The Companies Act, 20131 (hereinafter “the Act”) governs the concept of independent directors and their existence in India. As per the Act, every listed public company has a mandate to appoint a minimum of 1/3rd of total directors as independent directors in such Board of the company2.
Even unlisted public companies are required to appoint at least two independent directors if:
- the public company’s paid-up share capital is Rupees 10 crore or more;
- turnover of Rupees 100 crore or more; and
- public company with total unpaid loans, debentures and deposits comprising of more than Rupees 50 crore.3
Section 149(6)4 of the Act further provides the criterion applied to these directors adhering to the Act while conferring the roles and responsibilities upon the same.
Schedule 45 to the Act further provides for a mandate upon the independent directors to abide by a code of conduct (Code for Independent Directors). It sets out the basic guidance as to how an independent director is to function following their appointment and provides with duties to be discharged and the Code is directive in nature.
In Atul B. Munim v. Registrar of Companies6 it was held that “officer in default” and its interpretation to determine the liability is not a mechanical process which can be applied to the facts of every case and provisions of law.
In Rajendra Shah v. State of Maharashtra7 it was concluded by the Court that if a complaint does not disclose any prima facie case for making the accused liable as the principal officer for managing the day-to-day affairs of the company (directors), then they cannot be prosecuted for the company’s offence until it is proved that they consented to such action and the same had been brought to their attention.
The 2019 Amendment [the Companies (Amendment) Act, 2019]8 was brought into effect on 31-7-2019 bringing changes to the Act brought initially by the Companies (Amendment) Ordinance, 20189, the Companies (Amendment) Ordinance, 201910 and the Companies (Amendment) Second Ordinance, 201911. The amendment brought about changes in Section 21212 of the Act which deals with the procedure of investigating into fraud allegations against the company. Following the amendment, any key managerial personnel, officer, accused who took an unfair advantage in any form (asset, property, cash, etc.) can trigger the Central Government to file an application before the Tribunal or any other appropriate order to disgorge such asset, property, cash and also establish an unlimited liability upon such person who committed the offence.
This amendment has undoubtedly widened the ambit of Section 212 and now includes any person irrespective of it being an independent director to be held liable under the Act.
Problems faced by the institution of independent directors
The Satyam Computer Services financial fraud in India can be said to have triggered the Government and the Securities and Exchange Board of India (hereinafter “SEBI”) to introduce a stricter liability regime to govern directors and the traces of such a regime can be observed in various statutes such as the Act, the SEBI Act, 199213 and the rules and regulations inclusive of the listing agreements with stock exchanges (hereinafter “the listing agreement”).
However, while these stringent laws might have targeted the evils being undertaken by corporate entities but the manner of their implementation has brought about further negative implications, especially for independent directors. If there is a non-compliance to the statutory obligations by any body i.e. company, independent directors, non-executive directors, etc. they can be in a situation which would bring them severe reputational harm along with added risks of criminal liability even for the acts they did not consent to and had no control over.
In the recent IL&FS Financial Services (IL&FS) scam in 2019, the Ministry of Corporate Affairs (MCA) broadened the ambit and scope of investigation to include independent directors as well and filed a petition in the National Company Law Tribunal (hereinafter “NCLT”) seeking an implication of new parties following the Serious Fraud Investigation Office Report which had implicated officers such as independent directors for mismanagement.
This enlargement of the ambit to include independent directors enabled the MCA to act, to protect and determine any irregularities and facilitate investigation to understand an independent director’s role. This is the reason why this action was not challenged however, it can be said that this change to the mechanism can hinder an independent director’s will to exercise their independence and with their performance efficiency as he/she now becomes closely associated to the actions of the company irrespective of their “real” conduct.
The level of skill and care expected from executive directors while discharging their duties varies greatly from that of independent directors and their functions and therefore, the two should not be kept at an equal footing and be treated equally when it comes to such investigations pertaining to serious allegations. There is no doubt that an executive director exercises a much higher degree of control over the affairs of a company as compared to an independent director.
