Open Access Research Article
THE CONCEPT OF INDEPENDENT DIRECTORS: AN ANALYSIS BY: SAURABH MISHRA
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Article Details
AUTHORED BY: SAURABH MISHRA
Institution: Chanakya National Law University, Patna
Abstract
This research paper titled 'The Concept of Independent
Directors: An Analysis' discusses the importance and relevance of independent
directors in a company. The paper briefly explores the origin of this concept
in India and how it further developed with the maturity of the Indian market.
An enterprise cannot achieve appropriate corporate governance without
independent directors on its board. The paper aims to discuss the role of
independent directors in achieving the desired level of corporate governance
and how they can play an important role in the timely prevention of corporate
mismanagement.
Introduction
Independent directors' roles and
responsibilities are becoming more popular as they are being held more
accountable for fraud and poor management in listed businesses. When corporate
fraud is discovered, their obligations take on greater importance. The Indian
corporate system has been plagued by numerous corporate scams, ranging from the
ten years ago Satyam scandal, which is now worldwide infamous, to the most
current Nirav Modi scam. After the independent directors of one of the biggest
corporate frauds, the “ABG Shipyard Company”, came under scrutiny, the idea
became a hot topic of discussion. Recent scams have demonstrated how crucial an
independent director's role can be in preventing corporate fraud.
From the perspective of strong corporate governance, an
independent director involves a company's commitment to operate its companies
in a lawful, ethical, and transparent manner. Presence of independent director
on board can give a sense of extra security to shareholders and other
investors.
A Brief Account on The
Rise of The Independent Director in India
“The Committee on Corporate Governance has recommended that
the board of a company have an optimum combination of executive and
non-executive directors, with not less than fifty percent of the board
comprising the non-executive directors. The committee believes that the
definition of independence should be broad and flexible, focusing on material
pecuniary relationships that affect a director's independence. The committee
also emphasizes the importance of independent directors in bringing an
independent judgement to bear on board deliberations, particularly on issues of
strategy, performance, conflict management, and standards of conduct.
Good corporate governance requires a board composed of
individuals with certain personal characteristics and core competencies, such
as recognition of the board's tasks, integrity, accountability, track record of
achievements, and ability to ask tough questions. The committee also emphasizes
the importance of adequate compensation packages for non-executive independent
directors to attract talent and ensure they are adequately compensated for
their work.
The Committee recommends that the board should have an
optimum mix of executive and non-executive directors, with at least one-third
of the board comprising independent directors and at least half of the board
being independent. This is a mandatory recommendation for companies with
non-executive and executive chairman positions.”[1]
Clause 49 of the Listing Agreement
is a set of regulations issued by the Securities and Exchange Board of
India (SEBI):
Many of
the above said recommendations were
then incorporated in the Revised Clause 49 that is seen as an important statutory requirement.
Further, Following the passage of the 2013 Companies Act, SEBI updated Clause
49 in 2013 to conform to the new Act.
It regulates the corporate governance
procedures for Indian listed companies. Since its initial introduction in 2000,
the clause has undergone a number of revisions.
All publicly traded companies must have
at least one-third of their board members who are independent directors.
Independent directors must also be free of any material conflicts of interest,
possess the knowledge, skills, and experience necessary to contribute
effectively in the boardroom, be able to challenge management and voice their
concerns to the board, and be paid fairly for their work.
The Listing Obligations and Disclosure Requirements (LODR) Regulations, 2015, as issued by the Securities and
Exchange Board of India (SEBI) and companies Act 2013
Section 149(6) of the Companies Act of
2013 (the "Act") and Regulation 16 of the SEBI (Listing Obligations
and Disclosure Requirements) Regulations of 2015 (the "LODR") both
define independent directors. While section 149 of the Act's requirements must
be followed by unlisted firms, listed companies and those planning to list must
also abide by the LODR. The LODR defines an independent director as a person
who is not associated with the company, either as a promoter or director of the
company, its group companies, who does not have a material financial
relationship with the company or its group, as well as a person who has not
held a recent position where he might have been associated with the company in
a way that would have given him the ability to influence decisions.
