INDEPENDENT DIRECTORS: THINGS TO PONDER AS YOU ENTER INTO BRAVE NEW WORLD?

INDEPENDENT DIRECTORS: THINGS TO PONDER AS YOU ENTER INTO BRAVE NEW WORLD?

blog

May 29

2019

Posted by: CS Shilpi Thapar

In recent years, corporate governance has received increased attention because of high-profile most talked scandals i.e.  Enron in USA and Satyam and Reebok in India, involving abuse of corporate power and, in some cases, alleged criminal activity by corporate officers. The need for Independent Directors is recognized the world over.  One of the most of important driver for effective better corporate governance is appointment of Independent Director who with their specialized skills serves as strategic advisor to the company and act as a watchdog for the interest of stakeholders of the company.

The role and responsibilities of Independent Directors have increased substantially and become more stringent under Companies Act, 2013. Let us analyze the legal position of the Independent Directors under The Companies Act, 2013 :

Meaning of Independent Director-

A layman’s definition of an Independent Director can be –

A corporate director who has no material relationship with the company in which he or she serves as director.  For example, an independent director cannot be employed or have a family member employed by the company.

Independent Directors was not defined under The Companies Act, 1956. However clause 49 of the Listing Agreement provides the definition. As per earlier rule under Companies Act, 1956, it was not applicable to unlisted companies (whether public or private) and applicable only to listed companies. All listed companies have to appoint 1/3rd to ½ of total directors to be independent directors (depending upon executive/non-executive nature of chairman).

Independent Directors are well and extensively defined as per Section 149(6) under the Companies Act, 2013:

149(6) 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 organization 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.

 Need of Independent Directors…

  •  To fulfill statutory compliances for appointment of Independent Directors as laid down as per listing agreement and applicable provisions of The Companies Act, 2013.
  •  To have representatives on the Board who shall watch that the affairs of the company are run in a transparent manner, scrutinize the management performance, oversee that the interest of all its stakeholders (investors, employees, vendors, customers, government and society at large) are well protected, resolve the conflicts, establish best Internal controls and enhance the value of the company.

 Important provisions of Companies Act, 2013 to ponder before you accept position of Independent Director in any Company:- 

 Section 2(47) – Definition: ” Independent Director” means an Independent director referred to in sub-section(5) of section 149;

 Section 134(3)(d)-Financial Statements, Board Report: Board Report which shall be attached to the statements laid before a company in general meeting shall include a statement on declaration of status of independent directors made under section 149(6) (as discussed above)

 Section 135(1)-Corporate Social Responsibility(CSR): Every company having net worth of rupees five hundred crore or more, or turnover of rupees one thousand crore or more or a net profit of rupees five crore or more during any financial year shall constitute a Corporate Social Responsibility Committee of the Board consisting of three or more directors, out of which at least one director shall be an independent director.

  Section 149(4)- Listed companies to appoint Independent Directors: At least 1/3rd of the Board of every listed public company should consist of independent directors. The existing companies have been provided 1 year transition period to comply with the provisions of this Act (from the date of commencement of the Act). Also the every public company having paid up capital of Rs. 10 crore or more or public companies having turnover of Rs. 100 crore or more or having in aggregate outstanding   loans/debentures and deposits, exceeding Rs. 50 crore shall have at least 2 directors as Independent Directors.

 Maximum no. of directorships under the Companies Act, 2013 which Independent Director can hold is  20 companies out of which maximum of 10 public companies.  As per amended Clause 49B of Equity Listing Agreement vide SEBI Circular no.CIR/CFD/POLICY CELL/2/2014 dated April 17, 2014, a person shall not serve as an independent director in more than seven listed companies.  Further, any person who is serving as a whole time director in any listed company shall serve as an independent director in not more than three listed companies.

 Section  149(7-)Change in status of 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 as provided in sub-section (6).

 Section  149(8)- Provisions specified in schedule VI :The company and independent directors shall abide by the provisions specified in Schedule IV as under:

 The independent directors shall—

  • undertake appropriate induction and regularly update and refresh their skills, knowledge and familiarity with the company;
  • 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;
  • strive to attend all meetings of the Board of Directors and of the Board committees of which he is a member;
  • participate constructively and actively in the committees of the Board in which they are chairpersons or members;
  • strive to attend the general meetings of the company;
  • 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;
  • keep themselves well informed about the company and the external environment in which it operates;
  • not to unfairly obstruct the functioning of an otherwise proper Board or committee of the Board;
  • 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;
  • 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;
  • report concerns about unethical behaviour, actual or suspected fraud or violation of the company’s code of conduct or ethics policy;
  • acting within his authority, assist in protecting the legitimate interests of the company, shareholders and its employees;
  • 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.