It is pertinent to note that Section 149(12)14 of the Act provides for independent directors to be held liable only for the actions that were undertaken with their consent or if they had knowledge about the same. This is a protectionist provision which aims to ease the liability of independent directors and to enable them to discharge their functions fairly. However, it can be said that this provision in itself is very narrow and limited while providing protection as such directors still remain vulnerable at other stages of an investigation including summons, etc. which causes a greater reputational harm. This section though protective can be used only at a very late stage and thus, remains insufficient to provide a holistic protection to independent directors.
The Standing Committee on Finance in its Report15 has suggested various recommendations to provide further safeguards to independent directors and aid in mitigating their liability including:
- Modification to the clause limiting independent directors’ liability to ensure a holistic protection under other statutes as well apart from the Act.
- Non-issuance of arrest warrants against an independent director unless issued by a District Judge after the independent director has been given an opportunity of being heard.
- However, if an independent director is found to be directly involved or responsible in any illegal action, the protections should be removed and he/she should be duly prosecuted.
The authors are of the opinion that there exists a need of reform in the existing uncertain liability framework for independent directors including the dire need to address the existing disconnect between the principles of substantive conduct that such directors are required to abide by and the structural idea of their independence. The same is vital because of the co-relation between independence of such directors and good corporate governance regime as highlighted in the revered Uday Kotak Committee16.
The above argument has been made in light of the recent trend that suggest an increase in resignations by independent directors especially in listed companies by citing convincing reasons17. Notably in 2018 a total of 60618 independent directors resigned. Surprisingly, just in a span of 6 months in the year 2019, 412 independent directors resigned without providing any sufficient reasons other than the conventional “pre-occupation” and “personal grounds”. This alerting trend is no different from the year following the Satyam Scam Fiasco in 2009.
It is known that independent directors are not responsible for the key day-to-day management of a company unlike executive directors. Their main task is to essentially provide an external perspective in the management and independence in the decision-making procedure abiding by the corporate governance standards. They have been bestowed with duties like duty to abide by the articles of association, duty of care, good faith, diligence, skill and not gain unfair advantage19.
Along with the Act, the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 201520 (hereinafter “the LODR Regulations”) mandate every listed company to at least have half of their Board comprising of independent directors in case the Chairman is an executive director or a non-executive director being a promoter or being related to the promoters or holding a position at Board level or below the same. In other situations, the listed companies shall have at least one-third independent directors.
There is no threshold to determine as to what was within “the knowledge” of independent directors while the respective decisions were made. The same involves the dual play of actual as well as constructive knowledge. While actual knowledge essentially means something being known by the director in fact, the issue of constructive knowledge brings with itself a rather unsettled position in law as it essentially means something that the director “ought to know”. As noted above, there exists a problem of “information asymmetry” in the current regime which leads to independent directors not having sufficient means and knowledge to arrive at their decisions unlike their executive counterparts. Other issues like absence of difference between Board and management responsibilities, heavy personal liabilities, falling ethical standards in Board rooms and need for greater safeguards for independent directors exist in the current regime.
Most complaints made under the Negotiable Instruments Act, 188121 impute even independent directors causing them inconvenience in cases of dishonour of cheques. The same is problematic and requires consideration as such directors are not involved in the day-to-day management of the company in any executive capacity.
Protectionist measures for independent directors
The Supreme Court in Pooja Ravinder Devidasani v. State of Maharashtra22 has held that simply because a person is a director of a company, he/she does not become liable for all actions of the company. A non-executive director is not usually involved in day-to-day affairs of the company and can be made liable only when he/she was the helm of its affairs.
Even the Act provides certain mitigating factors which limit the liability of these directors. As noted above, Section 149(12) of the Act provides that these directors can be made liable for acts of omission or commission on part of a company only when they occur with:
- his/her knowledge;
- with his/her consent or connivance;
- attributable through Board processes; or
- where he/she did not act diligently.
The Act further makes it permissible for companies to obtain directors and officers insurance for its key managerial personnel in relation to indemnifying them against liabilities with respect to any default, breach of duty, breach of trust or negligence, etc.23
It may be further noted that the current liability regime casts liability on directors in broadly two ways. First being vicarious liability set out for those officers who are in charge of the company in relation to the conduct of its business. The same is based on the powers that have been assigned to the directors and it may be noted that the actual commission of any offence is not a prerequisite for such liability to be imposed. Secondly, vicarious liability being set out in relation to those officers who contribute towards the violation by conniving, consenting or failing to act diligently thereby facilitating the offence to take place. This liability requires a threshold of wrong on part of these directors as a result of their consent and/or connivance.
