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Trending: Call for Papers Volume 3 | Issue 2: International Journal of Advanced Legal Research [ISSN: 2582-7340]

A CRITICAL STUDY ON INDEPENDENT DIRECTORS AND EXERCISE OF THEIR INDEPENDENCE by - Dhiraj Kumar Pandey

ABSTRACT

Independent directors are considered to be custodian of shareholders and other stakeholders of the company; they can become whistle blower of the company in case of any irregularities by the executive directors. But, what happens if their independence is affected and they become paralyzed or deviated from their actual duties. This critical study talks about the statutory meaning & definition of independent directors where their duties and responsibilities are explained, and what are the possible reasons which affect their independence along with recent cases, and suggestions towards maintaining their independence and following good corporate governance. KEY WORDS: Company, Independent Director, Executive Director, Director, Independent

INTRODUCTION

Mukta-sango ‘naham-vadi’ dhrty-utsaha-samanvitah Siddhy-asiddhyor nirvikarah karta sattvika ucyate”

 One who performs his duty without association with the modes of material nature, without false ego, with great determination and enthusiasm, and without wavering in success or failure is said to be a worker in the mode of goodness.

-Bhagavad Gita as it is2

(Chapter Seventeen, Text-26) Above mentioned text from a spiritual book ‘Bhagavad Gita as it is’ fits perfectly on the roles, nature and objective of appointing an Independent Director in a Company. An Independent director must be of utmost integrity, honesty, fearless, above of all pecuniary interest or materialistic attachments and should be vigilant, informant and a critic to any decisions taken by executive directors which are against the shareholders and other stakeholders in a Company as he acts as a trustee of stakeholders and a protector of rights of a shareholder. And his main objective is to maintain a good Corporate Governance in the Company. Though, Section 149 of The Companies Act, 2013, provides for the appointment and eligibility of an Independent Director which should be in consonance with other regulations like SEBI (LODR) rules and Secretarial Standards, still the actual practice in corporate arena seems remote to the real objective of appointing an Independent Director.

MEANING AND DEFINITION

In a company, an Independent Director is a type of non-executive director, having no pecuniary interest or any material interest in the company or any previous relationship with the company or its executive directors in the past. He is a person of high integrity, honesty, who possesses relevant expertise and experience in the field in which they belong from (like Law, Finance, Art, Scientific Research etc). They are expected to be more aware regarding the extraneous actions taken by the company against its stakeholders as a stakeholder’s trustee and their main job is to ensure good corporate governance, critical analysis of policies brought by executive directors and to make safeguards against any future exploitation of stakeholders. According to Section 149(6) of The Companies Act 20133 an independent director is defined as follows: 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-
  1. Who, in the opinion of the Board, is a person of integrity and possesses relevant expertise and experience:
  2. (i) who is or was not a promoters 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.
  1. Who has or had no pecuniary relationship, other than remuneration as such director or having transaction not exceeding ten per cent of his total income or such amount as many be prescribed, 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;
  2. none of whose relatives –
    • Is holding any security of or interest in the company, its holding, subsidiary or associate company during the two immediately preceding financial years or during the current financial year:
Provided that the relative may hold security or interest in the company of face value not exceeding fifty lakh rupees or two per cent. Of the paid-up capital of the company, its holding, subsidiary or associate company or such higher sum as may be prescribed;
  • Is indebted to the company, its holding, subsidiary or associate company or their promoters, or directors, in excess of such amount as may be prescribed during the two immediately preceding financial years or during the current financial year;
  • has given a guarantee or provided any security in connection with the indebtedness of any third person to the company, its holding, subsidiary or associate company or the promoters, or directors of such holding company, for such amount as may be prescribed during the two immediately preceding financial years or during the current financial year; or
  • Has any other pecuniary transaction or relationship with the company, or its subsidiary, or its holding or associate company amounting to two per cent. Or more of its gross turnover or total income singly or in combination with the transactions referred to in sub-clause (i), (ii) or (iii);
  1. Who, neither himself nor any of his relatives-
  • holds or held the position or a key managerial personnel4 or is or has been employee of the company or its holding, subsidiary or associate company in any of three financial years immediately preceding the financial year in which he is proposed to be appointed:
Provided that in case of a relative who is an employee, the restriction under this clause shall not apply for his employment during preceding three financial years;
  • 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-
    1. A firm of auditors or company secretaries in practice or cost auditors of the company or its holding, subsidiary or associate company: or
    2. Any legal or consulting firm that has or had any transactions with the company, its holding, subsidiary or associate company amounting to ten percent or more of the gross turnover of such firm;
  • Holds together with his relatives two per cent. Or more of the total voting power of the company; or
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 hold two per cent. Or more of the total voting power of the company; or
  • Who possesses such other qualifications as may be