Hence, Schedule IV sets out a code of conduct for the role, responsibilities and functions of the independent director.

  Section 149(9)-Norms  for stock Option and remuneration: Notwithstanding anything contained in any other provision of this Act, but subject to the provisions of sections 197 and 198, an independent director shall not be entitled to any stock option and may receive remuneration by way of sitting fee up to one lacs provided under sub-section (5) of section 197, reimbursement of expenses for participation in the Board and other meetings and profit related commission as may be approved by the members.

  Section 149(10)& 11-Term of office: Subject to the provisions of section 152, Independent Directors shall hold office for a term upto 5 (original term) + 5 years (additional term subject to a special resolution). After expiry of term individual ineligible for re appointment for 3 years. His tenure shall be non-rotational.

An independent director shall not, during the said period of three years, be appointed in or be associated with the company in any other capacity, either directly or indirectly.

 Section  149(12)-Liability of Independent Director:Notwithstanding anything contained in this Act,—

 (i) an independent director;

(ii) a non-executive director not being promoter or key managerial personnel,

 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.

 Section 150(1)-Manner of selection of Independent Director:Subject to the provisions contained in sub-section (5) of section 149, an independent director may be selected from a data bank containing names, addresses and qualifications of persons who are eligible and willing to act as independent directors, maintained by anybody, institute or association, as may be notified by the Central Government, having expertise in creation and maintenance of such data bank and put on their website for the use by the company making the appointment of such directors:

 Provided that responsibility of exercising due diligence before selecting a person from the data bank referred to above, as an independent director shall lie with the company making such appointment.

  Section 150(2)-Appointment of ID to be approved in General Meeting:The appointment of independent director shall be approved by the company in general meeting as provided in sub-section (2) of section 152 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.

Section 152(5)-Explanatory Statement required to be given: In the case of appointment of an independent director in the general meeting, an explanatory statement for such appointment, annexed to the notice for the general meeting, shall include a statement that in the opinion of the Board, he fulfils the conditions specified in this Act for such an appointment.

  Section 161(2)-Alternate Director; if appointed as independent director shall be required to qualify as independent Director:  No person shall be appointed as an alternate director for an independent director by the board of directors as authorized by Articles of Association unless he is qualified to be appointed as an independent director under the provisions of this Act.

  Section 173(3)-Notice of Board Meeting and exception if an Independent Director is present:A meeting of the Board shall be called by giving not less than seven days’ notice in writing to every director at his address registered with the company and such notice shall be sent by hand delivery or by post or by electronic means:

 A meeting of the Board may be called at shorter notice to transact urgent business subject to the condition that at least one independent director, if any, shall be present at the meeting:

 Provided further that in case of absence of independent directors from such a meeting of the Board, decisions taken at such a meeting shall be circulated to all the directors and shall be final only on ratification thereof by at least one independent director, if any.

 Section  177(2)- Audit Committee :The Board of Directors of every listed company and every public company having paid up capital of more than Rs. 10 cr. Or turnover of more than Rs. 100 cr. Or Borrowings of more than Rs.50 cr. shall constitute the Audit Committee which shall consist of a minimum of three directors with independent directors forming a majority.

 Section 178(1)-Nomination and Remuneration Committee: The Board of Directors of every listed company and every public company having paid up capital of more than Rs. 10 cr. Or turnover of more than Rs. 100 cr. Or Borrowings of more than Rs.50 cr. shall constitute the Nomination and Remuneration Committee consisting of three or more non-executive directors out of which not less than one-half shall be independent directors.

 Schedule IV:Code for Independent Directors [Pursuant to section 149(8)]

  1. Guidelines of professional conduct:

An independent director shall:

  • uphold ethical standards of integrity and probity;
  • act objectively and constructively while exercising his duties;
  • exercise his responsibilities in a bona fide manner in the interest of the company;
  • devote sufficient time and attention to his professional obligations for informed and balanced decision making;
  • not allow any extraneous considerations that will vitiate his exercise of objective independent judgment in the paramount interest of the company as a whole, while concurring in or dissenting from the collective judgment of the Board in its decision making;
  • not abuse his position to the detriment of the company or its shareholders or for the purpose of gaining direct or indirect personal advantage or advantage for any associated person;
  • refrain from any action that would lead to loss of his independence;
  • where circumstances arise which make an independent director lose his independence, the independent director must immediately inform the Board accordingly;
  • assist the company in implementing the best corporate governance practices.

