or its holding, subsidiary or associate company in any of the three financial years immediately preceding the financial year.[11]

Further, the person should or should not have been an employee or proprietor or a partner of a firm of auditors or legal consultants of the company or its holding, subsidiary or associate company in any of the three financial years immediately preceding the financial year.[12] The person should also not be a Chief Executive or director of any non-profit organisation (NPO) that receives twenty-five per cent or more of its receipts from the company, any of its promoters, directors or its holding, subsidiary or associate company or that holds two per cent or more of the total voting power of the company.[13]

(c)?No Pecuniary Relationships: Apart from the director remuneration or other amount as may be prescribed, the person should not have or had any pecuniary relationship with the company, its holding, subsidiary or associate company, or their promoters, or directors during the year or the two immediately preceding financial years.[14] None of the relatives should have any pecuniary relationship that has been prohibited under Section 149(1)(d).

(d) Restriction on Voting Powers: He should not hold, together with his relatives, two or more than two per cent of the total voting power of the company.[15]

Therefore, these requirements ensure that the independent director is “independent” of the company (in real sense of the word) and would be able to objectively perform his or her duties without any fear, favour or prejudice.

(ii) Duties of Independent Directors

The J.J. Irani Committee Report on Company Law aptly summarises the functions and duties of independent directors:

While directors representing specific interests would be confined to the perspective dictated by such interests, independent directors would be able to bring an element of objectivity to Board process in the general interests of the company and thereby to the benefit of minority interests and smaller shareholders.[16]

Based on this, the Companies Act, 2013 provides a comprehensive “Code for Independent Directors” which not only lays down the guidelines of their professional conduct, but inter alia a list of their role, functions and duties as well.[17] Some of the important duties of an independent director include attending general meetings, being well informed about the operation of the company and its external environment, reporting concerns about unethical behaviour, actual or suspected fraud or violation of the company’s code of conduct or ethics policy, etc.[18]

However, it has been observed in various instances that some independent directors have failed to perform their duties according to these standards. The next section provides case studies of various such cases .

  1. Is the Institution of Independent Directors Effective

Recent years have witnessed major instances of corporate mismanagement and lack of corporate governance even in Indian companies that boasted of having high standards of compliance and governance.[19] Owing to this, questions have been raised about the accountability of independent directors and whether this institution is effective in the Indian context.

There has been a plethora of instances where independent directors have quitted when the company started facing some issues.[20] After problems surfaced in Jet Airways, several of its independent directors resigned from the Board of Directors of the company. In fact, although some directors cited “time constraints” as a reason for his resignation, they continue to hold this position in various other corporate giants. One of these was the head of Jet Airways’ Risk Management Committee and according to the Annual Report of Jet Airways, the Committee did not even meet once in 2017-2018.[21]

A similar situation was observed in Infrastructure Leasing and Financial Services (IL&FS) where several independent directors stepped down when the company defaulted on its payment obligations.[22] None of these directors have provided any adequate reasons for their immediate resignation in times of trouble. The Ministry of Corporate Affairs (MCA) wants to question the independent directors of the company in order to understand why did they not raise red flags when they should have sensed trouble.[23] Reports reveal that the Risk Management Committee of IL&FS, which includes independent directors as well, had not conducted even one meeting in the previous four years.[24] Although one of the independent directors took a defence of lack of knowledge, most people are not accepting this contention as they believe that even outsiders were aware of the internal concerns and thus, it was the duty of independent directors to raise questions.[25]

This raises serious questions regarding the role of independent directors in corporate governance. Instead of performing their duty of protecting the interests of the minority and reporting fraudulent conduct, they are often cited running away when things go wrong.

However, there have been occasions where independent directors have raised their voice against alleged corporate governance failures in their company and the results have been disastrous. One such example is the role played by Nusli Wadia in the Tata-Mistry spat. Although the National Company Law Tribunal (NCLT) dismissed the oppression and mismanagement charges alleged by Cyrus Mistry[26], removing an independent director because his views are contradictory to that of the majority shareholder raises serious concern regarding the effectiveness of the institution of independent directors.[27]

It is pertinent to note that not all independent directors perform their functions properly; but then there are some who are determined to work effectively and in compliance with their duties and expectations. Thus, the Government and the regulatory authorities like SEBI need to come up with solutions that ensure that not only are the independent directors incentivized and motivated to work, but they are also provided with adequate powers and protection to carry out their functions.