ESSENTIAL INGREDIENTS OF DEFINITION

On the basis of above definition, we can take out the following essential ingredients:
  1. An Independent Director is different from a managing director or a whole time director or a nominee director
It says that an Independent Director must be a non-executive director unlike executive directors like managing director, whole time director. It also excludes nominee directors5 who are nominated by the banks or other investors to safeguard their organizational interest.
  1. He should be a person of integrity and possesses relevant expertise and experience According to this, an independent director must be a person of integrity and possess relevant expertise and experience from the field he belongs to like law, finance, marketing, management, scientific research Here integrity word refers to the truthfulness and free from any bias towards organisation, meaning he should be a person who can bring the actual picture of the company before its stakeholders and on whose words stakeholders can believe.
  • An Independent Director is or was not a promoter and also not related to promoters or directors in the company, of its holding, subsidiary or associate company
This statement clarifies that an independent director must not have any previous or present connection with the company in its formation or running the entity in any way either directly or indirectly6 to establish his independence.
  1. An Independent Director must not have or had any pecuniary relationship
It is a very important requirement in which an Independent Director must not have any pecuniary interest meaning monetary interest or material interest in the company, which can affect his independence, he is only entitled to remuneration in the form of sitting fee or commission as such director or having transaction not exceeding ten per cent of his total income or such amount as may be prescribed, 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.
  1. An Independent Director himself nor any of his relatives holds or held the position or a key managerial personnel or is or has been employee in the Company or its holding, subsidiary or associate company
This requirement includes not only an independent director but also its relatives, where they cannot hold or has held any position or key managerial personnel or been an employee in the company or its holding, subsidiary or associate company to ensure that an independent director does not get biased and gives free and fair view of any irregularities of the company.

ROLE OF AN INDEPENDENT DIRECTOR IN A COMPANY

As discussed above, an Independent Director is not an Executive Director, Promoter, Key Managerial Personnel, Employee, or any way connected to company in any manner. So basically it is appointed to maintain the check and balances with respect to policies brought by the Executive Directors or Management of the company. Whose main objective is to maximise profit in any manner. In this situation an independent director works as a resistance and reminds them that they can’t usurp the interest or exploit the other stakeholders of the company and also the various statutory requirements in implementing those policies or ideas. An independent director is expected to perform independently, in an unbiased manner, and in the interest of various stakeholders of the company. Though it is a moral responsibility of a person appointed as an independent director but statutory provisions are also given in the form of requirement and definition. The definition of independent director is given under Section 149(6) of The Companies Act, 2013. Also requirements of disqualification under section 164 apply to all directors in general. In case of a listed public company, the Securities and Exchange Board of India (Listing Obligations and Disclosures Requirements) or SEBI (LODR) also applies to the company for proper corporate governance. And an Independent Director plays a vital role in maintaining a proper Corporate Governance.

CRITICISM  WITH  REGARD TO INDEPENDENCE  OF AN INDEPENDENT DIRETOR

In practical scenario it seems that independent directors are not actually independent and somewhere dependent on the executive directors or management of the companies. Due to which it becomes nearly impossible to achieve the objective7 of appointing an Independent Director. Despite of all legal provisions and moral responsibility of a person related to maintain the independence. Following are the reasons:
  1. The sitting fee and other charges like transport charges are fixed and given by the management of the company. Which in many a case varies director to director and somewhere it creates an indirect pecuniary relationship with the company.
  2. Generally executive directors includes Managing Director and whole time director who holds a major chunk of shares in the company, and it becomes easy for them to pass any resolution or policy that they want to bring in the company, and Independent Directors gets less or no chance to stop it.
  3. Most of the Independent Directors are either expert or professional in their field, and they start giving professional services to the And due to this they start defending the company against other stakeholders of the company.
  4. Independent Directors are required to report any irregularities in the company directly to the Authorities and its stakeholders, but despite of it we see that major irregularities takes place in the corporation for long time but it never gets reported.
  5. There is no hardcore laws or punishment prescribed for non-performing the duties by an Independent Director such as non-reporting of material irregularities by the management or executive directors of the company.
  6. Independent Directorship merely seems a post retirement plan, as a same independent director is appointed in the subsidiaries of a company, and becomes member of vital committees like Audit Committee, Nomination and Remuneration Committee, Stakeholders Committee etc. Where his main purpose is to receive more and more sitting fees and to give professional services.
“According to Corporate Governance Survey 2020 by online platform Local Circles, 79% individual shareholders have expressed concern about the independence of independent directors As many as 65% of individual shareholders said that independent directors in publically traded Indian companies are not acting to protect the interest of minority shareholders. The survey stated further that top three concerns of individual shareholders of such companies are accounting fraud, selling of company assets without shareholder knowledge and insider trading”8.

