The Companies Bill, 2011 - Welcome Reforms for Independent Directors

Introduction

When we hear that an individual is appointed as an Executive Director of a company, we know that his duties include fiduciary duties, statutory duties and duty to exercise skill and care in day-to-day affairs of the company.  Then, what about an ‘independent director’? Do they have any separate duty/liability that differentiates them from other directors?. Do they have any exemption from director’s duties? This article tries to analyse the concept of ‘independent director’ in the light of The companies Act 1956, The Companies Bill 2011, The Listing Agreement, and MCA circular.

Independent director – present scenario

The term’ independent directors’ is not defined by the Companies Act 1956. The Companies Act 1956, has not expressly distinguished the duties or liabilities of independent directors from that of other directors and deals both independent and other directors under the term ‘directors’. This had led to a situation, where independent directors are frequently hunted for offences committed by management of company relating to business of which the ID’s were not aware of. The Nagarjuna Finance case may be quoted as an example. The independent director who had resigned from the company in 1999 was charged for criminal breach of trust and cheating under IPC on account of failure by the company to pay back its public deposits, in the year December 2008.  Following the Satyam scam and the above case, the number of independent directors exiting the companies increased considerably and this tendency shows that the present position of independent directors in India is exposed to unlimited liabilities and risks. Many such directors are not willing to hold their position, for reason that the remuneration paid to them was less when compared to the liabilities thrown upon them.

MCA circular No.8/2011 dated 25.03.2011 was a great relief for independent directors. It dealt with prosecution of ‘officers in default’ and provided that no directors shall be held liable for any act of omission or commission by the company or by any officers of the company which constitute a breach or violation of any provision of the Companies Act, 1956, which occurred without his knowledge/ consent or connivance or where he has acted diligently in the Board process.  Under the circular, ROC was entrusted with the power to determine whether he is the ‘officer in default’ (Sec 5 of Companies Act 1956) and whether he failed to act diligently. The circular was given effect retrospectively, so that pending cases of directors could again be looked into for deciding whether he is an ‘officer in default’.

Realising the need for statutory definition on the duties and liabilities of independent directors and for securing higher standards of corporate governance, protection of interests of stakeholders, the Companies Bill 2011 has incorporated the following provisions.  See the table below -

Remarkable provisions under Companies Bill 2011

a. Statutory Protection: The most important reform brought about in the bill is Sec 149  (11), which provides shield to independent directors to escape from liabilities which arouse not as result of his act/omission.  The particular section could be interpreted that an independent director/non-executive director (not being promoter or key managerial personnel) shall be held liable, for 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.

b. Appointment/ Reappointment of an independent director to be approved by shareholders. This is a notable reform in the sense the final approval regarding the ID is handed over to shareholders. Reappointment of ID requires Special Resolution at GM. Thus the shareholders are given a chance to decide upon the director who would represent interests of all stakeholders (incl.shareholders)  at board meetings. Where the shareholders are doubtful about performance of an ID, they can reject his reappointment.

c. Sec 149 of bill stipulates that every listed public company shall have at least one-third of the total number of directors as independent directors and the Central Government may prescribe the minimum number of independent directors in case of any class or classes of public companies.

d. Non-Rotational director: Sec 152 (6),(7) of Companies bill not applicable to independent directors. Sec 152 (6)- retirement by rotation. Independent directors are not liable to retire by rotation at GM. The Companies bill excludes nominee director from ‘independent director’. The listing agreement had included nominee directors under the expression ‘independent director’. “Nominee director” means a director nominated by any financial institution in pursuance of the provisions of any law for the time being in force, or of any agreement, or appointed by any Government, or any other person to represent its interests.

e. An independent director shall hold office for a term up to 5 consecutive years on the Board of a company. He can hold office for two consecutive terms. But, such independent director shall be eligible for appointment after the expiration of three years of ceasing to become an independent director. It is also provided that an independent director shall not, during the said period of three years, be appointed in or be associated with the company in any other capacity, either directly or indirectly.

f. Where meeting of BoD is called at short notice to transact urgent business, atleast one independent director shall be present. If an independent director is not present, then the decisions taken at such a meeting shall be circulated to all the directors and shall be final only on ratification thereof by at least one independent director, if any.

g. Atleast 3 or more NED’s in nomination and remuneration committee and  ½ of them shall be independent directors.

h. His remuneration shall include only fees, commission etc approved by shareholders. But, he shall not be entitled to any stock option.

i. ID’s shall comply with Code of Conduct Schedule IV of the bill.

j. The resignation or removal of an independent director shall be in the same manner as is  provided in sections 168 and 169 of the companies bill 2011.

k. CSR committee set up under the bill, shall consist of atleast one independent director. (Pease refer authors’ article on CSR)

l. The re-appointment of independent director shall be on the basis of report of performance evaluation. The performance evaluation of independent directors shall be done by the entire Board of Directors, excluding the director being evaluated. On the basis of the report of performance evaluation, it shall be determined whether to extend or continue the term of appointment of the independent director.

m. Only an independent director can be appointed as alternate director to an independent director (An alternate director is appointed where a director leaves India for a period of not less than 3 months).

