Independent Directors A Reality Or A Concept?
INDEPENDENT DIRECTORS A REALITY OR A CONCEPT?
as a member of the Board of Directors, a General Counsel and a Company Secretary, I live and breathe the concept of independent directors. It is surprising that the "independent director" has been defined only as recently in the Companies Act, 2013 ("CA-2013") and till now remained under various guidelines issued by the Securities and Exchange Board of India ("SEBI"), as applicable to listed entities. If one were to do research under the CA-2013, the following in a nutshell,, would be the governance and expectations from an "independent director".
THE LEGAL FRAMEWORK
1. Sub-section (3) (d) of Section 134 (Financial statement, Board's report, etc.), requires that an independent director to provide a statement or declaration of independence under Sub-section (6) of Section 149 of CA-2013.
2. Sub-section (4) of Section 149 (Company to have Board of Directors), requires 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. (Unlisted public companies should appoint at least two independent directors (a) If the paid up share capital is in excess of ₹10 crores (US$ 1.3 million); (b) If the turnover is in excess of ₹100 crores (US$ 13.3 million); and (c) If the total of all the outstanding loans, debentures and deposits is in excess of ₹50 crores (US$ 6.5 million).
3. Sub-section (6) of Section 149 (Company to have Board of Directors), outlines the key requisites of "independence" of independent directors.
4. Sub-section (8) of Section 149 (Company to have Board of Directors), requires that the company and independent directors shall abide by the provisions specified in Schedule IV - Code for Independent Directors.
5. Section 166 (Duties of directors), outlines duties of a Director, which independent directors are also required to follow and are in addition to those outlined in Schedule IV - Code for Independent Directors.
In addition to the above, a Company that seeks to appoint Independent Directors, (a) may select the candidates from databank of independent directors (and undergo training programs as mandated by the Ministry of Corporate Affairs, Government of India) (Section 150); (b) provide justification of selection of independent directors in the explanatory statements to the notice to members of the company seeking their appointment at the general meeting (Section 150, Section 152); (c) appoint independent directors in the Audit Committee (Section 177) and the Nomination and Remuneration Committee and Stakeholders Relationship Committee ("NRC") (Section 178); (d) not remunerate them with stock options but provide remuneration by way of fee (Sub-section (5) of Section 197) or reimbursement of expenses for participation in the Board and other meetings and profit related commission as may be approved by the members;(e) ensure independent directors are appointed for no more than two consecutive terms of five years each (Section 149) and that they do not retire by rotation (Section 149, Section 152).
In addition to the above requirements outlined in the CA-2013, SEBI, not to just address the concerns around efficacy of the independent directors but also to safeguard the larger interests of the minority shareholders, on March 01, 2021 came up with a consultation paper on 'Review of Regulatory Provisions Related to Independent Directors' ("Consultation Paper"), with the following recommendations:
1. Independence: It is proposed that the cooling period of a candidate to determine independence, be increased from "two years" to "three years" for relationship of such director and its relatives (including material pecuniary relationship) with the listed entity, its promoter or directors, its holding, subsidiary or associate companies and shareholding in the listed entity; and to retain a cooling period of three years for such person either himself/herself or any of its relatives have been in the position of key managerial personnel ("KMPs").
2. Appointment and Re-appointment: It is being proposed that in addition to the right of the majority shareholders to vote for appointment of independent directors (by ordinary resolution for appointment and special resolution for re-appointment), an approval should also be sought by 'majority of the minority' (simple majority of shareholders, other than the promoter and promoter group) shareholders. Likewise, removal of independent directors, will follow a similar approval sequence.
3. Independent Director as Additional Directors and Casual Vacancy: It is proposed that independent director shall be appointed on the board only with prior approval of the shareholders at a general meeting. In case, of a casual vacancy, the approval of shareholders should be taken within a maximum period of 3 (three) months.
4. Resignation of Independent Directors: It is proposed that the resignation letter of an independent director shall be accompanied with a list of present directorships and membership in board committees. There should be a cooling-off period of 1 (one) year before a director can transition from an independent director to a whole-time director in the same company.
5. Review of Remuneration: Under the LODR, independent directors are permitted to be paid sitting fees (maximum of ₹1,00,000) besides being entitled to profit linked commission within an overall limit and re-imbursement of expenses and shall not be entitled to stock options. The proposals are varied between to remove profit linked commission and increase the sitting fees versus linking remuneration to profit or performance linked commission to ensure accountability and risk sharing.
6. Other Disclosures: It is being recommended that the NRC while identifying, shortlisting and selecting suitable candidates, basis skills, knowledge and experience on the Board, should prepare a report on the responsibilities and duties affiliated with a particular appointment and examine how closely each candidate satisfies the description. The NRC should also disclose the process followed to identify a candidate. Also it is recommended that the strength of the independent directors on NRC be increased from fifty percent to two-thirds.