CASES ON FAILURE OF ACTION BY INDEPENDENT DIRECTORS

Following are the cases which show the failure of prior action by the Independent Directors, where incidents could have been prevented, if prior reporting were done and action were taken:
  1. Satyam Computer Services Scandal9
In this case a serious long term financial irregularity came into picture, which was done by its Managing Director Ramalinga Raju, who falsified the company accounts for its own gain. This is the case where if Independent Directors were active and reported the fraud on time then the existence of a company and interest of shareholders would have been saved.
  1. Yes Bank FIASCO Case10
This is the true case of greed of an Executive Director named Mr. Rana Kapoor, who was also the Co-Founder, CEO and Managing Director of the Yes Bank. In this case his greed to maintain supremacy in the Board leads the Bank into trouble and handed it to Reserve Bank of India’s hand. In this case also Independent Director could have stopped such practice and have reported the misdeeds of its Managing Director to the Authorities so as to save the bank and its other stakeholders including poor customers of its bank.
  • Dewan Housing Finance Limited (DHFL) Case11
It is a classic example of misappropriation or irregularity or made up of false accounts, which led company into trouble and wiped out its investors money in a matter of days. This case shows the ineffectiveness of Audit Committees and an insufficient role of Independent Directors and puts a question mark on their independence.

CONCLUSION

The real objective of an Independent Director is to safeguard the interest of various stakeholders of a company as trustee of stakeholders and to maintain overall good corporate governance in the company. Though there are various challenges to it, considering the criticisms discussed in this article, but those challenges can be overcome or shortened through the ways suggested. Once those challenges are overcome, it will help a corporate and its stakeholder to know in advance future obstacles, irregularities or effect of irregularities which will ultimately safeguard stakeholder’s interest and also help company in its going concern and perpetuity.

SUGGESTIONS TO MAINTAIN INDEPENDENCE OF AN INDPENDENT DIRECTOR

After making above criticisms, following are the suggestions which can be used to maintain the independence and the objective of appointing an independent director can be achieved-
  1. There should be some statutory fund established under the act, to pay for sitting fees and other expenses paid to an Independent And it should also be fixed and regulated by the authorities and not by the company itself.
  2. Independent Directors or any of its connections should be stopped to give any kind of professional services to the
  3. There should be a law prescribing punishment for Independent Directors in case any previous irregularities are not reported by the Independent Directors and later it affects the stakeholders of the company in any way.
  4. There should be a restriction on independent directors joining subsidiaries of the same company and its vital committees. It will ensure the integrity of an independent director as it will stop them from working merely for increasing sitting fees.

REFERENCES

  1. Avtar Singh book on ‘Company Law’, EBC Publication
  2. https://www.directorsandboards.com/news/report-director-assessments-are-lacking
  3. https://www.thehindu.com/business/Industry/independent-directors-not-really- independent/article33419736.ece
  4. https://www.hindustantimes.com/business/satyam-scam-all-you-need-to-know-about- india-s-biggest-accounting-fraud/story-YTfHTZy9K6NvsW8PxIEEYL.html
  5. https://www.business-standard.com/about/what-is-yes-bank-crisis
  6. https://www.thehindubusinessline.com/money-and-banking/dhfl-accused-of-31000- crore-fraud/article26122764.ece
1 LLM (Corporate Laws) Student, Manipal University Jaipu 2 ISBN 978-93-84564-19-3 3‘The Companies Act, 2013’ (2020 edition) 4 Under Section 2(51) of The Companies Act, 2013 5 Nominee directors are neither the independent directors nor executive directors of the company. 6 Indirect relation includes relation through any of the relatives or association or firm he is interested in. 7 Objective refers to reporting of irregularities, going against the promoter for their wrong doings and taking all steps to safeguard stakeholder’s rights. 8https://www.thehindu.com/business/Industry/independent-directors-not-really-independent/article33419736.ece 9https://www.hindustantimes.com/business/satyam-scam-all-you-need-to-know-about-india-s-biggest-accounting- fraud/story-YTfHTZy9K6NvsW8PxIEEYL.html 10 https://www.business-standard.com/about/what-is-yes-bank-crisis 11https://www.thehindubusinessline.com/money-and-banking/dhfl-accused-of-31000-crore- fraud/article26122764.ece