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.