Independent Directors’ Role in Corporate Governance
There is no question that good corporate governance benefits
a company's reputation, staff, and clients. However, you also cannot view
corporate governance in a business-neutral manner. On the one hand, you cannot
have effective corporate governance while engaging in dishonest business
practices. How you integrate your beliefs and ideals into every facet of
conducting business is what corporate governance is all about.
The appropriateness and effectiveness of
corporate governance influence the development and future of any capital market
and economy, which is almost a given. Studies of businesses in India and
overseas have demonstrated that markets and investors pay attention to, respond
favorably to, and reward well-managed businesses with greater valuations. A
country having strong and transparent corporate governance laws are generally
ranked high in the “ease of doing business index”. A transparent corporate
governance is not only beneficial for the business of the corporation but also
have many other advantages such as benefit of the investors, foreign investment
and also a improves the global reputation. These businesses have the trait of
having processes in place that give boards and management the latitude they
need to innovate and move their businesses forward while yet operating within a
framework of effective accountability. They have a system of sound corporate
governance, to put it another way.
The importance of independent directors
has been highlighted in reports from the Blue Riband Committee of the USA and
other committees. However, the law does not distinguish between the various
types of directors, and all directors are legally equally and jointly liable
for the board's decisions and acts. It is believed that both independent and
non-independent non-executive directors contribute to the board's
deliberations, particularly on matters of strategy, performance, conflict
management, and standards of behavior. Therefore “Kumar Mangalam Birla Committee”
accordingly placed a strong emphasis on the non-executive directors'
qualifications, particularly those of the independent directors.
According to good
corporate governance, the board must be made up of people who possess a
specific set of personal qualities and core competencies, such as an
understanding of the significance of the board's duties, integrity, a sense of
responsibility, a history of achievements, and the capacity for challenging
assumptions. The directors must have a high level of devotion to the business
and set aside enough time for meetings, preparation, and attendance, in
addition to possessing financial literacy, expertise, leadership skills, and
the capacity for strategic thought. The
“Kumar Mangalam Birla Committee” also suggested that it's critical to
provide non-executive independent directors with an attractive package of pay,
both to ensure that they are adequately compensated for their work and that
these positions become financially attractive enough to draw talent.
Guidelines
On Integrity and Transparency in Governance and Responsible Code of Conduct the
CII Code 2020
The concerned
person's standing, capacity to raise concerns and proposals in a constructive
manner, and focus on attaining common success for the Board must all be taken
into consideration when evaluating independence. The Board ought to be diverse,
and gender diversity is a crucial part of the board's overall diversity. The
method used to choose independent directors is crucial. They offer critical
insight and sincere comments on how the organization is perceived by the
outside world, which can substantially aid board strategy and function.
Relevant expertise is a key factor in choosing independent
directors, but other factors, such as the organization's size and nature, as
well as the candidate's qualifications, should also be taken into
consideration. As an illustration, the Board of a start-up would have different
expectations and requirements than a large, established company that leads the
market, and independent directors should be chosen based on the needs of an
organization, not on pre-set criteria (like a specific amount of experience).
Particularly if they are members of the Audit Committee or Risk Management
Committee, independent directors should have the necessary training and
expertise.
An independent director must devote enough time to the
organization's business and be well aware of his or her rights and obligations
in both those capacities. He or she should independently analyze the offered
material and, if he or she disagrees with the management's or important
shareholders' evaluation, question them (in the organization's interest). When a lead independent director is selected,
the organization should make it easier for him to carry out his duties.
Additionally, the organization should facilitate meetings between the lead
independent director and other independent directors as well as between
independent directors and higher-ranking staff members (at least that one level
below management) and outside stakeholders.
