Independent Directors as ‘conscience-keepers of the Board’[i] are an indispensable tool for India’s corporate landscape that are focal in strengthening the foundation of companies to ensure enhanced corporate credibility. The concept of appointing Independent Directors in companies was introduced to strengthen the corporate governance mechanisms in India.[ii] The underlying rationale behind incorporating Independent Directors within the Board of directors is to have a means of objective assessment of company affairs. As custodians of the stakeholders’ interests, Independent Directors are suited to evaluate company performance without any conflict of interest, vested agendas or undue influence and work towards the legal, ethical & effective functioning of companies.[iii] Since Independent Directors are active participants of various functional departments of the company, they play a pivotal role in risk management of companies.[iv] As watchdogs of companies, they have sincerely contributed towards enhanced corporate governance compliance and transparency.[v] Bearing in mind that this is a fairly new concept in India’s corporate landscape, ‘important elements of the functioning of Independent Directors still remain obscure and unexamined’.[vi] Although, there exists a positive relationship between company performance and role of Independent Directors currently, there exist several obstacles in this mechanism that must be addressed to make it a robust system. In this incessant journey, this paper shall strive to identify few challenges concerning Independent Directors (hereinafter IDs) that continue to plague our system.
Questionable Independence of Independent Directors
In a recent corporate governance survey conducted by ‘Local Circles’, it was revealed that “79% individual shareholders believe that constitution of the Board of Directors of most Indian corporates is tilted towards promoters as many IDs aren’t really Independent”.[vii] Section 16(1)(b) of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, Section 149(6) of the Companies Act, 2013, & Rule 5 of the Companies (Appointment and Qualification of Directors) Rules, 2020, highlights the various relationships an individual can have with key persons of the company or the company itself that can disqualify them from being appointed as the independent director. Even so, the process of selection of IDs is still tainted by the promoters of the company since it is based on the Board’s nominations from the data bank.[viii] According to Section 150(2) of the Companies Act, 2013, the appointment of any ID must be approved in a general meeting, thus the dominance of majority shareholding ensures that the preference of the Board of Directors prevails. Appointment IDs by the majority shareholding of the company is a justified process since majoritarian decision-making is the very essence of any corporate mechanism. However, the agency conflict due to widespread promoter concentration in a company’s management interferes with the independent and bona-fide functioning of IDs. SEBI chief, Mr. Ajay Tyagi recently pointed out that the undue influence of promoters over IDs has often led to a comprise in the rights of minority shareholders in the past.[ix] The very essence of instituting IDs as protectors of legitimate corporate functioning is dependent on the absolute independence of IDs from promoters, without which the entire concept is incoherent. As a remedy, a two-pronged method can be employed to first ensure that a non-prejudiced approach is employed while appointing an ID for a company and then to verify on a periodic basis whether the ID is independent or a mere puppet of the promoters:
Firstly, the Companies (Creation and Maintenance of databank of Independent Directors) Rules, 2019, should be amended to maintain anonymity of prospective candidates such that the selection of IDs is solely based on the merits of their portfolios. In addition to that, a periodic follow-up regime for IDs must be instituted to ascertain whether they continue to exercise independent control and decision-making power over the company’s function after their appointment or whether they are compelled to succumb to the promoters’ domination. To achieve this, the IDs must be given the responsibility to furnish an annual report on the performance of executive-directors to a committee, as identified by the Ministry of Corporate Affairs or SEBI. This report can be created during the independent directors meeting as prescribed under Regulation 25(3) of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015. Since human behaviour cannot be fully controlled by laws and regulations, such a system of check & balances for IDs can help in ascertaining the relationship between IDs and the executive directors and promoters of the company and increase the accountability of IDs in a legitimate manner. These mechanisms shall supplement the recent proposal of ‘dual approval for appointment of IDs’ submitted by the SEBI in its recent consultation paper.[x]
Remuneration Policy resulting in Changing Loyalties
