LawZ Magazine

Independent Directors — A Critical Study

By Manjunatha N G

Introduction

Independent Directors play a pivotal role in maintaining a transparent working environment in the corporate regime. The Companies Act, 1956 does not expressly provide for Independent Directors except Clause 49 of the listing agreement that is applicable on all listed companies which mandates the appointment of Independent Directors on the Board. Independent Directors constitute such category of Directors who are expected to have impartial and objective judgment for the proper functioning of the company.

Provisions relating to Independent Directors under Companies Act, 2013

Section 149(4) of the Companies Act, 2013 provides for a special class of Directors called “Independent Directors”.

Attributes of an Independent Director (ID): As per Section 149(6) of the Companies Act, 2013 an ID in relation to a company means a director other than a managing director or a whole-time director or a nominee director —

  • Who is a person of integrity and possesses relevant expertise and experience;
  • who is not a promoter of the company or its holding, subsidiary or associate company;
  • who is not related to promoters or directors in the company, its holding, subsidiary or associate company;
  • who has no pecuniary relationship with the company, its holding, subsidiary or associate company or their promoters or directors amounting to 2% or more of its gross turnover or total income or INR 50 lakh, whichever is lower during the 2 immediately preceding financial years or during the current financial year;
  • who neither himself nor any of his relatives holds the position of a Key Managerial Personnel (KMP) or has been an employee of the company or its holding, subsidiary or associate company in any of the 3 financial years immediately preceding the financial year in which he is proposed to be appointed;
  • is not an employee, proprietor or partner in any of the 3 financial years immediately preceding the financial year in which he is proposed to be appointed of a firm of auditors or company secretaries in practice or cost auditors of the company or its holding, subsidiary or associate company; or any legal or consulting firm that has any transaction with the company, its holding, subsidiary or associate company amounting to 10% or more of the gross turnover of such firm;
  • holds together with his relatives 2% or more of the total voting power of the company;
  • is not a Chief Executive or Director of any non-profit organization that receives 25% or more of its receipts from the company or holds 2% or more voting power of the company.

Qualifications of IDs

An ID shall possess appropriate balance of skills, experience and knowledge in the fields of finance, law, management, sales, marketing, administration, research, corporate governance, technical operations and other disciplines related to company’s business.

Companies that require IDs: Section 149(4) provides that at least one-third of the total number of Directors shall be IDs in case of:

  • Public companies having a paid-up share capital of INR 100 crores or more; or
  • Public companies which have outstanding loans or borrowings or debentures or deposits exceeding INR 200 crores.

Ensuring best corporate governance practices

  • Every ID shall have to comply with the provisions specified in Schedule IV.
  • An ID shall not be entitled to any stock option and may receive remuneration by way of fee, reimbursement of expenses for participation in Board and other meetings and profit-related commission as approved by the board of members (Sections 197 & 198).
  • An ID shall hold office for a period of 5 years consecutively on the Board of a company and is eligible for reappointment on passing of a special resolution by the company (Section 152).
  • No ID shall hold office for more than 2 consecutive terms. Provided he shall be eligible for reappointment after the expiration of 3 years of ceasing to be an ID. Further, such an ID shall not be appointed or associated with the company in any capacity either directly or indirectly in those three years.

Manner of selection of IDs

Section 150 provides the manner of selection of IDs. It states that:

  • An ID may be selected from a databank containing names, addresses and qualifications of persons who are eligible and willing to act as IDs maintained by any body, institute or association as prescribed by the Central Government [Section 150(1)].
  • The appointment of IDs shall be approved by the company in the general meeting [Section 152(2)].
  • The data bank [Section 150(1)] shall consist of particulars regarding persons willing and eligible to be IDs: DIN (Director Identification Number); Name and surname in full; PAN number; Father’s/Spouse’s name (if married); Occupation; Full address with PIN code (present and permanent); Educational and professional qualifications; Details of experience and expertise; List of LLPs in which he was a designated partner, consisting of names of the LLP, nature of industry and duration with dates; List of companies in which he was a director, consisting of the name of the company, nature of industry, nature of directorship and duration with dates etc.
  • Any person who is desirous of getting his name included in the data bank of IDs shall make an application to the body, institute or association as notified by the Central Government.
  • Such data bank posted on the website shall be publicly accessible on the specified website, be substantially identical to the physical panel or data bank, be presented in a format convenient for both printing and viewing online, and contain a link to obtain software required to view/print the particulars free of charge.
  • The Central Government has the power to prescribe the manner of selection of IDs who fulfills the qualifications and requirements under Section 149.

Code for Independent Directors (Schedule V)

Guidelines for professional conduct:

  • To uphold ethical standards of integrity and probity;
  • To act objectively and constructively while exercising his duties;
  • To exercise his responsibility in a bona fide manner in the interest of the company;
  • To devote sufficient time to his professional obligations for informed and balanced decision making;
  • To avoid abusing his position to the detriment of the company and refrain from any action that would lead to the loss of his independence;
  • To assist the company in ensuring best corporate governance practices.

Functions of IDs

  • To bring an independent judgment on issues of strategy, performance, risk management, resources, key appointments and standards of conduct;
  • To scrutinize the performance of management in meeting agreed goals and objectives;
  • To safeguard the interests of all stakeholders, especially minority shareholders;
  • To balance the conflicting interests of all stakeholders;
  • To moderate and arbitrate in the interest of the company as a whole.

Duties of IDs

  • To undertake appropriate induction and regularly update and refresh their skills, knowledge and familiarity with the company;
  • To strive to attend all meetings of the Board of Directors and of the Board Committees of which he is a member;
  • To keep themselves well informed about the company and the external environment under which it operates;
  • To ensure adequate deliberations are held before approving related party transactions and assure that the same are in the interest of the company;
  • To report concerns about unethical behaviour, actual or suspected fraud of the company’s code of conduct;
  • Not to disclose confidential information including commercial secrets, technologies, advertising and sales promotion plans etc. unless such disclosure is approved by Board or by law.

Manner of appointment of IDs

  • The appointment process of IDs shall be independent from the company management where the Board ensures that there is appropriate balance of skills, experience and knowledge in the Board for proper and effective discharge of its functions.
  • The appointment of IDs shall be approved at the meeting of the shareholders.
  • The explanatory statement attached to the notice of the meeting shall include a statement that the ID proposed to be appointed fulfills the conditions mentioned in the Act.
  • The appointment of IDs shall be formalized through a letter of appointment which states the term of appointment; expectation of the Board from the Director and fiduciary duties and liabilities accompanying it; code of business ethics that the company expects its Directors and employees to follow; list of actions that the directors should not do while functioning as such in the company; remuneration, periodic fees, reimbursements of expenses for participating in the Board meetings etc.
  • The terms and conditions for appointment of IDs shall be posted on the company’s website.

Resignation or removal of IDs

  • An ID who resigns or is removed from the Board shall be replaced by a new ID within a period of 180 days from the date of such resignation.
  • The resignation and removal of an ID shall be carried out in accordance with Sections 168 and 169 of the Act (168 — resignation of Directors, 169 — removal of Directors by the Board).

Conclusion

The mandatory insertion of IDs in specified classes of companies is highly anticipated to pave the way for transparent and accountable corporate governance. One of the core objectives of appointment of IDs is to safeguard the interests of the minority shareholders. IDs as a regulatory authority are vested with the sole responsibility to monitor the proper conduct and impartial judgment owing to the interests of the investors. Hence, inclusion of IDs is expected to act as a strong instrument to check intended corporate scandals in the future.