Introduction
The Companies Act 2013 has enlisted various provisions which highlight the importance and need of corporate governance in a company. The rationale behind corporate governance is to promote the usage of ethical methods in the running of a company, which includes transaction between a Company-Company, Company-Stakeholder, Company-Employees, Company-Shareholder etc.The dissolving of the concept of corporate governance would require Transparency, Full disclosure, Independent Monitoring and equality amongst stakeholders.
The Companies Act 1956 lacked provisions which would strengthen the moral character of a company and hence even after various attempts of including corporate governance via amendments to the old Act, the legislature was unable to confer a higher degree of responsibility on Companies. The failure of the Clause 49 of the Listing Agreement led to the introduction of a stronger provision in 2013 with the provision of Independent Directors in Act.
This paper will discuss the concept of Independent Directors and the implication of this provision on Corporate Governance of a Company.
HISTORICAL EVOLUTION
The concept of Independent Director is not new, it can be traced in a lot of cases from the past. Mentioned below is the evolution of the concept of Independent Directors.
It gained limelight first in 1993 when the London Stock Exchange issued the Cadbury Report. The kew recommendations of this report were:
Independence of non-executive directors from the Management
Special provisions for Non-executive Directors e.t.c
2. The Greenbury Report Recommendations (1995):
The rising issue of the Director Remuneration
Executive Remuneration can be watched by Independent Directors
3. Kumarmangalam Birla Report(1999)
In 1999, A committee constituted by SEBI chaired by Shri Kumaramangalam Birla. The result of which was the addition of the Clause 49 in the Stock Exchange Listing Agreements (“Listing Agreements”)
4. Higgs Review (2003)
Sir Alan Higgs from England proposed stricter provisions with respect to composition of the Board of Directors and its evaluation by Independent Directors. He recommended:
Equilibrium between skills and experience of both executive and non-executive directors.
Absence of Executive Direction in atlas one annual meeting with Independent Director.
5. Naresh Chandra Committee (2002)
With International Scams like Enron, Qwest there was an emergence to bring in reforms in the field of corporate governance. Therefore, the Naresh Chandra Committee in 2002 recommended that the vagueness in the definition of Independent Director be erased and it should be made clearer.
6. Narayan Murthy Report (2003)
The objective of this committee was to evaluate the functioning of Corporate Governance in India with transparency. One of the major recommendation of this committee was to increase the value of the Audit Committee and the Non-executive Directors of the Company.
7. 2004 Amendement
SEBI vide circular SEBI/CFD/DIL/CG/1/2004/12/10 dated October 29, 2004, amended the listing agreement whereby the minimum age for independent directors was prescribed as 21 years. And hence, the nominee directors are called Independent Directors.
8. Enactment of The Companies Act 2013
‘Consultative paper on Review of Corporate Governance Norms in India’ in January 2013, by SEBI proposed various new provisions for better governance practices.
The concept of independent directors was proposed in the legislation by means of the Companies Bill, 2009 which was then enacted in the form of the Companies Act, 2013. The Act and the relevant Rules made thereunder contain extensive provisions dealing with independent directors. In fact, a whole schedule, namely Schedule IV has been prescribed under the Act which contains the “Code for Independent Directors”.
The comparative table highlighting the provisions with regard to independent director in terms of the Companies Act, 2013, previous clause 49 of the listing agreement and revised clause 49 is placed as Annexure I.
ROLE: INDEPENDENT DIRECTOR
Independent Directors play a very important role in a company as hold are a neutral or transparent perspective in matters of the company involving the board and the management also keeping in mind the interest of the stakeholders.They are a step forward in achieving the goal of strong Corporate Governance in a Company. There presence assures credible and reliable decision making in the eyes of Stakeholders.
Even though it is difficult for an Independent Director to ensure that the practices of a Company are ethical in isolation, there is always a possibility of collective representation of Independent Directors against a practise that they don’t approve of collectively. Besides providing input in all Company decisions, strategies, etc. they are also a part of Company Committees.
COMPARISON : PROVISIONS IN ACTS 1956 & 2013
QUALIFICATION:
In addition to the qualifications prescribed under the Listing Agreement, the new act prescribes detailed qualification criteria for independent directors. Under the new act, “independent director” means a person other than a managing director, a whole-time director or a nominee director:
1. Who, in the opinion of the board, is a person of integrity and possesses relevant expertise and experience;
2. Who is or was not a promoter of the company or its holding, subsidiary or associate company;
3. Who is not related to promoters or directors in the company, its holding, subsidiary or associate company;
4. 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 the current financial year; and
5. None of whose relatives have or had pecuniary relationships or transactions with the company, its holding, subsidiary or associate company, or their promoters or directors, amounting to 2% or more of the company’s gross turnover or total income or `5 million or higher amount which may be prescribed, whichever is lower, during the two immediately preceding financial years or during the current financial year.
