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ARE INDEPENDENT DIRECTORS REALLY INDEPENDENT?

Chakradhari Shubham & Abhishekh Mishra


As the preceding decade was touching its tail, the Indian corporate sector witnessed a perturbing upswing in the number of independent directors resigning from their duties on account of implausible reasons. According to a report[1], in the year 2019, as many as 1,393 independent directors have vacated their post for one reason or another. This surge in resignations by independent directors is alarming because it is unprecedented. Post India’s very own “Enron”; the infamous Satyam computers scam[2] and the resulting sacking of the related non-executive directors, the Indian corporate governance regime went through a rocky phase. The scam resulted in a shakedown of investors' trust in the efficiency and effectiveness of the internal check and balance mechanism provided through the appointment of Independent directors to the board. The sacking of Satyam’s independent directors post the scam raised an alarm and within two months from the confession of Mr. Ramalinga Raju, the independent directors of more than 100 listed companies resigned from the board. The recent IL&FS crisis[3] and the involvement of the company’s Independent directors in the cover-up of the complaint made by the whistle-blowers has juddered the claims of the independence of independent directors. It is the rising instances of corporate misfeasance that have unnerved independent directors leading to their mass resignation from the board. In light of the growing instances of corporate scams; there is an urgent need to reassess the role, duties, and liabilities of independent directors. The ever-growing instances of corporate frauds have questioned the efficacy of the much endorsed mechanism of check & balance and the role of independent directors in them, thus, giving rise to the question that “Are independent directors really independent?”    

NATURE OF OFFICE: INDEPENDENT OR IN(DEPENDENT)?


The various committee reports[4] on corporate governance have recognised that the promoter led companies constitute a sizable portion of the Indian market. The problem with these kinds of companies is that in certain cases the promoters’ interest may take precedence over the shareholders interest. These committees have therefore consistently focused on, amongst other things; the independence of directors. Independent directors are necessary to maintain transparency, fairness, accountability, verifiability and enforceability in a company.


The Companies Act, 2013 defines ‘independent director’ as a director who is not a managing director or a whole-time director or a nominee director. The independent directors are not concerned with the day to day affairs and management of the company and, they bring an external perspective in the affairs and management of the company. The statute[5]expects the independent directors to attend at least one meeting in a year without the presence of non-independent directors to review the performance of the management members and the non-independent directors. After the Satyam fiasco, the legislature has made tremendous efforts to strengthen the governance norms to prevent future corporate frauds and scams. The provisions of the Companies Act, 2013 and the LODR Regulation, 2015[6] governing independent directors are reflective of such efforts of the government. In furtherance of the objects of good corporate governance, SEBI revised the LODR Regulation, 2015 by notifying an amendment[7] to it in the year 2018. The amendment took a step towards independence of the Independent directors along with ensuring female representation in the board. The amended regulations require that the Independent director shall neither be a member of the promoter group of listed entity[8], nor should he be a non-independent director of another Company on board of which any non-independent director of listed entity is an independent director.[9] Post-amendment it is also mandatory for the company to have a minimum of 1 woman Independent director on the Board of Directors.[10] Moreover, implementing the suggestions of the Uday Kotak Committee on corporate governance, the amendment revised the criteria for evaluation of independent directors[11] and also, barred the appointment of alternate director for an independent director of a listed company.[12]Given the pivotal nature of the work performed by the independent directors, their role is very crucial in the context of the existing Indian corporate structure where companies are primarily controlled by the promoter groups, who are usually less concerned about the corporate governance issues and they oversee managerial behaviour.


The potential liability arising out of the duties and functions of the independent directors appears to be disproportionate. The Companies Act, 2013 has tried to mitigate such liability by providing safe harbour provisions in Section 149(12) of the Act. The Company Act, 2013 states that the independent director shall be liable only in respect of omission or commission by a company that had occurred with his knowledge, attributable through Board processes, and with his consent or connivance or where he had not acted diligently. Prima facie on the analysis of the Companies Act it seems that the act has provided all the safeguards to the independent directors against any liability in which the independent director has no direct involvement. It also seems that the independent director has an active, autonomous and important role in the vital decision making process of the company. However, the reality signs in a different tone. All the safeguards and autonomy provided to the directors is limited to the books and in theory, the ground reality is totally different. There have been numerous instances where the independent director has been held liable for acts in which he had no direct involvement. In Chitra Sharma and Ors v. Union of India and Ors.[13], the Apex Court, while issuing orders in relation to protecting the interests of home buyers in projects floated by Jaypree Infratech Limited, did not distinguish between the executive directors and non-executive directors of JIL in placing restrictions on them as regards leaving the country without the permission of the court, and on the alienation of the properties and assets of the directors and their families. Also, in Somendra Khosla v. State[14], the Delhi High Court ignoring the fact that the director in question is an independent director; accepted the contentions of the complainant and refused to quash the complaint against the independent director on the ground that, he was responsible for the day to day functioning of the business. Moreover, there are numerous statutes which do not differentiate between independent directors and other types of directors while fixing liabilities upon them. While fixing liability for the offences committed by a company, the Negotiable Instruments Act, 1881 makes every person in charge of, and responsible to the company for the conduct of its business at the time of the commission of the offence, liable.[15] Also, various other statutes like the Securities Contracts (Regulation) Act, 1956[16], Employees’ Provident Funds and Miscellaneous Provisions Act, 1952[17], Income-tax Act, 1961[18], Contract Labour (Regulation and Abolition) Act, 1970[19]; and, the Environment (Protection) Act, 1986[20] have erroneously ignored the distinction between role of the different types of directors while fixing liabilities upon them.


