Friday, September 17, 2010

More on Independent Directors

Can Independent Directors Appoint Alternates?

Despite closely following developments in the law relating to independent directors (IDs) in the recent past, this question took me by surprise. Considering the special position of an ID, it seemed to me that an individual occupying that position is incapable of being substituted, even if that were temporary in nature. However, a debate generated during the past week or so in Singapore suggests that the concept of alternates for IDs does, after all, exist. This has given rise to calls for greater clarity on whether the practice should be allowed and, if so, what safeguards need to be embedded to ensure that there is no dilution of corporate governance in those companies.

An alternate director is appointed where an original director is unable to attend board meetings for a period of time. Under Section 313 of the Indian Companies Act, an alternate director can be appointed during the absence of the original director “for a period of not less than three months from the State in which meetings of the Board are ordinarily held”. When the original director returns, the position of the alternate director stands vacated.

This concept is likely to create difficulties when applied to an ID. First, director independence is an essential element of an enhanced corporate governance framework. The identity of the ID is crucial to independence, and hence any ability to appoint alternate IDs will defeat this purpose. Second, while IDs are to be appointed (or at least subsequently approved) by the shareholders in general meeting, alternate directors can be appointed by the board, thereby considerably diluting the appointments process. This is the case even under Section 313 so long as the articles provide for that. Third, corporate governance norms do not usually provide for qualities that alternate directors ought to possess. For instance, it is not clear if alternate directors need to satisfy the requirements of independence that apply to the original IDs, even though they should logically apply.

Thus far, appointment of alternates for IDs does not seem to have captured much attention in India. To my knowledge, not many Indian companies have gone down the route of appointing alternates for IDs – but I would welcome correction if that is not the case. Considering that the concept of ID is being fine-tuned under the Companies Bill, it might make eminent sense to plug this point to avoid any ambiguity.

Takeovers and Independent Directors

In several jurisdictions, whenever a takeover offer is launched the board of directors of the target company must generally consider whether the offer is in the interests of its minority shareholders. In this behalf, courts attach importance to the views of an independent board while determining whether a takeover offer should be allowed to proceed. This practice is now embedded in corporate legal systems such as Delaware.

In India, the SEBI Takeover Regulations provide in Reg. 24(4) that the directors of the target company may, if they so desire, send their comments to shareholders after seeking the opinion of a committee of independent directors. Since the consideration of a takeover offer by the target company’s board is an optional matter, it is for the board (or a committee) to take a view on the offer. The offer therefore largely tends to be an affair between the acquirer and the controlling shareholders who are exiting the company, which leaves minority shareholders in the lurch if they are unhappy with the terms of the offer. One such scenario has played out in Vedanta’s offer for Cairn where the controlling shareholder is availing of non-compete fees which are not available to the minority shareholders. Due to resistance from the minority shareholders, the board of Cairn Energy has sought to deviate from the usual practice, and to appoint a committee of independent directors to look into the interests of the minority shareholders. While this is welcome, the desirability of the final outcome of the committee’s review would depend on process it follows to arrive at its decision, and also level of transparency in that process.

For the longer term, the Takeover Regulations Advisory Committee (TRAC) has noted that it is only optional under the present Takeover Regulations for the board (or independent committee) to make recommendations to the shareholders, and has recommended that this be made mandatory. See paragraph 13.0 of the Report and Reg. 26(6) of the proposed draft Regulations.

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