The cardinal rule on this argument can be understood from the Supreme Court decision in Sunil Bharti Mittal v. CBI24 wherein it has been held that the principle of alter ego can be applied only to make a company liable for the acts of a person who exercised a pervasive and significant control over the affairs of the company and not vice versa. Further, the directors can be made liable for the wrongs committed by the company only when there exists sufficient evidence proving that they played an active role with a criminal intent or otherwise. Vicarious liability shall not be imposed on any director without the presence of a legislative mandate. However, a few recent instances suggest that the Supreme Court has departed from the cardinal rule on the legal liability of independent directors25.
The authors most respectfully submit that mitigating factors that should be considered while ruling on the liability in such cases should be knowledge, exercise of due diligence, the actual independence that these directors were able to exercise, excessive intervention and control of majority shareholders and executive directors on these directors, etc.
The application of “business judgment rule” in India
The Act provides26 that in any proceeding relating to default, negligence, misfeasance, breach of trust/duty, if the Court is of the opinion that the officer acted in a reasonable manner, the Court may partly or wholly relieve him from the liability. In this manner, the business judgment rule protects the directors by taking into account factors like reasonableness, honesty, circumstances relating to their appointment, etc.
Conclusion and suggestions
An independent director and their importance can be said to have increased due to multiple reasons in recent times including as a means to protect public investors especially in regulated/controlled companies globally. The Uday Kotak Committee in 2017 emphasised the importance of these directors by stating:
The institution of independent directors forms the backbone of the corporate governance framework worldwide and in India. Independent directors are expected to bring objectivity into the functioning of the Board and improve its effectiveness. Independent directors are required to safeguard the interests of all stakeholders, particularly minority shareholders, balance the conflicting interest of the stakeholders and bring an objective view to the evaluation of the performance of the Board and management26.
The practical framework governing independent directors varies greatly from what the normative concept stands for. After analysing the present regulatory framework pertaining to the liability of independent directors, it can be said that it relies heavily on technicalities and procedural formalities while falling short on the aspect of implementing the same. There exists a huge gap between the expectations placed on the position of an independent director and the liabilities they have been bestowed with, which is filled with incongruities in the extant laws including a limitation to their powers, insufficient protection granted and uncertain liability regime.
The authors are of the view that there is a need to reassess this framework and reformulate corporate governance standards with an aim to expand the independent directors’ independence, protect their interests in order to provide a holistic strength and efficiency to their very functioning.
† BA LLB (Hons.) 5th year law student, Gujarat National Law University.
††BA LLB (Hons.) 5th year law student, Gujarat National Law University.
2 S. 149(4) of the Companies Act, 2013.
3 R. 4, the Companies (Appointment and Qualification of Directors) Rules, 2014.
15 Ministry of Corporate Affairs, Standing Committee on Finance 2011-2012 , 57th Report, The Companies Bill, 2011 (2012) <English_Book_Final (eparlib.nic.in)> accessed on 17-10-2021.
16 Securities and Exchange Board of India, Report of the Committee on Corporate Governance (2017) <SEBI | Report of the Committee on Corporate Governance> accessed on 18-10-2021.
17 Kala Vijayraghavan, Rica Bhattacharyya and Maulik Vyas, More Independent Directors take the Exit Fearing Legal Scrutiny (The Economic Times, 21-6-2019) <More independent directors take the exit fearing legal scrutiny – The Economic Times (indiatimes.com)> accessed on 17-10-2021.
18 Jayshree P. Upadhyay, Why Independent Directors are Rushing for the Exit Door <Why independent directors are rushing for the exit door (livemint.com)> accessed on 17-10-2021.
19 S. 166 of the Companies Act, 2013.
23 S. 197(13) of the Companies Act, 2013.
25 Chitra Sharma v. Union of India, (2018) 18 SCC 575; Usha Ananthasubramanian v. Union of India, (2020) 4 SCC 122.
26 S. 463 of the Companies Act, 2013.
26 Securities and Exchange Board of India, Report of the Committee on Corporate Governance (2017) <SEBI | Report of the Committee on Corporate Governance> accessed on 18-10-2021.