India: Independent Directors- Under The Companies Act, 2013

Last Updated: 26 February 2014
Article by Yogesh Malhan

In India, the gravity of Independent Directors (referred as "ID's") was recognized with the introduction of corporate governance. The Companies Act, 1956 (referred as "the Act, 1956") do not directly talks about ID's, as no such provision exists regarding the compulsory appointment of ID's on the Board. However, Clause 492 of the listing agreement which is applicable on all listed companies mandates the appointment of ID's on the Board. A need has been felt to update the Act and make it globally compliant and more meaningful in the context of investor protection and customer interest.

The Companies Act, 2013 (referred as "the Act, 2013") came into force as Act no. 18 of 2013 after obtaining the assent of the President on August 29, 2013. The Ministry of Company Affairs (referred as "MCA") enforced the 98 sections of the Act through the notification dated September 12, 2013.

One of the sections of the Act, 2013 is section 149 which also deals with the appointment and qualification of ID's on the board of the Company and their importance in good corporate governance in the Company. However the same section has not been implemented till date and will come into force as may be notified in the Gazette. The Act, 2013 has specifically defined the roles, duties, liabilities and the manner of selection of ID's in board and various committees of the Company which are as follows:

INDEPENDENT DIRECTORS - AN OVERVIEW

The need for the ID's aroused due to the need of a strong framework of corporate governance in the functioning of the company. There is a "growing importance" of their role and responsibility. The Act, 2013 makes the role of ID's very different from that of executive directors. An ID is vested with a variety of roles, duties and liabilities for good corporate governance. He helps a company to protect the interest of minority shareholders and ensure that the board does not favour any particular set of shareholders or stakeholders.

The role they play in a company broadly includes improving corporate credibility, governance standards, and the risk management of the company. The whole and sole purpose behind.

introducing the concept of ID is to take unbiased decisions and to checks various decisions taken by the management and majority stakeholders. An ID brings the accountability and credibility to the board process. These ID's are the trustees of good corporate governance.

POSITION UNDER THE STATUE

The Act, 1956: The Act, 1956 do not specifically give the definition of the ID. However one can find parameters mentioned in the Clause 49 of the listing agreement which is applicable to all listed companies in order to recognize a director as an ID. According to this clause ID's are those who apart from receiving director's remuneration do not have any material pecuniary relationships or transactions with the company, promoters, senior management, holding company or subsidiary or associates which affect their independence. Moreover he is not related to promoters or persons occupying management positions at the board level or at one level below the board and has not been an executive of the company in the immediately preceding three financial years. Apart from this he will be disqualified if he is not less than 21 years of age or holds 2% or more block of voting shares or shares or if he is a partner or executive of any statutory audit firm or the internal audit firm or the legal firm(s) and consulting firm(s) that have a material association with the company. All provisions of clause 49 are mandatory to be followed by every listed company.

According to NASDAQ "Independent director" means a person other than an executive officer or employee of the company or any other individual having a relationship which, in the opinion of the issuer's board of directors would interfere with the exercise of independent judgment in carrying out the responsibilities of a director4.

The Act, 2013: The Act, 2013 has adopted many of the provisions of clause 49 of the listing agreement and has defined the term 'Independent Director' u/s 2(47) which says that 'Independent Director' means an Independent Director as referred to in sub-section (5) of section 149. The new Act along with the definition of ID's also provides the criteria for appointing, qualifications, tenure, remuneration and liability of ID's.

As per sub-section 6 of Section 149 of the Act, ID means a director other than a managing director or wholetime director or a nominee director,

a) Who, in the opinion of the Board, is a person of integrity and possesses relevant expertise and experience;

b) - 1. Who is or was not a promoter of the company,

2. Who is not related to promoters or directors in the company

c) Who has or had no pecuniary relationship with the company

d) None of whose relative has or had pecuniary relationship or transaction with the company.

e) Who, neither himself nor any of his relative---

i. Holds or has held the position of a key managerial personnel

ii. Is or has been an employee or proprietor or a partner, in any of the three financial years preceeding.

iii. Holds together with his relative two per cent or more of the total voting power of the company; or

iv. Is a Chief Executive or director, of any nonprofit organization, or who possesses such other qualifications as may be prescribed.

MANNER OF SELECTION AND APPOINTMENT OF INDEPENDENT DIRECTOR

The process of identification and appointment of an ID itself provide hints about the likelihood of the person acting independently. A good way to identify and appoint an ID is to involve a nominations committee of the board, or involve the entire board. This will ensure that prejudice and proximity to management, or a majority shareholder, do not influence the selection of ID.