“Recommendation 5:
a. While constituting and
reconstituting the Board, it will be ensured that one or two independent
directors compulsorily have industry expertise in which the company operates,
to be able to contribute positively in providing advice to the management on
operational matters as well. In fact, for listed entities, it is a requirement
to state not just the relevant expertise or experience while proposing to
appoint an independent director, but also the skills/expertise/ competence
required by the listed entity, and those available with its board members.
b. As has been established,
women directors add a different perspective to the Board. This has been
established by many successful women directors who are making notable
contribution to corporate Boards. Given their competence and expertise, all
entities should strive to improve gender diversity at the board by inducting
more women directors.
c. Independent directors
should be fully cognizant of their role and responsibilities; they should
allocate sufficient time to the organization’s Board and spend it productively;
challenging management and significant owners; Board evaluation; management representations
made to external stakeholders etc. As an independent fiduciary, independent
directors should address their role and responsibilities with prudence and
care.
d. It may be considered (for
other than listed entities for whom it is a requirement) to hold at least one
meeting in a year, of only the independent directors (where there are more than
one independent director(s)), where the independent directors may discuss such
matters as they deem fit, including review of the quality, quantity, timeliness
and sufficiency of information flow between the management and the board of
directors.
e. If a lead independent
director has been appointed, the organization will facilitate the lead
independent director in aiding interaction among other independent directors in
context of the company’s matters and communicating their collective view to the
Chairman and management as appropriate.
f. The organization shall
also facilitate the interactions of independent directors with key external
stakeholders like auditors, and employees that are one level below the
management.
g. The Chairman will speak to
independent directors and gather their views outside the board room. This will
ensure everyone gets to express their views frankly while helping the Board
achieve its aim efficiently.”[2]
Legal framework related to independence of independent
directors
Following the loss of a significant company like Satyam
Computer Services, the Parliamentary Standing Committee on the Companies Act,
2009 noted that the position of independent directors took tremendous
significance. The fact that the Companies Act of 2013 clarified the roles,
responsibilities, and obligations of independent directors was one of its key
characteristics. Prior to that, the position of independent directors was
unclear because neither the Companies Act of 1956 nor the Securities and Exchange
Board of India (SEBI) Listing Agreement gave any guidelines in this regard. The
ability and moral character of the company's directors play a major role in how
successful the business is. According to the Companies Act of 2013, the
appointment of independent directors is carefully regulated.
The Companies Act of 2013 and the SEBI (Listing
Obligations and Disclosure Requirements) Regulations of 2015:
“Every listed public company shall have
at least one-third of the total number of directors
as independent directors and the Central Government may prescribe the minimum number of independent directors in
case of any class or classes of public companies.”[3]
“In case of a listed company, where the Chairperson of the Board of Directors is a non- executive
director, at least one-third of the Board of Directors shall comprise of independent directors and where the listed entity does not have a regular
non- executive Chairperson, at least half of the Board of Directors shall comprise of independent directors.”[4]
“The listed public company's board of
directors shall be composed as follows: (a)the
board of directors shall have an optimal combination of executive and
non-executive directors, with at
least one-woman director and not less than half of the board of directors
comprised of non-executive directors;
[Provided that the top 500 listed
entities' boards of directors must have at least one independent woman director by April 1, 2019, and the top 1000
listed companies' boards of directors
must have at least one independent woman director by April 1, 2020.”[5]
Qualifications and
Appointment of Independent Director
The selection of independent directors shall be made
independently of corporate management, and the Board shall ensure that the
composition of the Board is appropriately balanced in terms of knowledge,
skills, and experience to enable the Board to carry out its responsibilities
and functions. The shareholders must approve the appointment of the company's
independent director(s) at the annual meeting. A letter of appointment
detailing the terms and additional requirements is required to establish the
appointment of independent directors.
Independent directors in India are appointed for a maximum of
5 years and are eligible for reappointment for additional terms, per section
149(10) of the 2013 Companies Act. To re-appoint someone, a special resolution
must be approved. Furthermore, the Nomination and Remuneration Committee (NRC)
will make recommendations regarding whether or not Independent Directors should
be reappointed based on an annual evaluation of their performance. No
independent director may serve more than two terms in a row, despite what is
indicated in sub-section (10), however such an independent director shall be
eligible for appointment three years after ceasing to be an independent
director.