In National Small Industries v. Harmeet Singh Paintal,[21] the Supreme Court held that, for the purpose of making a director liable for any offence committed by the company, there must be specific averments made against the director which shows the manner in which the director was responsible for the conduct of the business of the company. Moreover, if a person, who is responsible for the conduct of the company, was not in charge of the conduct of the business of the company, then he can be made liable only if the offence was committed with his consent or connivance or as a result of negligence on the part of the director.


An independent director is one of the central pillars of the corporate governance which holds the mantle of good corporate governance and allows the investors to have faith in the business they intend to invest in. The role played by an independent director is of essence in deciding the fate of a company. It is so because these directors are the ones in whom the investors put in their faith for overseeing the acts of the board. It is the primary purpose of an independent director to oversee, guide, supervise and mentor the board of directors. Also, such directors are entrusted with the responsibility to be objective and evaluate the management’s performance.


While the statute and regulation preach the independence of independent directors in corporations, there are umpteen instances that question the presumption of independence. In fact the Indian corporate governance structure suffers from numerous inherent shortcomings that contribute towards the expropriation of independence; the widest being the provided procedure for appointment of the Independent directors. In the Indian scenario, the appointment of an independent director is done by the board of directors; also, the various remunerations paid to the independent directors are recommended and approved by the board of directors along with the shareholders in a general meeting. In addition to the appointment, the re-appointment and removal of an independent director heavily depends on the board and it is at board’s “mercy” that an independent director is re-appointed or allowed to continue in his position. An independent director is engaged in a part-time employment by the company on account of his expertise and experience in the field. But, in the contemporary business world, the boardroom environment has undergone a significant change; a change towards discussion of highly technical and complex matters in the boardroom. On account of these factors, an independent director is heavily dependent on the board of directors for the flow of information relating to the affairs of the company along with his employment and remunerations, thus being purloined of his independence.


RECOMMENDATIONS


The experts on the subject are striving hard to make the Indian market a model of corporate good governance for the globe but, in light of the recent corporate frauds in the Indian market; the role of independent directors is once again under strict public scrutiny. In addition to the public scrutiny, there exists a lack of confidence among the independent directors with regards to their independence and this in turn has led to mass resignation by independent directors from their post. Thus, it is the need of the hour that the legislature ensures that the independence promised to the independent directors under the statute is delivered to them in an effective manner. A suggestive method to do that would be to ensure a majority of independent directors in the boardroom. Also, there is a need to amend the procedure prescribed for appointment and removal of independent directors; the absence of control of the board over the office of independent directors will be a significant leap towards assuring the independence of the independent directors. Lastly, the provisions of Negotiable Instruments Act, 1881, Securities Contracts (Regulation) Act, 1956, Employees’ Provident Funds and Miscellaneous Provisions Act, 1952, Income-tax Act, 1961, Contract Labour (Regulation and Abolition) Act, 1970, Environment (Protection) Act, 1986, and of the any other relevant legislation imposing liability on the independent directors should be amended in order to bring them in consonance with the principle of qualified liability depending upon certain mitigating factors, as is provided under Companies Act, 2013. The limiting of liability and assurance of their independence will bring back the lost confidence of the independent directors and as a result will ensure that the interest of all the stakeholders of the company is protected.


Keywords- Corporate Governance, Companies Act, Company Law, Independent Directors

[1] Rica Bhattcharyya, Resignations by independent directors double in 2019 as risks grow, The Economic Times, (Dec. 26, 2019, 06:54 AM), https://economictimes.indiatimes.com/news/company/corporate-trends/resignations-by-independent-directors-double-in-2019-as-risks-grow/articleshow/72972968.cms. [2] FE Online, What was Satyam scam which toppled India’s fourth largest IT company from the top slots, Financial Express, (Jan. 11, 2018 11:53 AM), https://www.financialexpress.com/industry/what-was-satyam-scam-which-toppled-indias-fourth-largest-it-company-from-the-top-slots/1010389/#:~:text=The%20Satyam%20scandal%20was%20a,bank%20balances%20of%20the%20company [3]ET Online, IL&FS: The crisis that has India in panic mode, The Economic times, (Oct. 03, 2018, 11:37 AM), https://economictimes.indiatimes.com/industry/banking/finance/banking/everything-about-the-ilfs-crisis-that-has-india-in-panic-mode/articleshow/66026024.cms?from=mdr. [4] Report of Uday Kotak Committee on Corporate Governance submitted before Securities and Exchange Board of India on October 5, 2017. [5] The Companies Act, 2013. Schedule IV. [6] Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015. [7] Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements)(Amendment) Regulations, 2018 [8] Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, Reg. 16(1)(b)(ii). [9] Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, Reg. 16(1)(b)(viii). [10] Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, Reg. 17(1)(a). [11] Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, Reg. 17(10). [12] Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, Reg. 25(1). [13] (2018) 18 SCC 575. [14] 2019 SCC OnLine Del 6585. [15] The Negotiable Instruments Act, 1881, S. 141. [16] The Securities Contracts (Regulation) Act, 1956, S.24. [17] The Employees’ Provident Funds and Miscellaneous Provisions Act, 1952, S.14A. [18] The Income-tax Act, 1961, S.278B. [19] The Contract Labour (Regulation and Abolition) Act, 1970, S.25. [20] The Environment (Protection) Act, 1986, S.16. [21] National Small Industries v. Harmeet Singh Paintal, (2010) 3 S.C.C. 330.

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