Concept of Independent Directors in light of increasing Corporate Governance Mechanisms.

Independent directors (“ID“) play the role of upholding the interests of shareholders and ensuring that the company runs lawfully which includes its equitable functioning. The need for an in-house person(s) to monitor various facets of the company such as financial statement, auditing, the interest of minority shareholders is imperative. Persons performing this function cannot have a financial relationship or any other relationship as mentioned (in the Companies Act and its rules & regulations) with the company or its subsidiaries and any other relationship with the aforementioned should be revealed, for him/her to act true to such role. This has been incorporated in the Companies Act 2013 and the rules and regulations under the Securities and Exchange Board of India. It cannot go unsaid that a major chunk of legal concepts has been borrowed from English law and so the article aims at tracing its origins to establish the functions and objectives of an independent director.

The UK Corporate Governance Code (“the Code“) first published in 1992, had provisioned for a system to control and direct companies. The Board of directors make decisions on behalf of the stakeholders and are thus answerable to them. It is a pattern that for a board resolution to come into effect, the approval of shareholders in a general/extraordinary general meeting is mandatory (in most cases). The Code of 2016 mandates the presence of a senior independent director in the board committee for clearing the annual report. One may draw a parallel between the duties and liabilities of an independent director in the Companies Act 2013 to the role of non-executive director prescribed in the Code. The Code of 2016 mandates the following:

  • The chairman should hold meetings with the non-executive directors without the executives present.
  • Led by the senior independent director, the non-executive directors should meet without the chairman present at least annually to appraise the chairman’s performance and on such other occasions as are deemed appropriate.
  • Where directors have concerns which cannot be resolved about the running of the company or a proposed action, they should ensure that their concerns are recorded in the board minutes.
  • On resignation, a non-executive director should provide a written statement to the chairman, for circulation to the board, if they have any such concerns.

Companies Act, 2013 and the Rules

The Companies Act 1956 did not entail the role of an independent director but clause 49 of the SEBI listing agreement first introduced in February 2000 stated that the number of independent directors would depend whether the Chairman is executive or non-executive. In case of a non-executive chairman, at least one-third of board should comprise of independent directors and in case of an executive chairman, at least half of the board should comprise of independent directors. The amendment to clause 49 was made in September 2000 wherein, any institutional directors on the boards of companies (other than Govt. companies) were deemed as independent directors. The latest amendment to the composition of board via SEBI circular dated April 7, 2014; mandated the quorum of board with at least one-third being independent directors in the case of a non-executive chairman of the board; and in case of not having a regular non-executive chairman at least half the board should consist of independent directors. 

The Companies (Appointment and Qualification of Directors) Second Amendment Rules, 2018 specifies the qualification and responsibilities of an independent director; which was an amendment to the 2014 rules. The amendment rules have imposed the additional liability on the ID to be the guarantor or provide security for the debt of the company to any third person, its holding company, subsidiary, their promoters and directors. This has led to the triggering of insolvency proceedings against independent directors as Companies Regulations have mandated directors to stand as guarantors or provide security to creditors. The Supreme Court has established that the directors/members of a company are not subject to the moratorium which is availed by a company. Section 149 of the Companies Act states that every listed public company shall have at least one-third of the total number of directors as independent directors and the Central Government may prescribe the minimum number of independent directors in case of any class or classes of public companies. A listed company should have an audit committee with a minimum of three directors of which at least 2 of them must be independent directors as per section 177 Companies Act.

SEBI Regulations and Circulars

The SEBI (Listing Obligation and Disclosure Requirement) Regulations, 2015 confer responsibility and enable independent directors to carry on their managerial and supervisory functions. Regulation 4 (3) (14) has the enabling clause for independent directors to perform their role as a member of the board of directors and also as a member of the board of committee of directors. Regulation 16 defines an independent director who is a non-executive director, other than a nominee director of a listed entity. He must have relevant expertise and is a person of integrity in the opinion of the board of directors. He should not be or have been a promoter (defined in Companies Act) of the listed entity, its holding company, associate companies or subsidiaries. Nor should he/she be related to the promoters or directors to the aforementioned companies or hold/held the position of key managerial personnel (KMP) (including his relatives as defined in the regulation) in the aforementioned categories of companies. [Refer to regulation 16 for exhaustive information on qualifications of IDs).

Penalty:

SEBI vide its Circular dated April 08, 2015 has come up with a fine structure for not having an optimum combination of executive, non-executive and women directors on the board. This fine is for the violation by listed entities, of Clause 49 II A (1) of Listing Agreement. There are various timelines provided under which the type and quantum of fines vary accordingly. But for any non-compliance beyond September 30, 2015, SEBI may take any other action against defaulters.

Judicial Ruling:

The need for absolute adherence to these regulations has been declared by the Supreme Court in the case of SEBI v. Shri Ram Mutual Fund[1] where in the words of the Hon’ble court “once the violation of statutory regulations is established, imposition of penalty becomes sine qua non of violation and the intention of parties committing such violation becomes totally irrelevant. Once the contravention is established, then the penalty is to follow. It is to be taken in clarity that the courts/tribunals do not intend to interfere with the decisions of a company and their discretion. Judicial interference shall be exercised when a company obviates/subverts the law, engages in activities that are done by people within the company which cannot be done in their individual positions, violates any constitutional or statutory provision. In the case of Rustom Cavasjee Cooper v. Union of India[2] the court said: “It is again not for this Court to consider the relative merits of the different political theories or economic policies...”

Even in the case of the Government incorporating a company (under the Companies Act), it is not amenable to Judicial interference including through writ jurisdiction. The decisions taken by the management of a company shall be immune from judicial interference or else it would lead to micromanagement and violation of the constitutional provisions under Article 14 and 19. In the case of BALCO Employees Union v. Union of India (UOI) and Ors[3] it was ruled that the Government could have run the industry departmentally or in any other form. When it chooses to run an industry by forming a company and it becomes its shareholder then under the provisions of the Companies Act as a shareholder, it would have a right to transfer its shares. When persons seek and get employment with such a company registered under the Companies Act, it must be presumed that they accept the right of the directors and the shareholders to conduct the affairs of the company in accordance with the law and at the same time, they can exercise the right to sell their shares. In tune with this, the hon’ble SAT had held Vas Infrastructures Ltd [4] liable for failing to set up an audit committee as per clause 49 II A of the Listing Agreement read with section 21 of SCR Act, 1956.

Surmise:

Independent directors play a pivotal role in creating a balance in various departments of the company and act as whistle-blowers in cases of malfunctioning of the company. This is a statutorily empowered- internal mechanism to ensure impartial decision making and adherence to the law, which aids in timely adjudication by the National Company Law Tribunals and courts of law. They have powers parallel to that of veto power where fraudulent decisions that include financial, managerial and operational can be withheld and brought to notice. Thus one may see the roles of a financial guide, intellectual and business advisor, the Good Samaritan for public investors and other powers enabled by law being played by an independent director.

Krishnadas Saiju.


[1]  AIR 2006 SC 2287

[2] AIR 1970 SC 564

[3] AIR 2002 SC 350

[4] MANU/SB/0096/2018

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