  1. The Panacea Sought — Effective Governance or Extreme Governance

In order to ensure the efficacy of independent directors and enhance their role in corporate governance, the MCA has proposed to bring certain changes in the legal regime. MCA believes that independent directors are not performing their duty of objectively supervising corporate governance compliance and are merely enjoying perks of high office.[28]

MCA has suggested amendments to the Companies Act, 2013 and had asked for comments on the proposed amendments which were to be sent by 20-11-2018.[29] Newspaper reports also suggest amendments that seek to tighten the corporate governance norms related to independent directors.[30] Some of them are as follows:

(i) Cap on Total Pecuniary Relationship

The Report of the Committee to review offences under the Companies Act, 2013 stated that the “proportion that the financial rewards from the company constitute in the independent director’s overall earnings” plays a crucial rule in determining his “independence” from the company.[31] It was observed that the loss or even fear of loss of such revenue might make them vulnerable to the promoter group or majority shareholders.[32]

Therefore, the Committee recommended that the total pecuniary relationship with the company, its holding, subsidiary or associate company, or their promoters or directors, shall not exceed 20 per cent of his total income of which, professional or any services rendered by him, shall not account for more than 10 per cent of his total income.[33] Further, the sitting fees and expenses incurred for participation in Board and Committee meetings shall not be considered for this calculation. In its proposed amendments the MCA has incorporated these suggestions but has increased the percentage from 20 per cent to 25 per cent of his total income.[34]

(ii) Filing of Declaration of Independence with Registrar of Companies (RoC)

The proposed amendment provides for filing a declaration of independence with the RoC with such particulars of his/her independence as may be prescribed.[35] At present, the same is required to be given only at the first meeting of the Board in which the independent director participates as a director and thereafter at the first meeting of the Board in every financial year or whenever there is any change in the circumstances which may affect his status as an independent director.[36]

(iii) Resignation of Independent Directors

Under Section 168 of the Companies Act, 2013, a director may resign from his office by giving a notice in writing to the company. On receipt of such resignation notice, the company is required to intimate the RoC and the information of the resignation should be provided in the report of directors laid in the immediately following general meeting by the company.[37]

The proposed amendment requires independent directors to not only provide detailed reasons for their resignation within 7 days, but also states that the resignation would not be effective until the 30th day from the date of receipt of notice of resignation by the company.[38] It is pertinent to note that in case of other directors, the resignation would be effective immediately.

(iv) Removal of Independent Directors through Special Resolution

Under Section 169 of the Companies Act, 2013, a director, other than an independent director or NCLT appointed director, can be removed through an ordinary resolution. However, the section contains a proviso which states that independent directors can be removed only during their second term where they have been reappointed and only through a special resolution.[39] The MCA has proposed an amendment wherein the independent directors can now be removed during their first term of appointment as well.[40]

(v) Removal of Unfit Independent Directors by NCLT on Government Recommendation

In light of the lack of performance of fiduciary duties by independent directors, the MCA is considering amending the Companies Act, 2013 to permit the Government to evaluate the independent directors and then, based on the findings file an application for their dismissal with the NCLT.[41] Such dismissal would have the effect of disqualifying the person from holding any position in the Board for years.[42]

(vi) Requirement of Mandatory E-Registration

In a move to tighten norms for independent directors, the MCA has proposed a procedure of mandatory e-registration for independent directors. This will not only serve as a screening mechanism for appointment of independent directors but will also help in creating their database.[43]

(vii) Freezing of Assets of Independent Directors

The most severe step taken by the MCA, that spread shock waves all over the corporate fraternity, was the freezing of assets of independent directors of defaulting companies. By an order dated 22-11-2017, the Supreme Court restrained inter alia the independent directors of Jaiprakash Associates from transferring any of their personal assets.[44] In case of violation of the said order, the independent directors were to be liable for both criminal prosecution and contempt of court.[45] Similarly, the National Company Law Appellate Tribunal (NCLAT) also passed an order directing the freezing of assets of independent directors of Punjab National Bank.[46] However, the Supreme Court provided relief to them by putting a stay on the NCLAT order.[47]

While all stakeholders are unanimous about the professional standards expected of independent directors, these developments have created a hostile environment for the independent directors. With increasing obligations and compliance requirements, higher accountability and lower pay and incentives, their job has been made tougher than ever. Although the government intention behind such regulations is to keep a check on independent directors and ensure effective performance of their fiduciary duties, it might lead to a worse situation where no one would want to be an independent director. Thus, such an endeavour has potential to become counterproductive.