From a review of the above framework on the independent directors, it seems that from a legal and regulatory standpoint, changes are in the desired direction. As we have seen that expectations from an independent director are manifold both under CA-2013 and SEBI provisions, therefore, unless such person goes through a vigorous process, as outlined above, it would be difficult for a person to be appointed as an independent director. I would, however, also recommend that the Board's Report should include a report by the Independent Directors on (a) business resiliency and sustainability; (b) ethical business conduct and fraud prevention; (c) some of the material aspects they addressed in the audit committee and the NRC; and any other aspects in line with the provisions of law, under which they are so appointed.
Basis what seems to being reported of late, it appears that the independent directors in publicly traded Indian companies were not acting to protect the interest of minority shareholders. Further individual/minority shareholders seem to be expressing concerns about the independence of independent directors, their effectiveness in tackling fraud, preventing selling-off of company assets without shareholder knowledge, and insider trading. Further, there are reports that the independent directors have become a political post. The Indian Institute of Corporate Affairs, a couple of years ago had reported that "Instead of experienced domain experts, preference is being given to ex-IAS or recently to political affinity, so the whole idea of independent director has been vitiated."
I would say that despite some stellar work that the lawmakers have undertaken to provide a regulatory mechanism and outline the roles and responsibilities of independent directors, it seems there is a gap between how some corporates are looking at the appointment and engagement of their independent directors. Indeed some corporations, would look at appointment of independent directors as a box ticking exercise than leveraging their capabilities as required under the requirements of law. Should independent directors be seen in failing in their responsibilities, shareholders activism need to step up their voice, leading to a greater role and effectiveness of their independent directors and/or bringing it to the attention of the regulators. The regulators should set up a process to address the grievances of the shareholders, especially for inaction or misconduct of the independent directors. What strikes me, is that the appointment of independent directors having been very highly skewed in the hands of the Board, its committees and the shareholders and stakeholders should also have a say in the appointment.
The role that an independent director needs to perform are not only for shareholders but also for stakeholders of a company, therefore, should not the latter (like the employees, creditors, trade partners, etc.) have some role to play or a say in their appointment? For example, should not a Bank which has provided large credit to the listed/public company and have nominee directors on the board of the borrower, expect that the nominee directors be treated as independent directors, so as to have a dominant role in the board room? Should not CA-2013 be amended to state that a "nominee director" (which under sub-section (7) to Section 149, has been defined as "nominee director" means a director nominated by any financial institution in pursuance of the provisions of any law for the time being in force, or of any agreement, or appointed by any Government, or any other person to represent its interests) be treated as an independent director. Similarly, should not large trade partners/creditors to a company, as a part of their contractual arrangement may also negotiate to have independent directors on the board of the debtor to ensure effective governance? Likewise, for example for labor unions and there could be numerous examples for appointment of independent directors.
I would also add here that it is upon the management, how they want to utilize the independent directors, under the purview of law. Former bureaucrats, ex-IAS and the like due to their overall governance and analytical capabilities make a very good talent pool (like others from corporate sector) and should play a very active role in the governance of an organization. I would put the responsibility on the Chairman and the Chief Executive Officer and the Board to ensure that the independent directors are put to an effective use and be visible to stakeholders with their work than be visible only on the corporate websites. If stakeholders make a noise of ineffectiveness of the independent directors, such issues should be adequately addressed by the Audit Committee, in the Board's Report or by a regulator.
While both CA-2103 and SEBI requires that the remuneration of independent directors be paid by the Board, it requires a sound corporate culture, which ensures that the independent directors are able to work independently. I do believe that an independent should be adequately compensated for difficult work that they do, however, an independent director should be cognizant of the fact that their actions or inactions both could be adequately or adversely responded to. A "Yes-Man" (or Women) to the management may have a longer tenure in the organization, however, the reputation could be adversely impacted should things go adversely (alleged frauds at IL&FS, PMC Bank, Amrapali Group, Yes Bank, Kingfisher, Jet Airways, Reliance InfoCom… there are enough instances that the Yes-Mans have been adversely impacted, in addition to the Promoters). Therefore, independence is a very personal trait, though law elaborates, how independence should be achieved, it is a very personal issue, whether an individual wish to be independent.
CORPORATE ADVISOR AND BOARD MEMBER
"Institutions, unless flawed by design, do not fail, people do." This holds true for the universe of independent directors too; individual failures and abdication of responsibility has unfortunately created cynicism about the whole college of independent directors ignoring their contribution to the corporate governance framework. Failures are highlighted in the media and the courtrooms, successes remain hidden in the boardrooms and minutes. Independence is a state of mind and not of structures and situations. Whilst some prescriptions are important, an overdose of it creates a culture of compliance rather than commitment. There is a mistaken belief that strangers would make the best independent directors.