Determining remuneration of IDs is a complex challenge with severe consequences on both sides; while inadequate remuneration acts as an obstruction for experts to take-up this position of responsibility and also results in misplaced priorities of IDs in the longer run, extremely high remuneration of IDs raises suspicion regarding their independence. The terms of remuneration of IDs have been elaborated in S. 149 (9) and S. 197(7) of the Companies Act, 2013, and Rule 4 of the Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014. Accordingly, the only form of remuneration that is not dependent on the company’s net profit is the sitting fee under S. 197(5). Rule 4 of the Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014, sets a limit of Rs. 1,00,000-/- on the sitting fees that can be paid to any director for a meeting. It is important note here, that Rs.1,00,000-/- or less per meeting is not a satisfactory amount for any individual who occupies a position of such stature. The amount that any ID can make over and above the sitting fee is directly related to the net profit made by the company and that is a major cause of concern. Although, S. 149(9) of the Companies Act, 2013, provides that IDs are not entitled to stock options, but it allows IDs to have a share in profit-related commission. Profit is one of most significant indicators of successful functioning of any organisation, thus, striving to maximize it is not a misplaced priority. However, in the current regime, it is quite likely that majority portion of the IDs remuneration is dependent on company’s net profits, which is a cause of concern. One of the most signification duties’ of an independent director is to further the company’s corporate credibility, protect minority shareholder rights and meet governance standards. Due to the independent director’s on-going compensation mechanism, the focus of this ‘watchdog’ can easily shift to self-gratification by supporting decisions that increase net profits, something that executive directors are often guilty of. The Companies (Amendment) Act, 2020, inserted a proviso under S. 149(9) of the Companies Act, 2013, that provides that IDs may also receive remuneration in case of loss or inadequate profits. This is a noteworthy move by the Ministry of Corporate Affairs that shall encourage experts to take up the position of IDs in companies given the improved remuneration prospects for them.[xi] With respect to the above-mentioned change and it’s corresponding amendments, Harish Kumar, Partner, L&L Partners, has rightly expressed his concern regarding the revised remunerations limits fixed under Schedule V of the Companies Act, 2013, since they are understated considering the extensive scope of work and responsibilities of IDs.[xii] Nevertheless, the discourse surrounding IDs’ remuneration must continue because coming up with a satisfactory remuneration structure for IDs that does not interfere with the discharge of their duties or conflict with their interests is still extremely crucial. Attempts must be focused towards formulating a balanced composition of remuneration for IDs that increases their fixed pay in the form of sitting fees such that only a small percentage of their remuneration is dependent on the company’s net profits. Retaining the current combination remuneration structure for IDs that involves both a fixed pay and an incentive-driven pay is vital to reap the benefits of both these options. The challenge lies in striking the correct balance between the two components such that the fixed pay is an adequate amount to attract individuals to take up this position and not be driven by selfish interests while the incentive based pay motivates the IDs to optimize business operations.
Independent Directors: Frequently Quitting
The past two years has seen a significant rise in the number of resignations furnished by IDs to the company they were associated with. [xiii] The year 2019 alone recorded resignations by 1,393 IDs.[xiv] The reasons cited by these IDs include, “greater liability, rising number of corporate governance cases, increasing fear of fraud risk and chances of personal reputation being at stake led to the exodus”.[xv] The General Circular No.1/2020 issued by the Ministry of Corporate Affairs was an appreciable step forward towards protecting IDs from unreasonable liabilities and strengthening the existing corporate governance mechanism. Nonetheless, it is important to recognise that the real challenge lies in evaluating the liability of IDs to such degree that they do not end up as victims of excessive liabilities nor do they end up as pawns who can escape liability. For an ID to be efficient and effective in fulfilling its goals and objectives it is important they have access to the true and accurate picture of the company. To achieve this, empowering IDs in way that the promoters and executive directors of the company are liable to be truly transparent towards them with respect to company matters can sincerely help this case. But every step taken towards empowering the IDs should be paired with a certain amount of responsibility to maintain balance and ensure accountability. Another issue that concerns resignation of IDs is that often IDs resign simply to join the board of the said company in the capacity of an executive director. This is a controversial move on part of the IDs because it raises a serious question regarding the credibility of the IDs work while he was serving as the ID of the company. To correct this, the suggested cooling-off period by SEBI in their consultation paper is a step in the right direction.[xvi]
All in all, the purpose behind introducing IDs in India to establish a system of check and balances is very well thought of. But, the Ministry of Corporate Affairs and SEBI must keep a close eye on what form does an ID take on the company’s board in light of the provisions that govern it. Ensuring that IDs do not end up being counterproductive to the cause of corporate governance is vital to India’s corporate landscape. It is important to accept that regulating human behaviour through rules and regulation is complicated and that mischief with law is evitable. Thus, one must strive to maintain a proactive and ever-evolving approach rather than aiming for a singular robust system with no leaks.
