Position of an Independent Director: Companies Act, 2013

    On 1 March 2021, the Securities and Exchange Board of India (hereinafter referred to as “SEBI”) introduced a consultation paper.[1] The paper suggested amendments to improvise the role and the position of an Independent Director (hereinafter referred to as “IDs”) in corporate governance. It proposed to make changes in the provisions of the SEBI (Listing Obligation and Disclosure Requirements) Regulations with respect to the appointment and re-appointment of IDs, the removal of IDs, nomination, resignation, and remuneration of IDs. These changes, if applied in letter and spirit, will change the future of corporate governance. This paper aims to highlight the position of IDs under current provisions and the changes suggested by the SEBI in order to analyze their effect on the role and functioning of IDs in a company.

    Who is an Independent Director?

    The Ministry of Corporate Affairs (hereinafter referred to as “MCA”) introduced the requirement to have IDs in the Companies Act of 2013 (hereinafter referred to as “Companies Act”). As a result, every listed company ought to have one-third of the directors as IDs. The definition of IDs is given under Section 149(6) of the Companies Act, 2013. As per the definition given under the Act, an ID should not be related to the company, its holding, subsidiary or associate company, or to the directors and promoters of the company, or its holding, subsidiary, or associate company.[2] According to the Securities and Exchange Board of India [3], ID is a non-executive director who:

    “apart from receiving director’s remuneration, does not have any material pecuniary relationships or transactions with the company, its promoters, its directors, its senior management or its holding company, its subsidiaries, and associates which may affect the independence of the director.”

    An ID is expected to prove his independence and give a declaration as per Section 149(7) of the Companies Act, which reads:[4]

    Every independent director shall at the first meeting of the Board in which he participates as a director and thereafter at the first meeting of the Board in every financial year or whenever there is any change in the circumstances which may affect his status as an independent director, give a declaration that he meets the criteria of independence.”

    Moreover, Section 149(8) & (12) of the Companies Act and Schedule IV prescribe the Code for Independent Directors.

    Section 149(12) reads:[5]

    “Notwithstanding anything contained in this Act—

    (i) an independent director; &

    (ii) a non-executive director not being promoter or key managerial personnel shall be held liable, only in respect of such acts of omission or commission by a company which had occurred with his knowledge, attributable through Board processes, and with his consent or connivance or where he had not acted diligently.”

    Furthermore, all the listed public entities are mandated by the Companies Act to have one-third of the directors as IDs, whereas the requirement for non-listed companies to have IDs is at least two directors.[6]

    Role and Responsibility of an Independent Director

    As the name suggests, IDs should be independent in toto to make an unbiased judgment keeping in mind the interests of promoters and minority shareholders. They also keep the Board of Directors in check to enhance the credibility of the company and, are therefore, known as the watchdogs of corporate governance.[7] The IDs supervise the work of the promoters and provide a different outlook in the governance of the company. The Companies Act requires them to meet at least once a year to evaluate the performance of the company and assess the communication that took place between the company and its Board of Directors.[8]

    But is this independence real or alleged? Time and again, the promoters or the majority shareholders have been interfering with the independence of the IDs. One can take the example of the most recent and controversial case of Cyrus Mistry v. Ratan Tata, which questioned the independence of the IDs under the Companies Act. When Cyrus Mistry was removed as the chairperson of Tata Sons, six of the IDs objected to his removal and voted in his favor. This did not go well with Ratan Tata, the majority shareholder, and he removed these six IDs. This move was seen as a blatant violation of the independence enjoyed by the IDs under the Act. The involvement and control of promoters, Chief Executive Officers, etc., in the appointment and removal of IDs has corrupted the system. There was an urgent need to devise a method that looked into the interest of these IDs and protected their independence for better and transparent functioning of the Companies in India. SEBI’s Consultation paper looks like the first step in this direction.

    Suggestions by the SEBI- A boon or a bane?