Requisite Qualities:
In regard to a firm, an independent director is defined as a
director who is not the managing director, a whole-time director, or a
nominated director and who, in the Board's opinion, possesses the essential
knowledge and experience. A person who possesses the additional qualifications
that the Companies Act of 2013 may specify. An independent director must have
the necessary education, training, and experience in one or more of the
following areas: corporate governance, finance, law, management, sales,
marketing, administration, research, and other sectors relevant to the
company's activities.
A statement on the declaration made by an independent
director to be presented before a company in its general meeting before the
board of directors that he complies with all the requirements of an independent
director as set forth in Section 149(6) of the Companies Act, 2013, and the
provisions of Regulation 16(1)(b) of the Securities and Exchange Board of India
(Listing Obligations and Disclosure Requirements) Regulations 2015, and that he
has the necessary qualifications and is not disqualified under any law for the
time being in force.
According to “Companies Act, 2013, S. 149(6)”,
an independent director is a director who is not a managing director,
whole-time director, or nominee director. They must be an integrity-conscious
individual with relevant expertise and experience, not a promoter of the
company or its holding, subsidiary, or associate company, not related to
promoters or directors in the company, its holding, subsidiary, or associate
company, and have no pecuniary relationship with the company, its holding,
subsidiary, or associate company during the two preceding financial years or
the current financial year.
Relatives of the director must not hold
any security or interest in the company, be indebted to the company, have given
a guarantee or provided security in connection with the indebtedness of any
third person, or have any other pecuniary transaction or relationship with the
company, its holding, subsidiary, or associate company amounting to two percent
or more of its gross turnover or total income.
The director must not hold the position
of a key managerial personnel or be an 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 they are proposed to be
appointed. They must also not be an employee of a firm of auditors, company
secretaries, or a legal or consulting firm that has or had transactions with
the company, its holding, subsidiary, or associate company amounting to ten
percent or more of its gross turnover.
In addition, the director must not hold
two percent or more of the total voting power of the company or be a Chief
Executive or director of a nonprofit organization receiving twenty-five percent
or more of its receipts from the company, its promoters, directors, or its
holding, subsidiary, or associate company, and should possess other
qualifications as may be prescribed.
Thus, we can see that the provisions of the Act have mandated
the conditions not only for the individual proposed to become independent
director but also to his relatives. By this way the Act has tried to make sure
that the individual is in no way attached to the company and can take tough
stand when required in the best interest of the company and the shareholders.
The independent director should not share more than 2% of the
voting power of the firm with his relatives, per Section 149(6)(e)(iii) of the
Companies Act, 2013. Because of this, these requirements guarantee that the
independent director is actually "independent" of the corporation and
is free to carry out his or her duties impartially and without favor or bias.
Duties Of Independent
Director
(1) undertake
appropriate induction and regularly update and refresh their skills, knowledge and familiarity with the
company;
(2) seek
appropriate clarification or amplification of information and, where necessary,
take and follow appropriate professional advice and opinion of outside experts
at the expense of the company;
(3) strive to
attend all meetings of the Board of Directors and of the Board committees of
which he is a member;
(4) participate
constructively and actively in the committees of the Board in which they are
chairpersons or members;
(6) where they
have concerns about the running of the company or a proposed action, ensure
that these are addressed by the Board and, to the extent that they are not
resolved, insist that their concerns are recorded in the minutes of the Board
meeting;
(7) keep
themselves well informed about the company and the external environment in
which it operates;
(8) not to
unfairly obstruct the functioning of an otherwise proper Board or committee of
the Board;
(9) pay
sufficient attention and ensure that adequate deliberations are held before
approving related party transactions and assure themselves that the same are in
the interest of the company;
(10) ascertain
and ensure that the company has an adequate and functional vigil mechanism and
to ensure that the interests of a person who uses such mechanism are not
prejudicially affected on account of such use;
(11) report
concerns about unethical behavior, actual or suspected fraud or violation of
the company’s code of conduct or ethics policy;
(12) acting
within his authority, assist in protecting the legitimate interests of the
company, shareholders and its employees;
(13) not disclose
confidential information, including commercial secrets, technologies,
advertising and sales promotion plans, unpublished price sensitive information,
unless such disclosure is expressly approved by the Board or required by law.”[6]
Effectiveness Of the Institution of Independent Directors
Concerns regarding the independence of independent directors
have been raised by corporate mismanagement and a lack of governance in Indian
corporations. Due to problems like those with Jet Airways and Infrastructure
Leasing and Financial Services' (IL&FS) failure to make payments, many
independent directors have resigned from their seats. Why these directors
failed to raise caution flags when they ought to have been the subject of an
investigation by the Ministry of Corporate Affairs (MCA).