[i] Nikita Hora, Are Independent Directors Really “Independent” In Indian Companies Dominated By Promoters?, LiveLaw (12 March, 2017), https://www.livelaw.in/independent-directors-really-independent-indian-companies-dominated-promoters/.
[ii] Umakanth Varottil & Richa Naujoks, Corporate Governance In India: Law And Practice, India: The Business Opportunity, 289-342(2016).
[iii] Leslie Dashew, Importance of Independent Directors, Leslie Dashew: The Human Side of Enterprise, http://www.lesliedashew.com/_assets/pdf/articles/importance-of-independent-directors.pdf; Meena Gupta, A study on ‘Independency of Independent Directors in Corporate Governance’, ICSI, https://www.icsi.edu/media/portals/86/Independent%20Directors.pdf.
[iv] ET Bureau, Who are Independent Directors and what role they play, The Economics Times (2 January, 2013), https://economictimes.indiatimes.com/corporate-industry/who-are-independent-directors-and-what-role-they-play/slideshow/17853907.cms.
[v] Supra note 1.
[vi] SP Jain Institute of Management and ResearchDocument, Assessment of the role of Independent Director and its effectiveness for the growth and development of shareholders’ value of the firm, (September, 2017).
[vii] Local Circles, Corporate Governance Survey 2020: On Good Governance Day, individual shareholders highlight key issues with Corporate Governance at listed Indian companies, https://www.localcircles.com/a/press/page/corporate-governance-survey-2020#.YF2Fq1UzbIU; Press Trust of India, ‘IDs not really independent’, The Economic Times (25 December, 2020) https://www.thehindu.com/business/Industry/independent-directors-not-really-independent/article33419736.ece/.
[viii] §150 The Companies Act, 2013.
[ix] Anirudh Laskar, Independent Directors have failed minority shareholder: SEBI Chief, LiveMint (6 April, 2021), https://www.livemint.com/news/india/independent-directors-have-failed-minority-shareholders-says-sebi-chief-11617698351094.html.
[x] Consultation Paper on Review of Regulatory Provisions related to Independent Directors, SEBI (1, March, 2021) https://www.sebi.gov.in/reports-and-statistics/reports/mar-2021/consultation-paper-on-review-of-regulatory-provisions-related-to-independent-directors_49336.html.
[xi]Gaurav Noronha, MCA permits remuneration to Independent Directors in case of loss made by companies, The Economic Times (19 March, 2021), https://economictimes.indiatimes.com/news/economy/policy/mca-permits-remuneration-to-independent-directors-in-case-of-loss-made-by-companies/articleshow/81588634.cms?from=mdr.
[xii] Ruchika Chitravanshi, Profit or loss, independent directors of companies must get paid: MCA, Business Standard (March 19, 2021), https://www.business-standard.com/article/economy-policy/mca-puts-limits-on-remuneration-of-non-executive-and-independent-directors-121031900599_1.html#:~:text=At%20the%20lowest%20slab%20of,board%20meetings%20in%20a%20year.
[xiii] FE Bureau, IDs quitting over governance issues should state it clearly: SEBI, Financial Express (22 October, 2020) https://www.financialexpress.com/market/independent-directors-quitting-over-governance-issues-should-state-it-clearly-sebi/2111168/ .
[xiv] Rica Bhattcharyya, Resignations by IDs double in 2019 as risks grow, The Economic Times (26 December, 2019) https://economictimes.indiatimes.com/news/company/corporate-trends/resignations-by-independent-directors-double-in-2019-as-risks-grow/articleshow/72972968.cms?from=mdr.
[xvi] Consultation Paper on Review of Regulatory Provisions related to Independent Directors, SEBI (1, March, 2021) https://www.sebi.gov.in/reports-and-statistics/reports/mar-2021/consultation-paper-on-review-of-regulatory-provisions-related-to-independent-directors_49336.html.
This article has been authored by Rahi Dhuvad, a student at Jindal Global Law School. This article is a part of RSRR’s Corporate Governance Blog Series, in association with Argus Partners.