    The changes suggested by the Consultation Paper can be broadly classified into the following six categories:

    • Eligibility Criteria and Cooling-off period

    According to the current provisions, the Key Managerial Personnel (hereinafter referred to as “KMP”) or the employees or his/her relatives who have been the KMP of the listed entity, or its holding, subsidiary, or associate company in the past three years cannot be appointed as an Independent Director.[9] This provision was included to ensure that the person appointed as an ID is neutral and entirely unrelated to the affairs of the company. However, the ground reality is ironic. These independent directors are independent only on the paper and are usually appointed and removed on the whims and fancies of the promoters. The problem with the cooling-off period as per SEBI’s Consultation Paper is that it is not uniform. The current cooling-off period for an ID has been prescribed as follows:[10]

    “a. Cooling-off period of 3 years in case the person has been an employee / KMP or his / her relative has been a KMP of the listed entity / its holding company / subsidiary / associate company

    1. Cooling-off period of 2 years in case of a material pecuniary relationship between the person or his / her relative and the listed entity / its holding company / subsidiary / associate company.”

    As it can be seen from the above provision, there was no uniformity in the cooling-off period in relation to the eligibility criteria of an ID. There was a need to strike a balance. Therefore, the SEBI has proposed to harmonize the cooling-off period for eligibility conditions to three years.[11] The changes proposed to be made to the eligibility criteria of an ID are aimed to cure the prolonged ailment, and if these changes are implemented, then the independence of an ID will be undisputable.

    • Appointment and Removal Procedure

    The Consultation Paper suggested that the appointment and re-appointment shall be subject to the “dual approach” taken through a single voting process, satisfying the following two conditions:[12]

    “i. Approval of shareholders;

    1. Approval by ‘majority of the minority’ (simple majority) shareholders. ‘Minority’ shareholders would mean shareholders, other than the promoter and promoter group.

    The approval at point (i) above shall be through ordinary resolution in case of appointment and special resolution in case of re-appointment.”

    Both these conditions have to be satisfied, and even if one of them is not satisfied, the person will fail to get appointed or re-appointed as an ID. When the conditions mentioned above are not met, the listed company can:[13]

    “i. Propose a new candidate for appointment / re-appointment; or

    1. Propose the same person as an ID for a second vote of all shareholders but without an approval by ‘majority of the minority’ shareholders. The second vote can be proposed after a cooling-off period of 90 days but within a period of 120 days, and such approval for appointment/re-appointment shall be obtained through a special resolution. Further, the notice to shareholders will include reasons for proposing the same person despite not getting approval of the shareholders in the first vote.”

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    Concerning the procedure of removal, the current provision allows the removal of an ID through a simple majority in the first time and a special majority in the second one.[14] The removal provides for a procedure that ensures that an ID gets a reasonable opportunity to be heard. SEBI contended that in the process of removal by a simple majority, the promoters get significant control by virtue of their shareholding, and therefore, it suggested the “dual approval” procedure for their removal. The process of removal of an ID is the same as the process for his or her appointment and re-appointment.

    Moreover, as mentioned above, the primary responsibility of an ID is to protect the interests of the minority shareholders. The increased involvement of these minority shareholders in the process of appointment, re-appointment, and removal of an ID will make the process more appropriate and equitable.

    • Approval of Shareholders

    Listed companies appoint IDs as additional directors, subject to the approval of the shareholders at the next general meeting.[15] However, the suggestion given by the SEBI aims to reduce the time gap between the appointment of an ID and the approval given by the shareholders. The current process jeopardizes the interests of the minority shareholders as their approval is sought after the appointment. However, the proposal made by the SEBI makes it mandatory to take the approval of the shareholders in the general meeting before proceeding with the appointment of the ID.[16]

    • Resignation

    The present applicable procedure requires an ID to submit the reasons for his resignation within seven days.[17] However, it is prevalent for the IDs to take the process casually and give vague reasons for their resignation. It has been seen that the IDs resign from the post to get a material position in the company. SEBI tried to strike at the root of this problem and suggested that “the entire resignation letter of an ID shall be disclosed along with a list of his. or her present directorships and membership in board committees.” Moreover, suppose an ID gives vague reasons like personal issues and other commitments. In that case, he will have to go through a mandatory cooling-off period one year before he can join another board as a whole-time director.[18] These measures will keep a tight rein on the defrauding of IDs, hold them accountable, and help them in becoming relatively more independent.