According to reports, the IL&FS Risk Management
Committee, which includes independent directors, had not met in the preceding
four years. Even while independent directors claimed they were unaware of
internal concerns; the majority of people think that even outsiders were aware
of them. The significance of independent directors in corporate governance is
thus seriously questioned.
Despite some independent directors speaking out against
suspected corporate governance shortcomings, the outcomes were terrible. For
instance, questions concerning the efficiency of the institution of independent
directors were highlighted by Nusli Wadia's involvement in the Tata-Mistry
dispute. The removal of an independent director because his opinions differed
from those of the majority shareholder raises questions about the functioning
of the institution, even if the National Company Law Tribunal dismissed Cyrus
Mistry's claims of oppression and mismanagement.
The government and regulatory bodies like SEBI need to come
up with ways to make sure independent directors are motivated and encouraged to
work while also giving them the necessary authority and protection to do their
jobs.
Although Cyrus Mistry's claims of oppression and poor
management were rejected by the National Company Law Tribunal (NCLT), the
removal of an independent director because his opinions differ from those of
the majority shareholder raises serious questions about the efficacy of the
institution of independent directors.[7]
However, it is not very simple to answer whether the
institution of independent director has been effective or not in improving corporate
governance. The recent amendments in SEBI LODR which made it mandatory for
listed entities to have a proper vigil mechanism and whistleblower policy will
surely enhance the independence of the independent directors. Moreover, the
protection given by SEBI in reappointment of the independent director by
amending the existing provision of the LODR regulations clearly shows that the institution
of independent director is effective in improving corporate governance.
Conclusion And Suggestions
In India, the idea of an independent
director has changed over time to reflect the shifting demands and expectations
of the many stakeholders, particularly the shareholders who depend on them to
uphold sound corporate responsibility and governance. Finding qualified
candidates, maintaining their independence and effectiveness, and balancing
their rights and obligations are just some of the difficulties and restrictions
the idea faces. In order to make the independent director concept in India more
applicable and advantageous for businesses and society, it needs to be
constantly reviewed and improved. It is not always stringent conditions that
improve things, sometimes a good incentive may also work.
From the very starting the approach has
been to fix the pecuniary interest of the independent director so that they
will take decisions without getting influenced. But if we look at the other
side of the coin, then we can also question that why will a well qualified
person give his 100 % effort for a fixed remuneration? There has to be
something more than it so that the IDs may give their 100 % to the corporation
and improve the corporate governance.
[1]R???? ?? T?? K???? M??????? B???? C????????
?? C???????? G?????????, Report of the Committee Appointed by the SEBI on
Corporate Governance (1999).
[2] Confederation of Indian Industries (‘CII’), Guidelines on Integrity and Transparency in
Governance and Responsible Code of Conduct the CII Code 2020.
[4] SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, Reg. 17(1)(b).
[5] SEBI (Listing Obligations and
Disclosure Requirements) Regulations, 2015, Reg. 17(1)(a).
[7] Bhumesh Verma, Independent
Directors: Role, Responsibilities, Effectiveness, (2019) PL (CL) July 75.
Article Information
THE CONCEPT OF INDEPENDENT DIRECTORS: AN ANALYSIS BY: SAURABH MISHRA
Authors: SAURABH MISHRA
- Journal IJLRA
- ISSN 2582-6433
- Published 2024/04/05
- Issue 7
About Journal
International Journal for Legal Research and Analysis
- Abbreviation IJLRA
- ISSN 2582-6433
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