It must be understood and appreciated that unlike executive directors of a company, independent directors are not involved in the day-to-day functioning. Their powers are limited to raising questions when things get suspicious and they have no other alternative of finding out the wrongdoings of the company. Moreover, even if they try to fulfil their fiduciary duties genuinely, their decision might not always be taken into consideration by the Board.[48]

All these factors clubbed with the fact that the legal framework provides no protection to independent directors[49] have led various independent directors of repute to resign from the directorships they are holding. This might reflect badly on the Indian corporate landscape as it would discourage competent individuals from serving as independent directors.

  1. Conclusion: The Road Ahead

Tightening the corporate governance norms for independent directors might not be the ultimate solution to deal with the increasing corporate frauds and scandals. This is primarily because of two reasons: firstly, not all wrongdoings can be traced by the independent directors as they are not involved in the day-to-day functioning of the company and secondly, with increasing responsibility and liability, no incentive to blow the whistle and no recourse for protection under the current legal framework, the institution of independent directors may not be viable.

In such a scenario, it is important for the Government to understand that they should protect the genuine independent directors as well. In a country like India, where major corporates are owned by business families forming majority, often the job of the independent director is at the mercy of the promoters. At present, the changes proposed by the MCA would put the independent directors between a rock and a hard place where on one hand, if they try to raise red flags — the majority shareholders might remove them through a special resolution and on the other, if they do not do so, the MCA may take extreme steps like freezing their personal assets, removing and debarring them, etc .

Hence, the Government needs to balance the interests of the company and the independent directors. Excessive regulation will worsen the situation and is therefore undesirable. One method of achieving this objective is providing additional protection to independent directors and instead of the power of their appointment and removal being vested entirely with the majority, the minority shareholders should also be given a say. This would further the objective of appointing independent directors as one of the aims they seek to achieve is protecting the interests of minority shareholders.

Only if the independent directors believe they are protected under the law would they be able to perform their functions diligently. Increasing the effectiveness of their role is significant to achieving high governance standards as independent directors are the backbone of corporate governance.


*Bhumesh Verma is Managing Partner at Corp Comm Legal and can be contacted at bhumesh.verma@corpcommlegal.in. **Sara Jain is a Student Researcher with Corp Comm Legal (4th-year student of Maharashtra National Law University, Mumbai).

[1]    Rica Bhattcharyya and Sachin Dave, Lesson from Satyam: Corporate Governance Evolves, not Execution, Economic Times (7-1-2016)<https://economictimes.indiatimes.com/news/company/corporate-trends/lesson-from-satyam-corporate-governance-evolves-not-execution/articleshow/50476372.cms>.

[2]    Kaushik Dutta, Handbook for Independent Directors: Upholding the Moral Compass 13 (2nd Edn., 2017).

[3]    Avtar Singh, Introduction to Company Law 1 (11th Edn., 2014).

[4]    Shinoj Koshy, Preetha S. and Vandana V., The Responsibilities, Rewards and Liabilities of Independent Directors will be Transformed by the New Companies Act, 7 India Business Law Journal 25, 26 (2014).

[5]    SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, Regn. 17(1)(b).

[6]    SEBI (Listing Obligations and Disclosure Requirements) (Amendment) Regulations, 2018, Regn. 17(1)(a).

[7]    Pranav Mittal, The Role of Independent Directors in Corporate Governance, 4 NUJS Law Review 285, 287 (2011).

[8]    Companies Act, 2013, S. 149(6)(a).

[9]    Companies Act, 2013, S. 149(6)(f); Companies (Appointment and Qualification of Directors) Rules, 2014, R. 5.

[10]   Companies Act, 2013, S. 149(6)(b).

[11]   Companies Act, 2013, S. 149(6)(e)(i).

[12]   Companies Act, 2013, S. 149(6)(e)(ii).

[13]   Companies Act, 2013, S. 149(6)(e)(iv).

[14]   Companies Act, 2013, S. 149(6)(c).

[15]   Companies Act, 2013, Section 149(6)(e)(iii).

[16]   Jamshed J. Irani, Report on Company Law, at 23 (2005).

[17]   Companies Act, 2013, Sch. IV.

[18]   Prachi Manekar, Insights into the New Company Law 2015 45 (2016).

[19] M. Damodaran, Board Failures: If Winter Comes, BloombergQuint (24-12-2018) <https://www.bloombergquint.com/opinion/board-failures-the-year-corporate-governance-came-of-age-m-damodaran>.

[20]  Jayshree P. Upadhyay, Why Independent Directors are Rushing for the Exit Door, Livemint (19-12-2018) <https://www.livemint.com/Companies/bntAau6XcAhPfTZ5yCVx7O/Why-independent-directors-arerushingfortheexit-door.html>.

