1. Introduction

An Independent Director is one who can give an independent assessment of the company, in particular on the questions of strategies, productivity, risk evaluation, capabilities and ethical standards. They are the ones whose duty is to provide an impartial and informed evaluation in the assessment of management and board performance.

The concept of Independent Directors (IDs) emerged from the need to have a certain number of directors on the Board who would think and act independently to bring about a “healthy balance between the interests of the promoters and other stakeholders including minority and small shareholders. IDs are an important component in the overall framework of Corporate Governance.

Overall Structure Of Indian Firms: Vertical And Horizontal Agency 

India is one of the nations in the world which have the horizontal agency problem, as compared to USA and the UK, that has issues with vertical agency. The vertical agency problem in the US and some of the advanced countries is between the shareholders and the managers. However, in India, the agency problem is between the controlling/majority shareholder and the other shareholders. This is why it is known as the dilemma of the horizontal agency. Hence, according to SEBI’s consultation paper, one of the corporate governance mechanisms for overcoming horizontal agency problems is dual voting. Before moving forward, we would like to briefly elaborate the difference between the Promoter shareholders and Minority shareholders.

  • Promoter shareholders are those who by virtue of their voting rights or affirmative rights, or by any agreement or any other piece of document enjoy control over the affairs of the company. And all shareholders other than promoter shareholders are usually public shareholders.
  • Minority shareholders are also not defined. It won’t wrong to say that by drawing inference, minority shareholders can be considered as 10%.

Role Of Independent Directors In Corporate Scandals

Sadly, recent incidents of corporate scams allegedly occurred in the scanners of the independent director’s offices, such as Nirav Modi-Mehul Choksi story, PMC Bank, the Satyam scandal, etc. have put the position of ID under surveillance. Many IDs claim that they did not anticipate these frauds, or did they? These scams may hint towards the ulterior motive of IDs to gain profit at the expense of other stakeholders in the company.

Despite the numerous measures carried out, the concerns regarding the effectiveness of IDs in the context of corporate governance persist. However, SEBI in the recent times made an attempt to improve their efficacy to safeguard the interests of minority shareholders in its Consultation Paper On Review Of Regulatory Provisions Related To Independent Directors.

Dual Approval for Independent Director Hopes of Ushering into a New Era Shattered

The role of IDs in preventing corporate scandals became one of the overarching themes in Indian corporate governance, and when SEBI released a Consultation paper proposing a dual approval process for the appointment of IDs, leading companies in the country expressed serious concern. After the deliberations, the SEBI Board opted to drop the idea for dual-approval and went for the approval by a special majority for appointment of IDs.  There is, therefore, a sizzling controversy on the way IDs are appointed.

In this article, we have made a comparison of the old, recommended and the new legislative framework for the process of appointment and removal of independent directors. We have criticised SEBI for not accepting the recommendation which would’ve marked a watershed moment for the independent director.

2. provisions related to the appointment of independent director

Current Provisions Proposed changes Amendments
A. As per the current provisions, independent directors are:

  •  Recommended by the Nomination and Remuneration Committee,
  •  Appointed by the Board of Directors,
  •  And finally, confirmed by approval of majority of shareholders.

B. Companies appoint IDs as additional directors, subject to approval of shareholders of shareholders in next general meeting.

A. Appointment/re-appointment to be subject to “dual approval” taken through a single voting process:

1. Approval of majority of all shareholders (ordinary resolution in case of appointment and special resolution in case of re-appointment), AND

2. Approval of majority shareholders. of minority

  • If either of the tests fails, the appointment/ re-appointment is rejected.

In such case, the listed entity may:

  • Propose a new candidate for appointment/re-appointment, or
  • Propose the same candidate for second voting:
    • After a cooling off period of 90 days but before 120 days (without a separate requirement of approval by ‘majority of the minority’).
    • Such approval shall be sought through a special resolution.
    • Notice to shareholders shall contain the reasons for proposing the same person despite being rejected in the first take.

B. Appointment of IDs only with prior approval directors, subject to approval of shareholders in the General meeting

C. In case of casual vacancy due to resignation/removal/death/failure to get reappointed, approval of shareholders to be taken within 3 months from the date of such casual vacancy

A. Appointment and Re-Appointment of Independent Directors are to be done by approval of shareholders by way of Special Resolution.

B. Nomination and Remuneration Committee (NRC) have atleast 2/3rd IDs.

Now, the process of appointment of Independent Directors needs to complete 3 Stage.

  • Stage 1- Recommendation of NRC.
  • Stage 2- Approval by the Board of Directors.
  • Stage 3- Approval of Shareholders (By Special Majority)

3. Analysis

  • Dual Approval: A Road Towards Independence?

