Companies Act, 2013: Independent Directors

In this post, important changes relating to introduction of Independent Directors (IDs) in the new Companies Act, 2013 would be discussed. [For an analysis & discussion of M&A and Corporate Restructuring in the ‘new act’, kindly click here].

Now, the primary role of corporate governance is always to ensure the independence of the board of directors (BOD) in a company. Independent directors on the board predominantly enhance the monitoring and supervising of the management and the promoters of a company. Thus is turning immensely helps in protecting and safeguarding the interests of the public shareholders. The new Companies Act, 2013 on one hand bestows independent directors with greater say in corporate governance & on the other hand places greater demand from them. Now, the relevant provisions concerning IDs in the new act are Section 149, 150 and Schedule IV. The primary features concerning Independent directors (IDs) in the new Companies Act, 2013 are as follows-

Number of Independent Directors

The new Companies Act, 2013 requires all the listed companies to have at least 1/3rd independent directors on their board. But this provision of the Act is a slight departure from clause 49 of the listing agreement. Clause 49 of the Listing agreement issued by SEBI requires that at least 50% of the Board of Directors (BOD) must comprise of Independent Directors in case the chairperson is in an executive capacity or a promoter or related to a promoter. Now, one thing which must be noted is that the listed companies will be required to comply with the more onerous of the two requirements, while others can merely comply with the company law. The consequences of violation may also be different under company law and securities regulation i.e. under clause 49 of the listing agreement.

Definition of Independence

The definition of an Independent Director has been amply broadened and tightened.  For example, if a director is a chief executive of an NGO that receives funding from the company to a certain extent, the person would not qualify as an independent director. Also, the new Act has added some positive attributes of independence i.e. the candidate must be “a person of integrity and possess the relevant expertise and experience” in the opinion of the board. This definition of independent director was missing in Clause 49 of the listing agreement. Further, the Central Government is also vested with the power to prescribe qualifications for Independent Directors. Also, every Independent Director is also required to declare that he or she meets the criteria of independence.

Appointment

One of the most predominant and major criticism pertaining to the current appointment of Independent directors in the board is that they are appointed like any other director. This in turn gives promoters wide influence and clout in determining the identity of the independent directors. Even Clause 49 of the listing agreement does not put any onerous requirement in the appointment of independent directors on the board of listed companies. Now, the new Companies Act, 2013 has sought to remedy this. The new act mandates the formation of ‘nomination and remuneration committee’. The concerned committee is required to consider candidates for appointment as independent directors and to recommend to the board. This would bring in greater fairness and objectivity in the appointment of I.D. (Independent Director). However, the act does not provide for greater participation of minority shareholders in the appointment of I.D. through methods such as cumulative voting or proportionate representation. Thus, this is only an optional method and the new act does not make it mandatory for the companies to allow the participation of minority shareholders in the I.D. appointment.

Furthermore, the Act also contemplates the establishment of a data bank of IDs, from which persons may be chosen by companies.

Tenure

In order to ensure that IDs maintain their independence and do not become too familiar with the management and promoters, minimum tenure requirements have been prescribed. The initial term shall be 5 years, following which further appointment of the director would require a special resolution of the shareholders. However, the total tenure shall not exceed 2 consecutive terms.

Remuneration

Under the new Act, independent directors are entitled only to fees for attending the meetings of the board. They are being expressly disallowed from obtaining any stock options in the company. Further, IDs are also entitled for fees pertaining to reimbursement of expenses for participation in the Board & other meetings and profit related commission as may be approved by the members of the company. But, owing to these onerous requirements, the present provisions provide little room for companies to attract required talent by remunerating directors for the services they provide.

Roles and Functions

The role of an independent director is broadly set out in the Schedule IV of the Companies Act, 2013. The concerned schedule contains a code that sets out the role, functions and duties of IDs and incidental provisions relating to their appointment, resignation and evaluation. The code lays down certain broad guidelines like upholding ethical standards of integrity, acting objectively and most importantly devoting sufficient time and attention for informed and balanced decision making. There are certain critical functions entrusted to them – to scrutinise the performance of management and to satisfy themselves on the integrity of financial information and robustness of financial controls and risk management.  The role of audit committee has been enhanced thereby placing greater responsibilities on independent directors. The audit committee will now have to ‘examine’ financials (currently ‘review’) and approve related party transactions (currently they are ‘reviewed’).[1]

Thus, by defining responsibilities and duties in a mandatory code of conduct, onus has been placed on independent directors thereby reducing their chance of getting the ‘benefit of doubt’ in case of non compliances. This predominantly casts an important fiduciary responsibility on Independent Directors towards investor community and other stakeholders concerned. Discharging this responsibility, would require orientation, knowledge and involvement[2]. The downside of these onerous requirements is that many potential IDs would be hesitant in taking up the new role.

Liability

The new ‘Act’ has sought to balance the wide nature of the obligations, functions and duties imposed on IDs. The new act only seeks to restrict and limit the liability of IDs to 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.

[3]

Independent Meetings

The concept of independent meetings of IDs has been put in the new Companies Act, 2013. The act now requires all the IDs 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. IDs would also evaluate the performance of the chairperson of the company. Also, the act requires the IDs 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 (BOD) of a company. Further, the concept of independent board meeting of IDs is already prevalent in US and UK.

Conclusion

Lastly, the Companies Act, 2013 has bestowed greater empowerment upon the IDs 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 new act empowers the IDs to actually have a definite ‘say’ in the management of a company, which would thereby immensely strengthen the corporate governance. Now, it is time that India Inc put in all efforts to land worthy IDs on their board. Finally, it is anticipated that these new provisions regarding Independent Directors would thwart any 'Satyam and Reebok akin corporate scandal,recently witnessed by the corporate world.

TO VIEW THE COMPANIES ACT, 2013-Please Click HERE.

I can also be contacted at- rishabh.a.09@gmail.com

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[1] Available at http://indiacorplaw.blogspot.sg/2011/12/companies-bill-2011-independent.html, last visited 18/09/2013 at 2:42 AM

[2] Ibid

[3]Available at http://thefirm.moneycontrol.com/story_page.php?more_category=by_invitation&autono=947523, last visited on 18/9/2013 at 2:56 AM