Companies Act, 2013 and the concept of Independent Director

While there is a growing clamour amongst many promoters that in view of the strict provisions of the Act and the duties and liabilities thrust upon independent directors, it is very difficult to attract such people...

This article aims to elaborate not only the provisions under the Companies Act, 2013 which has introduced for the first time, the concept of an independent director, but also generally to assess as to whether the introduction of such a section will really usher in truly independent directors to the Board of the companies and thereby give any new meaning to corporate governance which can be compared with the best practices followed internationally.

Before we analyse the said provisions of the said Act, we would like to state what is understood by the word independent in common parlance. Concise Law dictionary 4th Edition 2012 defines the word independent or the expression independent as a person other than those who are employers and employees in relation to the scheduled employment. The word independent also means being or acting free of influence of something, not in subordinate position (as per the definition of Industrial Disputes Act section 2 (1)). All these point out to the fact that the independent director has to be truly independent in all respects. Therefore, it is necessary for the corporates while choosing the independent director that he or she should not only adhere to the strict rules prescribed under the provisions of Companies Act, but also in real terms it should be seen that every action taken by them is truly independent and is with the sole intention of the benefit of the shareholders.

It should be noted that the concept of independent directors was not something new to the Indian corporates, while it is an admitted fact that the earlier Act namely Companies Act, 1956 did not have such provisions which specifically mandated the appointment of an independent director, independent directors were brought to the Boards by virtue of clause 49 of the listing agreement. It is clause 49 of the listing agreement which mandated the introduction of independent directors into the Board of listed companies.

It is also to be noted that the Banking Regulation Act, 1949 had a concept of an independent director built in by introduction of section 10A to 10D by an amendment made to the said Act in the year 1968 to be precise w.e.f. 1.2.1969. The relevant section states that not less than 51% of the total members of the Board of Directors of a banking company shall consist of persons who have special knowledge or practical experience in respect of one or more of the matters namely Accountancy, Agricultural and Rural Economy, Banking Corporation, Economics, Finance Law and Small Scale Industries or any other matter which in the opinion of the Reserve Bank of India be useful for the banking companies.

It stipulates that out of the aforesaid no. of directors, the said directors shall not Have substantial interest in, or be connected with, whether as employee, manager or managing agent,- Any company, not being a company registered under section 25 of the Companies Act, 1956 (1 of 1956), or

Any firm,

Which carries on any trade, commerce or industry and which, in either case, is not a small-scale industrial concern, or

Be proprietors of any trading, commercial and industrial concern, not being a small-scale industrial concern.

Thereby the concept of independent directors in banking industries was established since 1969. Subsequent to that, the introduction of clause 49 of listing agreement reinforced the theory of independent directors in listed corporates. This in fact came into existence w.e.f. 31.12.2005 only.

The provisions of listing agreement laid down the criteria for independent directors as under:

1. Independent Director was defined as

'Independent director' shall mean non-executive director of the company who:

a. apart from receiving director's remuneration, does not have, in the opinion of the board, any material pecuniary relationships or transactions with the company, its promoters, its senior management or its holding company, its subsidiaries and associated companies which in the judgement of the board may affect independence of judgement of the director;(hence the anomaly is that the authority to judge the independence of a director to be appointed to the Board was again left to the Board itself);

b. is not related to promoters or management at the board level or at one level below the board;

c. has not been an executive of the company in the immediately preceding three financial years;

d. is not a partner or an executive of the statutory audit firm or the internal audit firm that is associated with the company, and has not been a partner or an executive of any such firm for the last three years. This will also apply to legal firm(s) and consulting firm(s) that have a material association with the entity;

e. is not, in the opinion of the board, a material supplier, service provider or customer of the company, which in the judgement of the board may affect independence of judgement of the director. This should include lessor-lessee type relationships also; and

f. is not a substantial shareholder of the company, i.e. owning two percent or more of the block of voting shares.

The old clause 49 was silent about the tenure and extent of companies, a person can be an independent director which has been amended as per the new clause 49 which is discussed in the comparison section (between old and amended clause 49).

Therefore, even in the absence of specific provisions under 1956 Act, a class of directors known as independent directors made it to the Boards of listed companies. However, it was always found that while they may fulfil the criteria as laid down by listing agreement and SEBI regulations. The big question remains whether they were and are really independent in functioning or not. The said listing agreement did not cast any responsibility or duty which may invite the regulatory wrath on them. Therefore, many of the independent directors often in the absence of any strict monitoring by an authority played into the hands of promoters and thereby did not enhance in real terms the corporate governance for which they were mandated.

In this background, the legislature felt the need to introduce a special section namely section 149 in the new Companies Act, 2013 dealing with independent directors.

We now deal with the provisions of 2013 Act:

Section 149 (4) states that 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.

It is necessary to look into the explanation given to section 149(4) which prescribes the qualifications for an independent director which says 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 non-profit 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 may be prescribed.

It can be seen that the amended definition of independent directors in the new Listing Agreement of SEBI is similar to the above mentioned explanation.

The Act also mandates the Audit Committee and Nomination and Remuneration Committee of a listed company to have at least 1/3rd of its members to be Independent Directors.

The Act provides for separate meetings to be conducted by the Independent Directors once in a year without the attendance of the non-independent Directors which shall look into the aspects mentioned in sub Schedule VII (3) to Schedule IV of the Companies Act, 2013.

It is also to be noted that SEBI vide its detailed Circular No. dated April 17, 2014 as amended Clause 35B and 49 of the equity listing agreements. The amendments are as under:

The concept of independent directors is very much in vogue in countries that practise common law. In India, it should be noted that we have woken up on this issue only after major scams have happened in corporate world like Satyam scam and many others of this nature. It is always better to be late than never.

If one is to read the explanation to sub-section 4 of the new Companies Act, while the aim in introduction of the provisions is very notable and noble, unless there is a constant monitoring by a regulatory agencies, all the said provisions can be hoodwinked by the smart promoters by appointing independent directors who fit into the criteria laid by the Act and SEBI Regulations, but still may dance to the tunes of the promoters. It is to be noted that the success of any regulation depends not in the letters alone but in spirit and the way it is enforced and practiced.

In order to counter this newly introduced section of independent directors, there is growing clamour amongst many promoters that in view of the strict provisions of the Act and the duty and liability cast on the independent directors they find it very difficult to attract independent directors. This in my view is something which needs to be ignored as this is nothing but a ploy to put impediments in the said Section and also to dilute the implementation of the said provisions.

In conclusion I would like to state that the shareholders should not be lethargic and should not be under the feeling that in view of the provisions of 2013 Act as also in view of the amended SEBI Regulation, the companies will be managed by truly professional and independent Boards. Only an alert investors as well as shareholder can make the provisions enforceable. Shareholders activism holds the key to the enforcement and implementation of such provisions in letter and spirit.

Disclaimer - The views expressed in this article are the personal views of the author and are purely informative in nature.