Friday, April 11, 2008

Amendments to Clause 49

SEBI has on April 8, 2008 issued a press release and circular amending certain provisions of Clause 49 relating to corporate governance, and can be viewed here: http://www.sebi.gov.in/Index.jsp?contentDisp=WhatsNewScroll&FilePath=/press/2008/200895.html
The composition of board of directors has been required to be as under:
(a) where chairman is an executive chairman, atleast half the board has to comprise of independent directors
(b) where the chairman is a non-executive chairman, then one-third of the board has to comprise of independent directors
The primary amendment brings item (b) on par with item (a) above in certain specific situations.
A brief analysis is as below:

Mandatory provisions:
1. If the non-executive Chairman is a promoter or is related to promoters or persons occupying management positions at the board level or at one level below the board, at least one-half of the board of the company should consist of independent directors.

Will impact companies
– having a non-executive Chairman who is a promoter or related to promoters &
– Having a non-executive Chairman related to persons occupying management positions at the board level or at one level below the Board.
Such companies will need to ensure that one-half of the board consists of independent directors.
This changeover is from a situation where if a company had a non-executive Chairman, then only one-third of the board needed to consist of independent directors.
Given that a large part of Corporate India comprises business houses / promoter driven enterprises, the impact can be quite a very high magnitude.

2. Disclosure of relationships between directors inter-se shall be made in the Annual Report, notice of appointment of a director, prospectus and letter of offer for issuances and any related filings made to the stock exchanges where the company is listed.

An ambiguity which is created is whether the inter-se relationship amongst directors that needs to be disclosed in specified documents/filings is with reference to:
- ‘reporting relationship’ OR
- relationship of being ‘relatives’

3. The gap between resignation/removal of an independent director and appointment of another independent director in his place shall not exceed 180 days. However, this provision would not apply in case a company fulfils the minimum requirement of independent directors in its Board, i.e., one-third or one-half as the case may be, even without filling the vacancy created by such resignation/removal.

- This is an on-going requirement
– essentially, if an independent director has retired/resigned/been removed, then his replacement should be found within 180 days.
- no impact where minimum requirement of independent directors is satisfied without filing up the vacancy.

4. The minimum age for independent directors shall be 21 years.
Companies will need to ensure incoming directors are of this age.
An ambiguity – what about companies who already have directors below this age OR does the capacity to contract as per Indian Contract Act anyway rules out those below 21 years of age from being a director, and hence this modification was not really required?

Non-mandatory provisions:
- The Board - A non-executive Chairman may be entitled to maintain a Chairman’s office at the company’s expense and also allowed reimbursement of expenses incurred in performance of his duties.

- Independent Directors may have a tenure not exceeding, in the aggregate, a period of nine years, on the Board of a company.
Some ambiguities which arise due to this requirement:
- Does the tenure already served require being reckoned for directors on board a listed company?
- Does the tenure served by a director prior to listing of a company which lists hereafter require being reckoned

Whilst the provision is itself non-mandatory – but in case of non-adoption, a specific disclosure in the annual report needs to be made and companies wanting to ensure good governance will be faced with the above ambiguities whilst complying.

Some segments will be able to ensure immediate compliance. for example in case of banking companies, the Banking Regulation Act already has a mandatory requirement limiting an independent director’s term to 8 years – itself a stricter standard than SEBI’s non-mandatory requirement limiting the term to 9 years.
- The company may ensure that the person who is being appointed as an independent director has the requisite qualifications and experience which would be of use to the company and which, in the opinion of the company, would enable him to contribute effectively to the company in his capacity as an independent director.

As mentioned though these three requirements are non-mandatory, in case of non-adoption, a specific disclosure in the annual report needs to be made.
These modifications to clause 49 reflect a continuing eye being kept by SEBI on Corporate India and prevailing Corporate governance standards - which is quite comforting! Clarifying the ambiguities will pave way for smooth adoption of these changes.
One aspect which may be challenging for Corporate India is the timing of these modifications - with financial years largely ending in March, with adoption of annual accounts within the quarter ending June, followed by circulation of annual report, may mean disclosures having to be made as on the date of the Annual report on the compliance with clause 49, and therefore compel steps to ensure compliance starting very quickly.

1 comment:

Somasekhar Sundaresan said...

The amendment made by SEBI to the Listing Agreement follows a consultative paper published over a year ago, proposing this change. Here is what I wrote in the Business Standard then:-

"Currently, if the chairman of the company were a “non-executive director”, one-third of the board would need to comprise “independent directors”. If the chairman were an executive chairman, one half would have to comprise independent directors. SEBI has now proposed that if the chairman were not an “independent director” then one half of the board would need to comprise independent directors. If the chairman were an independent director, only one-third of the board would need to comprise independent directors.

The regulator ought to take into account that there is no requirement of any law for every company to necessarily have a “chairman”. Under company law, any director of the Board may act as chairman to conduct any board meeting. Therefore, nothing really turns on this amendment for companies that could choose not to have a stated chairman.

However, if a company desires to have a stated chairman and is unable to find an independent director to hold that position, it would need to find even more independent directors to occupy half its board.

The capital market ecosystem has failed to provide independent directors of the quality envisaged for them. There is also an abject lack of infrastructure to protect independent directors from the iniquities in the market system. Recently, a highly reputed retired Supreme Court judge, who could walk into any multinational board as a top-notch independent director told me how he would never agree to be an independent director. He would never want to be in a position of having to explain that he was not a person “in-charge” of the day-to-day management should a creditor prosecute the company for a bounced cheque, or should an Enforcement Directorate official send him summons on the company’s interpretation of an ambiguous exchange control law.

Insurance products protecting independent directors from liability face an enforceability risk. Indian company law provides that any indemnity given to directors could be void in certain situations. It is only when a claim is actually made under such insurance policies that the defence of insurance companies would become clear. Today, one only meets the sales and marketing representatives of the insurers. Once the lawyers take over, independent directors could be in for a nasty surprise.

.....SEBI’s mandate from Parliament is to also develop the capital market ecosystem. Independent directors do not grow on trees. It is time to address the supply side for independent directors, rather than merely push up demand for them by legal prescription."