    • Transparency in the role of Nomination and Remuneration Committee

    According to the proposal made by the SEBI, For the appointment of an ID[19], the Nomination and Remuneration Committee (hereinafter referred to as “NRC”) shall:

    • Evaluate the balance of skills, knowledge, and experience on the Board and prepare a description of roles and capabilities required for the appointment.
    • The proposed candidate should have these qualities given in the above description.
    • To identify suitable candidates, the committee may use the services of external agencies, choose candidates from diverse backgrounds and consider the time commitments of the appointees.

    Moreover, the notice given to the shareholders for appointment of directors shall include:[20]

    • Skills and capabilities required for an ID and how the proposed candidate for ID meets the criteria.
    • Channels used for searching for appropriate candidates.

    The Consultation Paper extensively lays down a procedure for the NRC to follow for an ID appointment. The disclosure made to the shareholders will ensure transparency in the process of appointment of the candidate for the post of an ID. Therefore, this change is much desired and will help in getting efficient and deserving candidates to the listed entities.

    • Remuneration

    As per the Companies Act, IDs are to be given commission out of the profit.[21] IDs never had access to Employee Stock exchange plans. Therefore, very few competent candidates are interested in the position of an ID of a company. Addressing this concern, the SEBI has suggested providing ESOP to the IDs to increase the compensation paid to the IDs for the services they render.[22] This is a well-thought plan and will in improving the performance of the companies as in order to utilize the benefits of ESOPs thoroughly, the IDs will work hard throughout their term. This suggestion is groundbreaking because it keeps a lucrative deal on the table to ensure that the IDs do not sway and stay loyal to their duties.

    Conclusion

    All things considered, the suggestions made by SEBI’s Consultation have addressed most of the concerns and controversies encompassing the role and responsibility of an Independent Director. If these suggestions are implemented, the position of an ID would be outside the reach of any undue influence and allow the appointed candidate to perform his or her duties diligently. 

    References

    [1] Aishwarya Kataria,Proposals to revamp the rules governing the Independent Directors”, 125 taxmann.com 249 (2021).

    [2] The Companies Act, 2013, s. 49.

    [3] The Indian Companies Bill, (No. 59 of 2009), s. 32.

    [4] The Companies Act, 2013, s.149(7).

    [5] Ibid, s. 149(12).

    [6] Ibid, s. 149(4).

    [7] Yash Jain and Ayushi Dubey, Independent Directors: A Reality or an irony?” 117 taxmann.com 249 (2020).

    [8] Supra 4.

    [9] Securities and Exchange Board of India “Consultation Paper on Review of Regulatory Provisions related to Independent Directors,” March 1, 2021, available at: https://www.sebi.gov.in/reports-and-statistics/reports/mar-2021/consultation-paper-on-review-of-regulatory-provisions-related-to-independent-directors_49336.html (last visited on March 29, 2021).

    [10] Ibid.

    [11] Ibid.

    [12] Ibid.

    [13] Ibid.

    [14] Ibid.

    [15] Ibid.

    [16] Ibid.

    [17] Ibid.

    [18] Ibid.

    [19] Ibid.

    [20] Ibid.

    [21] Ibid.

    [22] Ibid.

    BY- ANANYA BAJPAI | WEST BENGAL NATIONAL UNIVERSITY OF JURIDICAL SCIENCES

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