Independent directors as the name suggests are directors on Board of a company who are independent individuals, not having any other relationship or transaction with the company. The concept of Independent directors gained momentum in the late 1980s and early 1990s due to the uncovering of various corporate frauds and misfeasance. In India, Clause 49 of the listing agreement mandates appointment of independent directors on Board of a listed company. With the passage of the new Companies Act of 2013, the concept of independent directors has found place in the Companies Act itself. The requirements prescribed under the Companies Act 2013 seem to be much more stringent than that of the listing agreement.
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 492of 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.
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.
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 favor 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.
MEANING AND DEFINITION OF INDEPENDENT DIRECTOR
As per Section 2(47), “independent director” means an independent director referred to in sub-section (5) of section 149;
Section 149 (6) contains that –
An independent director in relation to a company, means a director other than a managing director or a whole-time 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) (i) who is or was not a promoter of the company or its holding, subsidiary or associate company;
(ii) who is not related to promoters or directors in the company, its holding, subsidiary or associate company;
(c) who has or had no pecuniary relationship with the company, its holding, subsidiary or associate company, or their promoters, or directors, during the two immediately preceding financial years or during the current financial year;
(d) none of whose relatives has or had pecuniary relationship or transaction with the company, its holding, subsidiary or associate company, or their promoters, or directors, amounting to two per cent. or more of its gross turnover or total income or fifty lakh rupees or such higher amount as may be prescribed, whichever is lower, during the two immediately preceding financial years or during the current financial year;
(e) who, neither himself nor any of his relatives—
(i) holds or has held the position of a key managerial personnel or is or has been 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 he is proposed to be appointed;
(ii) is or has been an employee or proprietor or a partner, in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed, of—
(A) a firm of auditors or company secretaries in practice or cost auditors of the company or its holding, subsidiary or associate company; or
(B) any legal or a consulting firm that has or had any transaction with the company, its holding, subsidiary or associate company amounting to ten per cent. or more of the gross turnover of such firm;
(iii) holds together with his relatives two per cent. or more of the total voting power of the company; or
(iv) is a Chief Executive or director, by whatever name called, of any nonprofit organisation that receives twenty-five per cent. or more of its receipts from the company, any of its promoters, directors or its holding, subsidiary or associate company or that holds two per cent. or more of the total voting power of the company; or
(f) who possesses such other qualifications as prescribed below:
An independent director shall possess appropriate balance of skills, experience and knowledge in one or more fields of finance, law, management, sales, marketing, administration, research, corporate governance, technical operations or other disciplines related to the company’s business.
APPLICABILITY TO COMPANIES
Following class of companies are required to appoint at least 1/3 of total number of directors on their Board of Directors as independent directors:
- Listed Companies
- Public Companies having paid up capital of one hundred crore rupees or more
- Public Companies having turnover of three hundred crores or more
- Public Companies which have aggregate outstanding loans or borrowings or Debentures or deposits exceeding two hundred crores
POSITION OF INDEPENDENT DIRECTORS UNDER THE STATUTE
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 whole time director or a nominee director,
WHO CAN BE AN INDEPENDENT DIRECTOR?
Section 149(6)of the Companies Act,2013 specifies as to who can be an independent director. In simple words, any of the following persons can be termed as independent director:
- A person who is not a Managing Director nor Whole-time Director Nor a Nominee Director; in other words, a director who is either non-executive or part time professional director.
- A person with relevant experience, expertise and integrity in the opinion of Board of Directors. Therefore, while considering the appointment of Independent Director, the Board has to deliberate as to whether the person is a man of integrity and possess experience and expertise and thereafter pass a resolution. Though the word ‘relevant’ is used it does not narrow down the choice about the person. The person may be having experience in the line of business in which the company is engaged and others may have experience in the fields such as law, finance, economic, management, business, trade, commerce etc.etc.
- A person who neither was nor is a promoter of the company nor its holding or subsidiary or associate company. ‘Associate company’ has been defined in sub-section (6) of Section 2 of the Companies Act, 2013.
- A person who neither was nor has any pecuniary relationship with the company, its holding, subsidiary, or associate company or their promoters, or directors during the preceding two financial years or during the current financial year.
- A relative who has or had pecuniary relationship or transaction with the company, holding company, subsidiary company, associate company or their promoter director or director and the value of such relationship or transaction does not exceed 2% of its gross turn-over or its total income or Rs.55,00,000 or such higher amount as may be prescribed during the immediately two preceding financial years or during the current financial year.
- A person who neither himself nor his relative had held or holding the position of KMP or currently is or has been the employee of the company, its holding, its subsidiary or its associate company during any three financial years immediately preceding the financial year in which he is sought to be appointed.
- A person who neither himself nor any of his relatives is or has been
- an employee or proprietor or a partner, in any of the immediately preceding three financial years, in the firm of auditors, company secretaries in practice or cost auditors of the company or in its holding company or subsidiary company or associate company;
- in any legal or consulting firm that has or had any transaction with the company, its holding company, subsidiary company or associates company, amounting to 10% or more of the gross turnover of such firm
- or a person who either holds together with his relatives two per cent or more of the total voting power of the company; or (iv) a person who is neither Chief Executive nor Director, or by whatever name called, in any Non-Profit Organization that receives twenty five percent or more of its receipts from the company or any of its promoters, directors or its holding, subsidiary or associate company or that holds 2% or more of the total voting of the company.
