Proportional Representation and Director Removal under Companies Act, 2013

Principle of Proportional Representation under Section 163 and Removal of such Directors under Section 169 of Companies Act, 2013

Introduction

The Board of Directors (the Board) is the primary interface between the Company and its various stake holders. Directors are elected by shareholders to represent them and are tasked with making important decisions, such as corporate officer appointments, executive compensation and dividend policy and such other matters affecting their interests. The Board as a main functionary is primary responsible to ensure value creation for its stakeholders.

The Shareholders are the real owners of the Company and are concerned about the various aspects of the decision making by the Board. They have the ownership rights and exercise such rights by casting votes at the Annual General Meetings (AGMs)/Extra-Ordinary General Meetings (EGMs) in respect of such matters which should be approved by the Shareholders before implementing the same. They are more concerned about the economic viability of the investee company so to feel sure about the safety of their investment and being the recognised owners of the company to enforce their rights to control the company as and when the company enters into contractual relationship with third persons thereby incurring greater obligation.

Under the Companies Act, 2013 (the Act), the powers have been divided between two segments: one is the Board of Directors and the other is of Shareholders. The Directors exercise their powers through meetings of Board of directors and shareholders exercise their powers through AGMs/EGMs. Although constitutionally, all the acts relating to the company can be performed in General Meetings, most of the powers in regard thereto are delegated to the Board of directors by virtue of the constitutional documents of the company viz. the Memorandum of Association and Articles of Association. Thus, the Act has tried to demarcate the area of control of directors as well as that of shareholders.

Further, a company being an artificial person with no physical existence, functions through the instrumentality of the Board of directors which is guided by the wishes of the majority, subject, of course, to the welfare of the company as a whole. It is, therefore, a cardinal rule of company law that prima facie a majority of members of a company are entitled to exercise the powers of the company and generally to control its affairs. Usually, the general rule is that the decision of majority shareholders in a company binds the minority. The majority is in the position where they are connected to every part of the company. Hence, it bifurcates the whole set of shareholders into two categories of shareholders i.e. Majority shareholders and Minority Shareholders.

To prohibit the misuse of powers by the majority shareholders the Act has a provided us a “Principle of Proportional Representation for Appointment of Directors” (the Principle) as enunciated in Section 163 of the Companies Act, 2013. Using which the Company may provide an opportunity to minority shareholders to have an appropriate representation on the Board of the Company.

Through this study we will try to understand the appointment of directors by using the option of proportional representation and the aspects relating to their removal and we will also linger on to understand a dilemma with respect to such removal of such directors.

Problem

Generally, the majority of the shareholders controls the Board of Directors and the decision of majority shareholders in a company binds the minority, and such minority is deprived of its legitimate rights to approve certain matters. This can better be understood with the help of following:

Example:

A Public Company has total 9 directors on the Board and is required to comply with Section 152(6) of the Companies Act, 2013, wherein it needs to have atleast 2/3^rd of directors as Rotational Directors whose office shall be liable to retire by rotation i.e. 9*2/3 = 6 directors and the remaining consists of Non-Rotational Directors i.e. 1/3^rd of directors = 9*1/3 = 3 directors.

Further, out of such Rotational Directors, atleast 1/3^rd of directors shall retire at every AGM. Now, at the ensuing the AGM, out of 6 directors, 2 directors shall retire (i.e. 6*1/3 = 2 directors) and shall be eligible for re-appointment.

Now, assuming there is one shareholder holding 50.6% of total voting rights of the company (Majority) and other shareholders hold the remaining 49.4% of total voting rights (Minority).

Voting at the Meeting

Shareholders	Director-1 (D1)	Director-2 (D2)
Majority	Yes	No
Minority	No	Yes

Now, since the majority has voted in favour of D1 and voted against D2, hence, Director-1 gets appointed (Majority get its wishes) by passing an ordinary resolution and the director voted in favour by minority is not appointed hereby and accordingly, the minority does not have any say in this matter.

Section 163 of the Act (as reproduced)

Notwithstanding anything contained in this Act, the articles of a company may provide for the appointment of not less than two-thirds of the total number of the Directors of a company in accordance with the principle of proportional representation, whether by the single transferable vote or by a system of cumulative voting or otherwise and such appointments may be made once in every three years and casual vacancies of such Directors shall be filled as provided in sub-section (4) of section 161.