While the Listing Agreement restricted the appointment of a person related to the promoters or persons occupying management positions at the board level or one level below, the new act has restricted the appointee from having a relationship with the promoter or directors of the company, its holding, subsidiary or associate company. From this, it can be inferred that unlike the Listing Agreement, the new act does not require the appointee to be unrelated to a person occupying management positions at the board level or one level below the board. Considering that the new act does not supersede or replace the Listing Agreement, companies will have to comply with the requirements under both, until the rules framed in this regard provide greater clarity. Further, while the Listing Agreement does not contain any stringent provisions with respect to the relatives of the proposed appointee, the new act provides that neither the independent director nor any of his/her relatives:
Holds or has held a key managerial position or is or had been an employee of the company or its holding, subsidiary or associate company in any of the three financial years preceding the financial year in which he/she is proposed to be appointed;
Is or has been an employee or proprietor or partner, in any of the three financial years immediately preceding the financial year when he/she 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 consulting firm which has or had any transaction with the company, its holding, subsidiary or associate company amounting to 10% or more of the gross turnover of such firm;
3. Holds together with his/her relatives 2% or more of the total voting power of the company;
4. Is a chief executive or a director, by whatever name called, of any non-profit organization which receives 25% or more of its receipts from the company, any of its promoters, directors or its holding, subsidiary or associate company.
ADDITIONAL FEATURES:
a) Pecuniary Relationship:
The Listing Agreement states that an Independent Director should not have any pecuniary relationship with either the company, its promoters, its directors, or its holding company, its subsidiaries etc. at the time of appointment as there is a possibility that they affect the decision making capacity of the Independent director and his/her free will to make one.
The New Act also brings out an additional condition of the existence of such a relationship either in the current financial year or in the preceding two financial years.
The disqualification arising from any pecuniary relationship in the previous two financial years under the new act may be unreasonably restrictive, as there may be situations where a pecuniary transaction of the proposed independent director may safely be considered to be of a nature which does not affect the director’s independence.
b) Nominee Director
The new Act distinguishes between the Nominee Director and Independent Director. The new Act defines the Independent Directors can be enrolled in the data bank maintained by any institute, body or association but it is unclear on whether companies may only appoint candidates listed in the data bank or may appoint candidates fulfil the criteria mentioned regardless of whether they have not been enlisted in the data bank. The Listing Agreement states that the board of a company could appoint as an Independent Director any individual it deemed fir, so long as he/she fulfilled the qualifications set forth in the agreement.
c) Independent Character
The new Act requires the Independent Directors to give a declaration of independence at the first meeting of the board in which they participate and thereafter at the first meeting of the board in every financial year or whenever there is a change in circumstances which affects their status as an independent director.
As the new act does not override the provisions of the Listing Agreement, the conflicts highlighted above require a clarification or an amendment to the Listing Agreement to bring it in conformity with the new act. Several other restrictions have also been built into the new act to ensure that there is no financial nexus between an independent director and the company. For instance, the new act prohibits independent directors from receiving stock options of the company. The Listing Agreement does not prohibit the issue of stock options. Rather it provides that the maximum limit on stock options to be granted to independent directors can be decided by a shareholders’ resolution.
The new act limits the remuneration of independent directors to sitting fees, reimbursement of expenses for participation in the board and other meetings, and such profit-related commission as may be approved by the shareholders. This is yet another area of inconsistency with the Listing Agreement that will have to be clarified by the regulators.
d) Increasing Responsibility
Independent Directors are intended to make sure that the company carries on its functions with the interest of shareholders in mind etc. However, it can be concluded that their role is limited to an advisory role. The new provisions under the 2013 Act provides for their role in the company including provisions on their performance and functions.
Conclusion
In light of various scams that have occurred in the past, there is a requirement of determining and defining the role and power (inclusive of their extent) of Independent Directors in preventing and detection of fraud considering that they have a very limited opportunity to ensure the same. The new act not only increases the liability of the independent directors w.r.t the company but also ensures the diligent running of the company.
The provision of Independent Directors bring transparency and Independence to the table which was the need of the hour, but with that it also ensures performance of controlling/managerial functions.
From one perspective the new Act forces a more elevated amount of obligation by plainly characterizing Independent Directors role and risk in instances of disappointment, then again it forces confines on their compensation. These may end up being disincentives for people to acknowledge arrangements as Independent Directors. Forcing a high level of obligation on Independent Directors may turn out to be counter-profitable, as Independent Directors can’t be held subject for transgressions of the board.
Even though the new Act expects to present more extensive roles,greater autonomy and characterized liabilities on Independent Directors, it additionally restricts their powerful working by virtue of their being a minority (i.e. 33%) of the board. Further, certain arrangements relating to Independent Directors in the new Act struggle with the Listing Agreement, requiring changes in the Listing Agreement to guarantee that it keeps on applying alongside the new Act.