Independent directors are an essential component of scrutiny and accountability within the governance structure of a listed company; thus, it is critical that minority shareholders have a significant role in their appointment. SEBI’s consultation paper introduced additional voting power for minority shareholders in the election of independent directors. That means that listed companies with Promoter shareholders must guarantee that their Article of Association ensure that IDs are appointed through a dual voting mechanism. This framework ensures IDs to be nominated separately both by the shareholders as a whole as well as the minority shareholders as a separate class. The company would have to wait for at least another 90 days before the vote could be taken if the votes failed to obtain the requisite majority — this time by a special resolution of all the shareholders. While avoiding the pitfall of transforming minority protection into minority control, this approach provides the minority a considerably stronger say in the appointment of independent directors. Moreover, it will promote greater dialogue between companies and their shareholders before the appointment of the IDs. Furthermore, the quality & credibility of IDs is pivotal, thus the authors support greater disclosures when IDs are proposed so that shareholders may make rational and informed voting decisions.

Currently, only a 51% shareholder approval is necessary to nominate or remove such directors, and no separate sign-off from minority shareholders is required. The present approach allows the company’s promoters a “significant influence” over the appointment and removal of IDs, undermining their capacity to hold contrary views to promoters. In a company with a Promoter shareholder, minority shareholders may not own requisite shares to influence the voting outcome. The fundamental objective of the IDs is to safeguard the interests of the minority shareholders, and therefore, the authors believe that it is advisable to provide minority shareholders more voice in their appointment.

Equally, we are keen to ensure that the protection of minority shareholders does not become control by minority shareholders. It serves as a platform where minority shareholders’ voices could be heard without them becoming dominant. The authors maintain that our objective of true “independence” could only be achieved by way of dual voting system, where IDs of listed companies are appointed by all the shareholders as well as the minority shareholders.

We reckon that this approach provides minority shareholders with the appropriate degree of influence and eliminates the possibility of surprise non-re-election of IDs without exposing the boards to the risk of being hijacked by special interest groups. It also guarantees that all directors continue to represent the entire shareholder constituency and avoids a distortion of ownership and voting rights. The 90-day cooling-off period serves as an essential unblocking mechanism, allowing shareholders to engage in a dialogue that has a possibility of creating a solution acceptable to everyone. This would mean more rights to minority investors, better disclosures and also responsibility for promoters.

We feel it is crucial to provide minority shareholders more voice in the election of IDs so that the directors can effectively represent independent shareholders’ interests. IDs are an important source of challenge and control within a listed company’s governance structure, therefore it is critical that minority shareholders have a substantive say in their election.  We consider that it is an essential improvement in the overall package of measures to provide minority shareholders more input in election of IDs.

  • The hopes of ushering into era of pro minority dashed

There were some good suggestions like dual standards of appointment, composition of nomination and remuneration committee, their reappointment by executive directors, etc. But on 29 June 2021, SEBI, in its annual Board meeting, discussed the consultation paper and accepted recommendations which were not there in the paper. So, SEBI had a great chance to overhaul the law regarding IDs. A lot of hopes were there with respect to ensuring independence of IDs when this consultation paper was brought out. It was thought that recommendations would be made after thorough analysis of provisions. But all these hopes were broken in this SEBI Board Meeting on review of regulatory provisions relating to IDs. This opportunity to dismantle and overhaul the entire framework was squandered away.

Berns et al. 2009, in their study, noted that shareholding in US is much diversified. So, the companies are completely managed and controlled by the management. But in India, companies are primarily family run companies – Adani, Aditya Birla, Reliance Industries, etc. So, promoters have become a menace and they do not allow the directors to independently exercise powers. Promoters decide who will become directors, or in some cases they themselves become directors. If we want to appoint IDs whose job is to review working of executive directors, and to protect interests of minority shareholders, the promoters would be the major obstacle. Therefore, it was suggested to have a dual mode of appointment and removal of IDs. But SEBI did not accept it.

In India, average investor does not invest money based on market trends, rather we feel safe in the commercial wisdom and business acumen of a few individuals and family names. Corporate succession planning, which is an important aspect of corporate governance has played an important role in EU, US and UK, but it has not yet found support in India.

The fact that the promoters hold a good amount of voting rights in the corporation means that the IDs would not be independent of their control. As SEBI has mandated a special majority, it is not difficult for promoters and major families to arrange such percentage of votes. Even retail shareholders mimic the decisions of key individuals in India.

In Foss v. Harbottle[1], the principle of majority rule was upheld. So, when the consultation paper provided this two-step appointment, it was a new development. But then SEBI completely rejected this idea and only accepted special majority of all shareholders. The hopes of ushering into era of pro minority were dashed.

4. Conclusion

The fact of giving public shareholders a say in appointment of IDs was aimed to increase shareholder activism and to give them a greater say in management of affairs of company, as the control should come from within the company for good corporate governance. If a regulator has a greater influence, it would mean that the entire structure of corporate governance is reducing the say of shareholders. Therefore, shareholders must be encouraged to have a greater voice in the appointment of IDs. Giving special majority does not address this problem as majority shares are already held by powerful promoters. Since public shareholders are less in number, they should be encouraged in having a say. In this regard, sharper focus is required in the areas of appointment and role of the independent directors. Therefore, what began with a bang ended with a whimper!

[1] Foss v. Harbottle, (1843) 67 ER 189 (UK).

Author Detail

Disha Lohiya –
Email: [email protected]
Year: 4th Year
Institution: National Law University, Jodhpur
Prateek Sharma –
mail: [email protected]
Year: 5th Year
Institution: Himachal Pradesh National Law University, Shimla

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September 2021