In case of Government Company- Section 163 shall not apply to :-

(a) a Government Company in which the entire paid up share capital is held by the Central Government, or by any State Government or Governments or by the Central Government and one or more State Governments;

(b) a subsidiary of a Government company, referred to in (a) above, in which the entire paid up share capital is held by that Government company. – Notification dated 5th June, 2015.

The Principle Explained

According to Section 163, a company’s articles may provide for the appointment of directors by proportional representation and if such, articles provide so, then, not less than 2/3^rd of the total number of directors shall be appointed by using this method, implying that provisions in the articles are required to invoke this section. Meaning thereby that in such case, there can only be 1/3^rd of such directors, who are outside of the purview of this principle and can be appointed as per the normal method of appointment as provided in the Act.

Further, such 2/3^rd directors can be appointed by single transferable vote, cumulative voting, or other means and this option is available to all the companies registered under the Act, however, the Government Companies as mentioned above cannot avail this option. This method of appointing directors in a company ensures that minority shareholders’ interests are fairly represented.

Further, such appointment is valid for a period of 3 consecutive years and thereafter, the same can be made by complying with this section. Further, any casual vacancy arising of such directors shall be filled by complying with Section 161(4) of the Companies Act, 2013. Any person so appointed shall hold office only up to the date up to which the director in whose place he is appointed would have held office if it had not been vacated.

An important point to note here is that Section 163 overrides the Section under Section 152(6) of the Companies Act, 2013.

Section 169(1) of the Act (as reproduced)

(1) A company may, by ordinary resolution, remove a director, not being a director appointed by the Tribunal under section 242, before the expiry of the period of his office after giving him a reasonable opportunity of being heard:

Provided that an independent director re-appointed for second term under sub-section (10) of section 149 shall be removed by the company only by passing a special resolution and after giving him a reasonable opportunity of being heard:

Provided further that nothing contained in this sub-section shall apply where the company has availed itself of the option given to it under section 163 to appoint not less than two-thirds of the total number of directors according to the principle of proportional representation.

Section 169(1) of the Act-Explained

This section deals with process of the removal of directors by the shareholders by passing on ordinary resolution or special resolution as the case may be. It becomes mandatory to give a reasonable opportunity of being heard before such removal.

Further, the director appointed by the Tribunal cannot be removed under this section.

Second proviso explained-

Further, the second proviso to this sub-section provides that the removal of directors is not possible in the company where it has opted for Section 163 to appoint not less than two-thirds of the total number of directors according to the principle of proportional representation. Literal meaning is that where a company has composed of its Board Composition as per the Principle of Proportional representation, then None of its directors can be removed under Section 169.

Dilemma –

Whether the language used in Second proviso to Section 169(1), should be construed in its literal meaning or should be logically interpreted?

Second proviso to Section 169(1)-

Provided further that nothing contained in this sub-section shall apply where the company has availed itself of the option given to it under section 163, to appoint not less than two-thirds of the total number of directors according to the principle of proportional representation.

Literal Interpretation

According to this, none of the directors on the Board of the company, which has opted for proportional representation on the Board, can be removed under Section 169 of the Company. This leads to unjustified protection available to 1/3^rd of the directors under Section 163, from being removed from their positions under Section 169.

Logical Interpretation

According to this, the directors whose appointment has been made by using the method of Proportional Representation i.e. atleast 2/3^rd directors, cannot be removed by the shareholders under Section 169 and remaining 1/3^rd directors should be kept outside this purview and should be under the category of directors who can be removed by following the process under Section 169.

Conclusion – It can be concluded that the Companies Act, 2013 has tried to cover every aspect which may have an impact on its governance practices and to strengthen the role of minority shareholders by providing an option to appoint directors through proportional representation. Although, to deal with instances of Oppression and Management of minority, a separate set of provisions are available i.e. Section 241 to Section 246 of the Act. However, the Principle of Proportional Representation can be beneficially used by the Companies to protect the interests of minority shareholders, although it is unclear how far this will be enforced. The requirements have been kept optional, and it is up to the companies to decide whether or not to execute them and while opting this method, the above problems should be lingered upon critically.