Under the Act, 2013, strict eligibility criteria have been laid down for the appointment of an ID for example; an ID should not be related to the company or its holding or its subsidiary or its associate company, he himself or his relatives should not have or had any pecuniary relationship or transaction with the company or its holding or its subsidiary or its associate company during the current financial year. He also has to declare to the board that he is independent at the time of his appointment and also whenever there is a change that may affect his independence. Both the company and the ID shall abide by the provisions of the act5. Also the appointment of ID shall be approved at the meeting of the shareholders and the explanatory statement attached to the notice of the meeting for approving the appointment of an ID shall include a statement that in the opinion of the Board, the ID's proposed to be appointed fulfils the conditions specified in the Act, 2013 and the Rules and the proposed director is independent of the management. An ID shall hold the office for a term up to five consecutive years, but shall be eligible for re-appointment on passing of a special resolution by the company and disclosure of such appointment in the board's report. He is not entitled to any stock option or any remuneration, but he may receive sitting fee and any profit related commission as approved by members.

The Act, 2013 has described the manner or procedure for selection of ID's under section 150. This section says that selection of an ID shall be done from a Data Bank maintained by anybody, institute or association, as may be notified by the Central Government, containing names, addresses and qualifications of persons who are eligible and willing to act as ID. It also says that the appointment of an ID shall be approved by the company in general meeting and the explanatory statement indicating the justification behind appointing such person, attached with the notice of general meeting.

ROLE AND DUTIES OF INDEPENDENT DIRECTORS

The role of an ID is considered to be of a great significance. The guidelines, role and functions and duties and etc are broadly set out in a code described in Schedule IV of the Act, 2013. The code lays down certain critical functions like safeguarding the interest of all stakeholders, particularly the minority holders, harmonizing the conflicting interest of the stakeholders, analyzing the performance of management, mediating in situations like conflict between management and the shareholder's interest and etc.

The code also lays down certain important duties like keeping themselves updated about the company and the external environment in which it operates, not disclosing important and confidential information of the company unless approved by the board or required by law, actively participating in committees of the board in which they are chairperson or members, keeping themselves update and undertaking appropriate induction and refreshing their knowledge, skills and familiarity with the company, regularly attend the general meetings of the company and etc.

MEETINGS & COMMITTEES

The Act, 2013, requires all the ID's to meet at-least once in a year. The meeting must be convened without the presence of the non-independent directors and members of the management. An ID would also evaluate the performance of the chairperson of the company. Also, the Act, 2013 requires an ID to review the performance of the non-independent directors and the Board as a whole of the company. These measures would immensely aid in ensuring the smooth and proper functioning of the Board of Directors of a company.

The Act, 2013 has also emphasized on the appointment of an ID as a member or as a chairperson in various committees. For instance in the Audit committee which shall comprise of minimum three directors, ID's should form a majority. In the same way, the Nomination and Remuneration Committees which shall consist of three or more non-executive directors, ID's should not be less than half of the total number of members. For the Stakeholders Committee, the Board of Directors of the Company which consist of more than one thousand shareholders, debenture-holders, deposit-holders and any other security holders at any time during a financial year shall constitute a Stakeholders-relationship Committee consisting of a chairperson who shall be a non-executive director and such other members as may be decided by the board.

LIABILITY

The Act, 2013, has sought to balance the wide nature of the obligations, functions and duties imposed on an ID. The Act, 2013, restricts and limits the liability of ID's to the matters which are directly relatable to them. Section 149 (12) limits the liability of an ID "only in respect of 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".

Nominee directors, despite not being considered as 'independent' under the new definition, would nevertheless be eligible for immunity, as long as they are non-executive.

CONCLUSION

The new concept of having ID is a welcome step for corporate governance in India. The Act, 2013 has conferred greater empowerment upon ID's to ensure that the management & affairs of a company is being run fairly and smoothly. But, at the same time, greater accountability has also been placed upon them. The Act, 2013 empowers the ID's to have a definite 'say' in the management of a company, which would thereby immensely strengthen the corporate governance.

However it is also important to keep in mind that good corporate governance is not just the outcome of appropriate selection and effective functioning of ID's. Every director, whether independent/nonindependent, executive/non-executive has a distinct role in the functioning of the company. It is only when the entire board functions effectively which results to good corporate governance and benefit minority as well as majority shareholder in its long term which maintains a good corporate image in the market.

Footnote

1. Intern BBA LLB, IV Year, B.V.D.U New Law College, Pune

2. As available on the website of BSE & NSE

3. Ministry of Corporate Affairs ( h t t p : / / w w w. m c a . g o v . i n /Mi n i s t r y / p d f / CommencementNotificationOfCA2013.pdf)

4. NASDAQ Rule 4200 a(15)

5. Schedule IV, Code for Independent Directors, Companies Act, 2013.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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