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Legal Capsule by Law Office of Madhavan Srivatsan

Independence of Independent Directors: A Myth Or Reality?

Authors: Madhavan Srivatsan, Jherrna B. Sharma and Khizer A. Qureshi
Law Office of Madhavan Srivatsan

The stability of the Company reflects through its ability to generate wealth and generate profit not only for the promotes but for the minority shareholders as well. In pursuance of achieving the objective of generating wealth and profit, often times the Companies overlook its ethical boundaries in order to create more income for promoters at the cost of minority shareholders, which have proven to be disastrous on revelation. In order to ensure a constant flow of profits without crossing moral and ethical boundaries, Corporate governance was evolved to restrain the Companies from doing unjust acts and foster the trust of the investors and other stakeholders. These days Corporate Governance is a reality which cannot be overlooked by any Company which wants to be successful.

There are a number of factors which compel a Company to adhere to a set of Corporate Governance principles, one of them being the role of “Independent Director” in the structure of the Board of directors. The directors of a company fit in the top most managerial hierarchy of the Company. Thus, it is required out of them to bear the highest sense of responsibility and accountability to the real owners i.e. the shareholders. This transparency ensures that the shareholders who have invested in the growth and enhancement of the Company are always aware of the ways in which the Company is progressing

The constitution of the Company does not just include executive directors but non- executive directors as well and Independent directors who with the assistance of this nexus of contracts between various managers, investors and stakeholders etc., ensure complete transparency in the working of the Company. It is with this aspect in mind that the concept of Independent Directors needs our attention.  
Section 149(6) of the Companies Act, 2013 states an Independent Director in relation to a Company shall be a director other than a managing director or a whole-time director or a nominee director. She/ He shall possess appropriate 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.
A person shall only be appointed as an Independent Director if such person:
(a) is a person of integrity and possesses relevant expertise and experience in the opinion of the Board;
(b) who is or was not a promoter of the company or its holding, subsidiary or associate company as well as who is not related to promoters or directors in the company, its holding, subsidiary or associate company;
(c)  who has or had no pecuniary relationship, other than remuneration as such director or having transaction not exceeding 10% of his total income or such amount as may be prescribed, with the company, its holding, subsidiary or associate company, or their promoters, or directors, during the two immediately preceding financial years or during the current financial year;
(d)  Further none of the relatives of such person-
(i)  is holding any security of or interest in the company, its holding, subsidiary or associate company during the two immediately preceding financial years or during the current financial year;
Provided that the relative may hold security or interest in the company of face value not exceeding fifty lakh rupees or two per cent. of the paid-up capital of the company, its holding, subsidiary or associate company or such higher sum as may be prescribed;
(ii) is indebted to the company, its holding, subsidiary or associate company or their promoters, or directors, in excess of such amount as may be prescribed during the two immediately preceding financial years or during current financial year; 
(iii) has given a guarantee or provided any security in connection with the indebtedness of any third person to the company, its holding, subsidiary or associate company or their promoters, or directors of such holding company, for such amount as may be prescribed during the two immediately preceding financial years or during current financial year; or
(iv) has any other pecuniary transaction or relationship with the company, or its subsidiary, or its holding or associate company amounting to two per cent. or more of its gross turnover or total income singly or in combination with the transactions referred to in sub-clause (i), (ii) or (iii);]
(e)  who, neither himself nor any of his relatives-
(i)   holds or has held the position of a key managerial personnel or is or has been employee of the company or its holding, subsidiary or associate company in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed;
Provided that in case of a relative who is an employee, the restriction under this clause shall not apply for his employment during preceding three financial years
(ii)  is or has been an employee or proprietor or partner, in any of three financial years immediately preceding financial year in which he is proposed to be appointed
     (A)  a firm of auditors or company secretaries in practice or cost auditors of the company or its holding, subsidiary or associate company; or 
       (B) any legal or a consulting firm that has or had any transaction with the company, its holding, subsidiary or associate company amounting to 10% or more of the gross turnover of such firm; 
(iii)  holds together with his relatives 2% or more of the total voting power of the company; or 
(iv)  is a Chief Executive or director (by whatever name called) of any non-profit organization that receives 25% or more of its receipts from the company, any of its promoters, directors or its holding, subsidiary or associate company or that holds 2% or more of the total voting power of the company.
After the enactment of the new Companies Act, 2013 Securities Exchange Board of India, through an official circular No. CFD/POLICY CELL/2/2014 dated April 17, 2014 amended Clause 49 of the Listing Agreement to bring it into conformity with the new Act. As per clause 49, the board of directors of the Company shall have a combination of executive and non-executive directors with not less than 50% of non-executive directors in the Board of Directors. Where the Chairman of the Board is a non-executive director, at least one third of the Board should comprise of Independent Directors and in case he is an executive director, at least half of the Board should compromise of Independent Directors
On perusal of the above-mentioned laws, one understands that the underlying principal with respect to Independent Directors is extremely vast owing to the role that is expected of them to play. The defining factor of that principal is “independence” both in law and in practice. Whilst the law may undertake such independence to interpret financial/pecuniary independence vis-à-vis the Company, the outlook of such interpretation must materialize in action in the board meetings in the form of decisions which must also be taken in an independent manner. It’s this practice aligned with the law which must be taken into account when deciding the independence of “Independent Directors” in the Company.
This independence becomes all the more important as it is the Independent Directors who in their capacity as members of the Board undertake various decisions for the benefit of the minority shareholders and stakeholders who might not have a say in the day to day functioning of the Company which in its ambitions of achieving higher profits may take decisions that might be detrimental to their interests. Thus, the Independent Directors, as a part of the constitution of the Board keep a checks and balance on the Executive body of the Company, where they not just focus on the interest of the shareholders, they also focus on how the Company is working without violating the interest of the stakeholders and the society at large. The Independent Director, thus need to be vigilant and act such as to avoid any fraudulent decisions or auditing practices from taking place on their watch. However, if the Independent Directors are themselves in a minority position with no rights to veto any decision, then, it needs to be seen, how effectively can they protect the interest of “minority shareholders”.

The Independent Directors have a duty to differ with the majority in the event the board is acting in a manner which is not in the best interest of the minority shareholders. Demonstration of independence by boards and Independent Directors has always been different, as the corporate dice is always loaded in the favor of the promoters and their nominees, hence, a dissenting opinion of the Independent Director shall not be taken in consideration, thus nullifying the very role they were sought for.

The Govt. of India, in recent months has announced various proposals and intentions to reform the Corporate Governance rules by introducing concepts of
Corporate literacy tests, and a creation of a data bank of Independent Directors so as to provide uniformity in knowledge and skills. While this proposal is still at a very initial, it still doesn’t answer the root cause of the issue which lies in the very nature of practice of how companies function in India. In the global market, the prevailing market atmosphere left no option for the Companies to rectify their board structure. The financial crisis of early 2000s with the demise of firms like ENRON, WorldCom and Arthur Anderson initiated this change in these countries, whereas in India with the rise in NPAs and poor financial health of major banks and NBFCs and the dramatic collapse of IL&FS, and default admission by DHFL, the signs are too distinct for India’s corporates to take an effective measure.
It is yet to be seen and tested, whether, having a larger or majority of independent directors on the Board of such companies in India which are going through process of liquidation could have prevented such companies from going into liquidation. The direct question to be asked is, are the corporates in India really inclined to give majority of board seats to the independent directors, without which, the Independent directors may only be seen as “Effective Preachers” rather than “Effective Administrator” as they may not get to exercise their freedom in actual sense in minority position.   

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