 2.Role and functions:

The independent directors shall:

  • help in bringing an independent judgement to bear on Board’s Deliberations especially on issues of strategy, performance, risk management, resources, key appointments and standard of conduct;
  • bring an objective view in the evaluation of the performance of board and management;
  • scrutinize the performance of management in meeting agreed goals and objectives and monitor the reporting of performance;
  • satisfy themselves on the integrity of financial information and the financial controls and the systems of risk management are robust and defensible;
  • safeguard the interests of all stakeholders, particularly the minority shareholders;
  • balance the conflicting interest of stakeholders;
  • determine appropriate levels of remuneration of executive directors, 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;
  • moderate and arbitrate in the interest of the company as a whole ,  in situations of conflict between management and shareholder’s interest.

 3.Duties:

 The independent directors shall—

  • undertake appropriate induction and regularly update and refresh their skills, knowledge and familiarity with the company;
  • 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;
  • strive to attend all meetings of the Board of Directors and of the Board committees of which he is a member;
  • participate constructively and actively in the committees of the Board in which they are chairpersons or members;
  • strive to attend the general meetings of the company;
  • 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;
  • keep themselves well informed about the company and the external environment in which it operates;
  • not to unfairly obstruct the functioning of an otherwise proper Board or committee of the Board;
  • 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;
  • 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;
  • report concerns about unethical behaviour, actual or suspected fraud or violation of the company’s code of conduct or ethics policy;
  • acting within his authority, assist in protecting the legitimate interests of the company, shareholders and its employees;
  • 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.

 4.Manner of appointment:

  •  While selecting independent directors (ID’s) the board shall ensure that there is appropriate balance of skills, experience and knowledge in the board.
  • The appointment of IDs of the company shall be approved at the meeting of the shareholders.
  • The Explanatory Statement attached to the notice of the meeting  for approving the appointment of IDs shall include a statement that in the opinion of the board, the IDs proposed to be appointed fulfils the conditions specified in the Act and the rules made there under and that the proposed director is independent of the management.
  • The appointment of independent directors  shall be formalized through a letter of appointment, which shall set out the terms of appointment, the expectation of the board from the appointed director, the fiduciary duties, provisions for D & O Insurance Policy, code of business ethics, remuneration and other fees, list of actions which IDs should not do while functioning as such in the company.
  • The terms and conditions of appointment of independent directors shall be open for inspection at the registered office of the company by any member during normal working hours and also terms and conditions of the appointment letter should be uploaded on the company’s website.

 5.Re-appointment:

 The re-appointment of ID’s shall be on the basis of report of performance evaluation.

 6.Resignation or removal:

  •  The resignation or removal of an independent director shall be in the same manner as is provided in section 168 & 169 of the Act.
  • An independent director who resigns or is removed from the board of the company shall be replaced with 180 days from the date of such resignation or removal, as the case may be .

  7. Separate meetings:

  • 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 and review the performance of the non-independent directors and the Board as a whole of the company.
  • They shall also evaluate 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 to perform their duties.

 8.Evaluation Mechanism:

  • The performance evaluation of ID’s shall be done by the entire board of directors, excluding the director being evaluated.
  • On the basis of evaluation report, ID shall be reappointed or continue his terms as ID.

 

 Section 149 (12)-Penalty for non compliance of independent director provisions: Penalty under Companies Act, 2013; INR 50,000 to INR 5,00,000 v. upto imprisonment upto 10 years or fine upto INR 25 crores under the SCRA. Independent director liable for acts/omissions of company unless lack of knowledge/ consent or “acting diligently” is proved. There is no restriction on indemnification by company.

 From the above, it is quite evident that the roles, functions and duties of Independent directors have increased substantially. One has to ponder on all these provisions thoroughly before accepting the invitation for becoming Independent Director of the Company. Further, it is also noted that remuneration and fees to be given to Independent Directors as per provisions of The Companies Act, 2013 is not consistent with the duties, roles, functions and responsibility of the Independent Directors as enumerated in the Act. The Companies Act,2013 have put lot of restrictions for Independent Directors that now even, the most eligible candidates will be more cautious before the joining the board of any company as Independent Directors or even extending their terms as ID’s.

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