The concept of independent directors in India is evolving because a large part of the economy, and more so the bigger business entities, are still owner (promoter) driven. In the West most of the larger corporations have outgrown the presence of the owner or families. India is maybe half a century away before a larger part of the corporate landscape will be comprising of institutions where the owner and the management will be two different sets of people. The real maturity of the Board and its stewardship role is truly visible in action in these setups. There is need to demonstrate patience and maturity till then.
To be ready, there is clearly a need to develop capacity and capability of independent directors. Many of them today are friends and acquaintances of owners; of late large numbers are also coming from the corporate world or the bureaucracy. Though qualified and professional in approach, the role that they need to play as an independent director is very different. This transition has to be handled through a process of education, training and experience. It will take a while but will get there. It would not be sensible to be impatient and based on some cases of negligence and wrong doing to besmirch the entire institution of independent directors in India. The temptation of over regulating by more laws, vicious and disproportionate prosecution would be like killing the baby at birth. More importantly, the government should not step in to become a kind of an executive controller of independent directors.
FOUNDER DIRECTOR, PADUP VENTURES, INDEPENDENT DIRECTOR
The role of Independent Directors on the Board of a Company is a combination of monitoring and advisory functions. The importance of each of these functions is obvious and varies from company to company. While good compliance and corporate governance is non- negotiable, the advisory function in most cases is quite overstated.
Most companies especially promoter driven ones take independent directors only when mandated by law, and their expectation mostly is to fulfill the statutory obligations. The strategy inputs are a 'good to have' and purely advisory in nature anyway. The big question is "Are independent directors truly independent?"
The issue around skills and training of independent directors and their ability and competence to grasp the nitty gritty of law is also an important one that needs to be addressed effectively. In many cases, the independent directors just coast along with the Board without being able to exercise independent judgment. Furthermore, their role is often compromised by a lack of time, domain knowledge, and resources needed to comprehend the complex information and data provided by the company.
One of the big issues around the independent directors is that the current legal regulations fail to address the fundamental issues that affect the liability framework of independent directors. At present, the liability framework governing independent directors entrusts them with disproportional liability risks and duties.
ADVOCATE, ARBITRATOR & MEDIATOR FORMER GENERAL COUNSEL: ADITYA BIRLA GROUP
If someone should ask me if there has been a lot of hype about Independent Directors and as to how they have transformed the governance landscape, I would be hesitant to dismiss that there is some hype. Independence is a state of mind. Despite certain legal and regulatory parameters set out to determine independence. the assertion of independence comes in the form of certification by the potential independent director candidate. It is no doubt expected of the NRC to screen independent director candidates and choose the best suited for that role. How then is that role defined? In other words, how does the independent director, from his appearance, demonstrate that he/she is independent? By appearance I mean, the manner in which he/she actually conducts himself in the course of Board & Committee deliberations.
Consequently, what is in the mind must translate into action. If an independent director believes there's something amiss but does nothing about it, then his/her independence is in the mind but not in his actions. Among many attributes that an independent director ought to possess, let me pick possessing relevant 'knowledge' of business/ Industry as one such attribute. In my opinion, displaying ignorance is a virtue as compared to the vice of half-baked knowledge. An independent director ought not to be afraid of asking questions for fear of being smirked at by his other Board colleagues. Questioning is a manifestation of inquisitiveness. If quest for information is stifled then the independent director would be inhibiting independence not just in his mind but also in action.
The role of the "Independent Directors" as champions of good governance is, to my mind, is seen at the level of each individual and his or her reputation of acting independently. I am not sure I can say the same thing about all the Independent Directors as a whole.
The law can only be an enabler or definer of what an independent director "should do". What an independent director "can do", is what an individual believes one should do. The boundary of law is wide and is open to interpretations. While at one end of the boundary, below which could lead to violations of law, an independent director may want to keep a low trajectory and wish to dance to the tune of the promoters, be a Yes-Man and only act to be a tick in the box; the other end like a horizon is limitless and given the empowerment Indian law provides, can be a huge contributor in keeping the corporate ship sailing at all times both in turbulent or calm waters. The choice to be at what side of spectrum is purely personal. If you listen to your conscience and take action accordingly in the best interest of the organization, you gain independence that help you achieve faith, trust, confidence and support of the organization and stakeholders as a whole. The law in India on independent directors has evolved and shall continue to do so, we as independent directors, should imbibe the intent of law and act in accordance with the best interest of the organization, doing things in the most ethical manner, even at the risk of losing one's assignment. A management that makes you avoid listening to your conscience, is making you lose your independence, reputation and ethics, which once lost, cannot be purchased with any amount of money you may make. So always do the right thing and lean on law, should you seek guidance, how to be independent and effective.