[21] Dev Chatterjee, Jet Saga: All Board Members are Equally Liable for the Crisis, Say Lawyers, Smart Investor (22-4-2019) <https://smartinvestor.business-standard.com/market/story-579780-storydet-Jet_saga_All_board_members_are_equally_liable_for_the_crisis_say_lawyers.htm#.XNwcY-gzZPY>.

[22]   IL&FS Financial Arm’s CEO Ramesh Bawa Quits as Company Defaults on LC Payments, Business Today (22-9-2018)

     <https://www.businesstoday.in/current/corporate/il-and-fs-financial-services-ceo-ramesh-c-bawa-quits-company-defaults-on-lc-payments/story/282726.html>.

[23]   IANS, MCA Wants to Question Erstwhile IL&FS “Independent Directors”, Moneylife (14-5-2019) <https://www.moneylife.in/article/mca-wants-to-question-erstwhile-ilfs-independent-directors/57156.html>.

[24]   Joel Rebello and Kala Vijayaraghavan, RBI Audit of IL&FS Group Makes Independent Directors Jittery, Economic Times (1-10-2018) <https://economictimes.indiatimes.com/markets/stocks/news/rbi-audit-of-ilfs-group-makes-independent-directors-jittery/articleshow/66022060.cms>.

[25]   Ibid.

[26]   Cyrus Investments (P) Ltd. v. Tata Sons Ltd., 2017 SCC OnLine NCLAT 261.

[27]   Vidya Sunderam, Cyrus Mistry’s Case Shifts Focus on Role of Independent Directors, 38 Taxmann’s Corporate Professionals Today 11-12 (2017).

[28] Sidhartha, Independent Directors Face Mandatory E-Registration, Times of India (8-5-2019) <https://timesofindia.indiatimes.com/business/india-business/independent-directors-face-mandatory-e registration/articleshow/69224866.cms>.

[29]  Ministry of Corporate Affairs, Notice Inviting Comments: Amendments to the Companies Act, 2013 (11-11-2018) <http://www.mca.gov.in/Ministry/pdf/NoticeAmendmentsCA2013_05112018.pdf>.

[30]  Veena Mani, MCA Plans to Frame Tougher Regulations for Independent Directors, Business Standard (4-7-2018) <https://www.business-standard.com/article/economy-policy/mca-plans-to-frame-tougher-regulations-for-independent-directors-118070301360_1.html>.

[31]   Ministry of Corporate Affairs, Report of the Committee to Review Offences under the Companies Act, 2013, 55 (August 2018).

[32]   Ibid.

[33]   Id. at 64.

[34]   Ibid (n 29).

[35]   Ibid.

[36]   Companies Act, 2013, S. 149(7).

[37]   Companies Act, 2013, S. 168(1).

[38]   Ibid (n 29).

[39]   Companies Act, 2013, S. 169(1).

[40]   Ibid (n 29).

[41] Rajat Arora, Government May Ban Unfit Independent Directors from Holding Any Board Position for Five Years, Economic Times (19-10-2018)<https://economictimes.indiatimes.com/news/economy/policy/govt-may-ban-unfit-independent-directors-from-holding-any-board-position-for-five-years/articleshow/66279607.cms>.

[42]   Ibid.

[43]  Veena Mani, MCA Plans to Frame Tougher Regulations for Independent Directors, Business Standard (4-7-2018) <https://www.business-standard.com/article/economy-policy/mca-plans-to-frame-tougher-regulations-for-independent-directors-118070301360_1.html>.

[44]   Chitra Sharma v. Union of India, 2017 SCC OnLine SC 1660.

[45]   Ibid.

[46]   Tarun Sharma, NCLAT Upholds MCA’s Move to Freeze Assets of Independent Directors in PNB Fraud Case, Moneycontrol (12-7-2018)<https://www.moneycontrol.com/news/business/markets/nclat-upholds-mcas-move-to-freeze-assets-of-independent-directors-in-pnb-fraud-case-2704611.html>.

[47]   Indu Bhan, SC Stays NCLAT Order Allowing Asset Freeze of 4 Independent Directors, Financial Express (11-8-2018) <https://www.financialexpress.com/industry/sc-stays-nclat-order-allowing-asset-freeze-of-4-independent-directors/1277280/>.

[48]   Ministry of Corporate Affairs, Report of the Committee to Review Offences under the Companies Act, 2013, 55 (August 2018).

[49] Paval Lall, Why Independent Directors go for the Escape Hatch, Rediff (2-12-2018) <https://www.rediff.com/money/report/why-independent-directors-go-for-the-escape-hatch/20181202.htm>.

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