Saturday, December 17, 2011

Companies Bill, 2011: Independent Directors

Corporate governance generally places a fair amount of emphasis on board independence, and it is no different in India. Having a minimum number of independent directors (IDs) on the board is said to enhance monitoring of the management and promoters, and thereby protect the interests of the public shareholders. The Companies Bill, 2011 takes the concept of board independence to another level altogether as it spends several pages (a couple of sections and an entire schedule) to deal with IDs. This has no doubt emanated from the excessive debate on independent directors that emerged in the wake of recent corporate scandals. Some of us have had the opportunity (here and here) to analyze the importance of independent directors and to suggest reforms, a few of which have been incorporated in the Bill. These “Satyam provisions”, if we may refer to them as such, deserve a closer examination. The relevant provisions are clauses 149, 150 and Schedule IV.
Number of IDs
The Bill requires listed companies to have at least 1/3rd independent directors on their board. This is a slight departure from clause 49 of the listing agreement, which requires at least 50% IDs in case the chairperson is in an executive capacity or a promoter or related to a promoter, and hence this represents a dilution from the existing position. This might, however, have relatively minimal impact, if at all.
Definition of Independence
The definition of an ID has been considerably tightened. For example, if a director is a chief executive of an NGO that receives funding from the company to a certain extent, the person would not qualify as an independent director. Moreover, the definition now includes positive attributes of independence (that was not the case under clause 49): the candidate must be “a person of integrity and possess the relevant expertise and experience” in the opinion of the board. The Central Government is also vested with the power to prescribe qualifications for IDs. Every ID is also required to declare that he or she meets the criteria of independence.
One of the key criticisms of the current regime for IDs is that they are appointed like any other director, thereby leaving promoters with tremendous influence in determining the identity of the IDs. That has been partially addressed by making a nomination and remuneration committee mandatory (a departure from clause 49 that does not mandate a nomination committee). The committee is required to consider candidates for appointment as IDs and to recommend them to the board. This brings about greater objectivity to the ID nomination process, at least to some extent. However, the Bill does not go to the extent of providing greater participation by minority shareholders in the ID appointment process through methods such as cumulative voting or proportionate representation, which continue to be optional for companies to adopt rather than a mandatory requirement.
Furthermore, the Bill contemplates the establishment of a data bank of IDs, from which persons may be chosen by companies.
In order to ensure that IDs maintain their independence and do not become too familiar with the management and promoters, minimum tenure requirements have been prescribed. The initial term shall be 5 years, following which further appointment of the director would require a special resolution of the shareholders. However, the total tenure shall not exceed 2 consecutive terms.
Under the Bill, IDs are entitled only to fees for attending meetings of the board, and possibly commissions within certain limits. The Bill expressly disallows IDs from obtaining stock options is companies. While it is understandable that excessively remunerating IDs could impinge upon their independence, the present provisions leave little room for companies to attract the required talent by remunerating directors for the services they provide. Since the Bill also imposes significant responsibilities and duties on IDs, as we shall see, positions for IDs on listed companies are unlikely to find takers of the requisite calibre unless they are appropriately remunerated. Attempts to achieve a proper balance may be fraught with difficulties under the present dispensation.
Roles and Functions
Schedule IV of the Bill contains a code that sets out the role, functions and duties of IDs and incidental provisions relating to their appointment, resignation and evaluation. While the guidelines are useful in specifying the roles and functions so as to introduce clarity, they are extremely prescriptive in nature. This makes the role of IDs quite onerous, and may enhance the level of monitoring of listed companies, which is crucial for corporate governance. The downside, of course, is that it could instil fear in the minds of potential IDs that may dissuade them from taking up the position.
In order to balance the extensive nature of functions and obligations impose on IDs, the Bill seeks to limit their liability to matters directly relatable to them. The Bill limits the liability of an ID “only in respect of acts of omission or commission by a company which had occurred with his knowledge, attributable through board processes, and with his consent or connivance or where he had not acted diligently.” This again seems to be a reaction to specific instances in the recent past where IDs were subject to legal action for no fault of their own, as evident from the Nagarjuna Finance episode that occurred in 2009. While it is useful to provide a limitation of liability clause, much would depend on the manner in which this is interpreted by courts based on the specific facts and circumstances of individual cases. Other ways of addressing the liability issue would be to expressly provide for directors and officer liability insurance, which are also specified in the Bill.
In sum, while several concerns regarding board independence have been addressed in the Bill, some areas require refining as discussed above. Although the intention is noble, the implementation could give rise to difficulties. Corporate governance norms are dynamic in nature and require reconfiguration periodically to keep pace with the changing business climate. Usually, while the basic governance framework is dealt with by statute, the details are dealt with codes of conduct that are more flexible in nature. Since the catastrophes that marked the India corporate sphere in the last 2 or 3 years have assumed significant political overtones, they have resulted in excessive reaction in terms of detailing every single governance norm concerning IDs in the legislation itself. While it may address some immediate problems, it is bound to result in a great amount of rigidity. Experience clearly evidences the enormous difficulties in amending companies legislation in India, and any changes in the governance norms in the future is likely to be as cumbersome. The question remains whether there has been a knee-jerk reaction to current scandals that may adversely impact genuine businesses during times ahead.


Anonymous said...

Sir this question is with regard to number of Independent Directors. You have highlighted the Difference b/w Clause 49 and Companies Bill 2011. You have stated that Bill of 2011 dilutes the effect of Clause 49.
But what real difference does Clause 149 of the CB 2011 make? Companies are bound to follow both right. So they will take into consideration the highest common factor i.e 50% ID where chairman is Executive Director.
So the Crux of my query is how does a clause like this wrt number of IDs in the CB, 2011 make any difference? The Companies are required to follow both. Non compliance with CB, 2011 results in penalty by ROC, wheras violation of Clause 49 results in penalty by SEBI. Am I right?

V. Umakanth said...

@Anonymous. That would be right. Listed companies will be required to comply with the more onerous of the two requirements, while others can merely comply with the company law. The consequences of violation may also be different under company law and securities regulation (listing agreement), as you have pointed out.

Anonymous said...

State the legislation/circular/enactment and its section/regulation no. which contains the criteria for determining the Independence of a Director?
can someone please answer this question?

Anonymous said...

hello, if you read the new published companies act 2013, i guess it will solve your queries.