India predominantly consists of a large number of promoter- led companies with controlled interest i.e. Family businesses with fewer than 30% of businesses surviving the third generation ownership. More than 23% of the board directors are family members which may lead to promoter interest taking precedence over that of other stakeholders and cause governance concerns. To recognize this challenge, Section 149 of the Companies Act, 2013 statutorily require Independent Directors (hereinafter “ID”) in public companies and more specifically Regulation 17(1)(b) of the SEBI Listing Obligations and Disclosure Requirements (hereinafter “LODR”) Regulations 2015 require them in listed companies. This director is expected to pay attention to the integrity of financial information and related party transactions along-with safeguarding the interests of the minority shareholders among other duties mentioned under Schedule IV of the Companies Act, 2013. Yet, the graph of independent directors resigning seems to be on the rise with every year.
Therefore, there is a dire need to strengthen the independence of these directors and seal the many existing loopholes. In this context, the Securities and Exchange Board of India (hereinafter “SEBI”) has recently issued a Consultation Paper (dated March 1, 2021) to seek public views on the matter relating to broadening the eligibility criteria for IDs, the process of appointment / re-appointment and removal of IDs, enhancing transparency in the nomination and resignation of IDs, strengthening the composition of Board Committees and remuneration of IDs.
DEFINITION OF INDEPENDENT DIRECTORS
It is well-known that an independent director should be independent, in the sense that they should not be related to the listed entity, its promoter or directors, its holding or subsidiary, etc. and shall have no pecuniary relation as such. The SEBI (LODR) Regulations, 2015 also provide for a cooling-off period of 3 years in case the person is an employee/ key managerial person (hereinafter “KMP”) or their relatives are KMPs and a period of 2 years if there is a case of a material pecuniary relationship between the person or relatives and the companies. The consultation paper proposes to harmonize the cooling periods to a uniform period of three years.
Nevertheless, most companies choose to appoint ‘home directors’ who may be neighbors, school or college friends who act on the promotor’s directions and still comply with all the requirements to be an independent director. Even though on the face of it, they seem to have no connection with the listed entities or their employees or directors but still make the independence of that director rather doubtful. They may seem to act in a fiduciary manner yet, the interests of the controlling shareholders will always seep in. To strengthen the independence of an ID, SEBI needs to incorporate a clause to recognize such invisible and indirect relations while appointing an ID.
APPOINTMENT/ RESIGNATION/ REMOVAL OF INDEPENDENT DIRECTORS
Currently, an Independent Director is appointed by the board and then approved by the shareholders at the general meeting through an ordinary resolution. Like mentioned earlier, the independence of a director is compromised when a known individual is hired, moreover affecting the minority shareholding drastically. Section 150 of the Companies Act, 2013 tried to address this problem by proposing a Data Bank which became operational only last year with the coming of the Companies (Creation and Maintenance of Databank of Independent Directors) Rules, 2019 (hereinafter the “Databank Rules”) and Companies (Appointment and Qualification of Directors) Fifth Amendment Rules, 2019 (hereinafter the “Amendment Rules”). The Amendment Rules stipulate that every individual who wishes to be an independent director must apply for inclusion of their name in the data bank. Nevertheless, the Companies Act, 2013 specify that a director may be selected from the bank if the listed entity cannot comply with the requirements, thus not making it mandatory in nature. However, the Amendment Rules run the risk to contradict the statutory provisions.
The consultation paper proposes a dual approval structure, like that in the United Kingdom. The single voting process will not only get the approval of the shareholders but also the approval by the majority of the minority shareholders through an ordinary resolution. If either of the thresholds is not met, then the listed entity may propose a new candidate or propose the same person for a second vote (without a separate approval requirement) after a cooling-off period of 90 days but before 120 days. While this proposal may seem to please the minority shareholders at the first glance, if the candidate is rejected, they can be reconsidered again, making the whole process futile. While implementing a law that has worked in the UK, India needs to take into account that having promotor driven companies may use the second voting process to their advantage, leaving no room for change in the circumstances.
There is a need for clarification whether the independent directors will be mandatorily picked from the database system. If so, then a candidate chosen from there reduces the burden of due diligence on the minority shareholders and brings in more transparency while shortlisting candidates. Further, once a candidate is rejected, the listed entity should have a longer cooling period or the option to not vote on the candidate again.
For the removal of a director, SEBI has proposed to replace removal by simple majority to a dual approval structure to give the minority shareholding more power. Whereas, when an ID resigns under the Section 168 of the Companies Act, 2013, the director can give a resignation with reasons within thirty days but seven days under the SEBI (LODR) Regulations, 2015. While SEBI proposes to bring the laws in conformity with the SEBI (LODR) Regulations, 2015, it also provides a mandatory cooling-off period of one year before joining other boards to prevent conflict.
ROLE OF NOMINATION AND REMUNERATION COMMITTEE
While there is a need to prescribe disclosures for transparency in the Nomination and Remuneration Committee (hereinafter “NRC”), SEBI has proposed to evaluate the skills, knowledge and experience while considering a wide range of backgrounds. The candidate has to make certain disclosures to the shareholders that they have the skills and capabilities required and disclose the channels for searching candidates. Having said that, recently, the MCA decided that these directors will have to take a proficiency test within a period of two years from the date of inclusion in the data bank to qualify which led to a large number of resignations.[i] With the proposal in the consultation paper being implemented, it will dissuade the directors further.
It should be noted that the proficiency test is widely criticised for not being an adequate pillar to assess the candidate as having a standardised test to assess directors for various types of companies will not benefit. Furthermore, it places a false assurance on the shareholders. To get a better assessment of the prospective candidate, SEBI should strongly consider replacing the proficiency test with these criteria.
THE MISSING LINK?
There are still some other factors that SEBI needs to take into account to encourage independent directors to stay. One of them being the liability imposed on an Independent Director. The Ministry of Corporate Affairs issued a circular that clarified under Section 149(12)(2) of the Companies Act, 2013, IDs should not be implicated in criminal or civil proceedings under the 2013 Act unless they were a part of a default/non-compliance committed by the company. However, this safe harbor provision neither grants immunity under all the statutes nor stops them from being summoned in the course of inquiry or trial. Therefore, placing a burden of proof on them to prove that they were diligent in their duties and had acted in a bonafide manner.
Many statutes have realized the shortcomings with companies misusing these IDs and have tried to rectify the situation by amended their laws. Recently, the definition of occupier under Section 2(zs)(ii) of the Occupational Safety, Health and Working Conditions Code, 2020 has excluded an independent director. It was realized that having IDs doing the day to day work of an occupier defeats the purpose of an ID under the Companies Act. Yet, having all statutes to individually act on this, is a slow and cumbersome process. Therefore, there is an urgent need for SEBI to act on such matters before investor confidence is lost.
These proposals are seen as a welcoming move to encourage more individuals to work as Independent Directors. Moreover, the consultation paper does have its merits in giving minority shareholders a chance in appointing and increasing remuneration by maybe reconsidering reviving Employment Stock Option Plan (“ESOPs”). Thus if such amendments are to be brought in, there can be a relief given to the independent directors and can lead to an increase in appointments.
[i] Rule 6(1) of the Companies (Appointment and Qualification of Directors) Rules, 2014 (India); Due to many resignations, the rule was amended to exclude experienced independent directors who have served for a period of no less than 3 years as a director or KMP in a listed public company or in an unlisted company with a paid up capital of rupees ten crores or more.