- A person who possess such other qualification as may be prescribed.
STRENGTH OF INDEPENDENT DIRECTORS
Section 149(4) requires every listed company to appoint minimum one-third of the total number of directors as independent directors. For companies, other than the listed companies, Rule 4 of The Companies (Appointment and Qualification of Directors) Rules, 2014 provides that following class of public companies shall have at least two persons as independent directors:-
a) Public Companies having paid up share capital of Rs.10 Crores or more
b) Public Companies having turn over of Rs.100 Crore or more
c) Public Companies having outstanding loan, debentures and deposits, in aggregate, in excess of Rs.50 Crore.
APPOINTMENT OF INDEPENDENT DIRECTORS
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 act. 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 fulfills 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
Section 150(1) says that an independent director may be appointed from out of the data bank maintained by any association, body, institute as may be notified by Central Government. It is clarified that it is not mandatory that independent director should be appointed only from the data bank in view of the word ‘may appearing in the Section. Needless to say, appointment of independent director shall first be considered in the meeting of the Board of Directors and later on approved by the company by way of ordinary resolution in general meeting as per Section 152(2). However, the second tenure of five consecutive years shall be by way of special resolution passed in the general meeting. The Explanatory Statement shall give proper justification for choosing such person as independent director and also include a statement that in the opinion of the Board of Directors, he fulfills the conditions specified in the Act for such an appointment
- It is clarified that it is not mandatory that independent director should be appointed only from the data bank in view of the word ‘may’ appearing in the Section. Needless to say, appointment of independent director shall first be considered in the meeting of the Board of Directors and later on approved by the company by way of ordinary resolution in general meeting as per Section 152(2). However, the second tenure of five consecutive years shall be by way of special resolution passed in the general meeting
TENURE OF OFFICE
- An independent director shall hold office for a term up to 5 consecutive years on the Board of a company, but shall be eligible for reappointment on passing of a special resolution by the company and disclosure of such appointment in the Board’s report.
- No independent director shall hold office for more than 2 consecutive terms, but such independent director shall be eligible for appointment after the expiration of 3 years of ceasing to become an independent director provided that he shall not, during the said period of 3 years, be appointed in or be associated with the company in any other capacity, either directly or indirectly
- Any tenure of an independent director on the date of commencement of this Act shall not be counted as a term under the above provisions.
DUTIES AND RESPONSIBLITIES OF INDEPENDENT DIRECTORS
Role and functions
The Independent Director shall:
- Help in brining an independent judgement to bear on the Board’s deliberations especially on issues of strategy, performance, risk management, resources, key appointments and standards of conduct
- Bring an objective view in the evaluation of the performance of board and management
- Scrutinise the performance of management in meeting agreed goals and objective and monitor the reporting of performance
- Satisfy themselves on the integrity of financial information and that financial controls and the systems of risk management are robust and defensible
- Safeguard the interest of all stakeholders, particularly the minority shareholders
- Balance the conflicting interest of the stakeholders
- Determine appropriate levels of remuneration of Executive Director, key managerial personnel and senior management and have a prime role in appointing and where necessary recommend removal of executive directors, key managerial personnel and senior management and
- Moderate and arbitrate in the interest of the company as a whole in situation of conflict between management and shareholder’s interest
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.
Resignation, reappointment and removal
The independent director may resign by sending a letter of resignation in writing to the company and such letter shall be considered in the meeting of Board and when accepted the prescribed return shall be filed with ROC. The Director’s Report (immediately following the date of resignation) shall contain a reference of such resignation. It is also incumbent upon such director to send such letter of resignation, containing detailed reasons to the Registrar of Companies within a period of thirty days. In the Companies Act, 1956, there was no legal obligation for an independent director to send a copy of the letter of resignation to the ROC. An independent director can also be removed by the company by passing an ordinary resolution in general meeting after giving him a reasonable opportunity of hearing pursuant to a Special Notice as permissible under Section 169 of Companies Act, 2013. The procedure for sending notice and hearing is the same as was provided under old Act. Appendix I to Schedule IV prescribes that vacancy so arisen shall be filled within a period of 180 days from the date of either resignation or removal. The re-appointment of Independent Directors shall be on the basis of report of performance evaluation
Separate meetings of independent directors
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.
The meeting shall include:
- Review the performance of non-Independent Directors and the Board as a whole
- Review the performance of the Chairperson of the company, taking into the account the views of Executive Directors and Non-Executive Directors
- Assess the quality, quantity and timeliness of flow of information between the company management and the Board that is necessary for the Board to effectively and reasonably perform their duties
OTHER PROVISIONS RELATING TO INDEPENDENT DIRECTORS
- The appointment of independent director shall be approved by the company in general meeting and the explanatory statement annexed to the notice of the general meeting called to consider the said appointment shall indicate the justification for choosing the appointee for appointment as independent director.
- 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.
- The company and independent directors are required to abide by the provisions specified in Schedule IV of the Act.
- An independent director shall not be entitled to any stock option and may receive remuneration by way of fee, reimbursement of expenses for participation in the Board and other meetings and profit related commission as may be approved by the members.
- An independent director 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.
- The provisions relating to retirement of directors by rotation shall not be applicable to appointment of independent directors.
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/non-independent, 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.