Independent opinion

The departments within the company should submit note for approval to the Board for its decision where such item is related to performance/continuity of business and board members has the right to express their opinion on the same. As per the meaning assigned to the term ‘independent director’ in some developed countries, a director can be called an independent director, only if there are no circumstances or relationships affecting  his judgment or opinions.  The clear cut provisions in the bill would ensure that ID’s are ‘independent’ in their opinion  and would ensure transparent & unbiased decisions  at Board level. The bill has stressed the term ‘relatives’ while excluding certain persons from candidature for ID. Sec 2 (77) of Companies Bill 2011 defines ‘‘Relative’’, with reference to any person, means anyone who is a  related to another, if—

(i) They are members of a Hindu Undivided Family;

(ii) They are husband and wife; or

(iii) One person is related to the other in such manner as may be prescribed.

The companies act 1956 had included the following under ‘relatives’ –

1. Father.

2. Mother (including step-mother).

3. Son (including step-son).

4. Son's wife.

5. Daughter (including step-daughter).

6. Father's father.

7. Father's mother.

8. Mother's mother.

9. Mother's father.

10. Son's son.

11. Son's son's wife.

12. Son's daughter.

13. Son's daughter's husband.

14. Daughter's husband.

15. Daughter's son.

16. Daughter's son's wife.

17. Daughter's daughter.

18. Daughter's daughter's husband.

19. Brother (including step-brothers).

20. Brother's wife.

21. Sister (including step-sister).

22. Sister's husband.

So, on enactment of bill director/promoters would find it difficult to induce their relatives into the Board. This itself would trigger free discussions and increase in overall participation at board meetings.

Effective Audit Committee

The Companies Act required every public company having paid up capital of not less than Rs. 5 crores to constitute an audit committee of non executive directors. But, the companies bill giving more importance to corporate governance, stipulates that every listed company and such other classes of companies as may be prescribed shall constitute an audit committee.

The companies bill provides that majority of the audit committee (minimum 3 directors) shall be independent directors (The listing agreement had provided for two out of three directors of the Audit committee shall be independent directors).

The SE listing agreement had provided that chairman of audit committee shall be an independent director. But, the bill does not stick on to such a requirement. It provides that majority of members of Audit Committee including its Chairperson shall be persons with ability to read and understand, the financial statement.

Relief under Sec 463

Similar to section 633 of Companies Act 1956, the companies bill also contains provisions for relief in certain cases.  The court may relieve any officer of the company for negligence, default, breach of duty, misfeasance or breach of trust against an officer of a company, if it appears to the court hearing the case that he has acted honestly and reasonably. Its provided that in a criminal proceeding under this sub-section, the court shall have no power to grant relief from any civil liability which may attach to an officer in respect of such negligence, default, breach of duty, misfeasance or breach of trust. No court shall grant any relief to any officer unless it has, by notice served in the manner specified by it, required the Registrar and such other person, if any, as it thinks necessary, to show cause why such relief should not be granted.

Conclusion

The companies bill expects the ID’s not to sit idle or silent, but to bring to the table matters that would secure of interests stakeholders and company as a whole. Some experts have raised a doubt that the long tenure for independent directors may affect the ID’s capacity to stay neutral. The independent director may not object even when transacting businesses affecting the interests of stakeholders, as his tenure depends on the performance evaluation conducted by the board.  Usually, Non-executive directors and ID’s don’t take part in day today affairs of the company, they are concerned only to decision making activities at Board level. As the independent director is not concerned of day to day management of company, they may not have special opinions to contribute. Often this was the reason for decisions unfavourable to stakeholders. The companies bill seeks to break this barrier through its notable provisions. Let's hope, these reforms would ensure better corporate governance and protection of interests of stakeholders of the company.

Note: The views expressed are personal.

Written by: Victor J. Uruvath

CS  Professional Programme Student,  Kerala.

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