Meaning of Independent Director

Preethi Suresh

An Independent Director  is a non-executive director of a company and helps the company in improving corporate credibility and governance standards.

Section 149 of the Companies Act, 2013 falls under chapter XI – Appointment and Qualification of Directors. The applicable rules are Companies (Appointment & Qualification of Director) Rules, 2014.

Here we are going to analyse subsection 6 of section 149 which explains the meaning and prerequisites to become an Independent Director.

Section 149 (6) An independent director in relation to a company means a director other than a managing director or a whole-time director or a nominee director,—

For example, XYZ Bank grants a loan of ₹ 20 lakhs to C Ltd. XYZ Bank appoints Mr. S as nominee director in C Ltd.Mr. S cannot become an Independent Director in A Ltd.

Section 149(6)(a) who, in the opinion of the Board, is a person of integrity and possesses relevant expertise and experience.

For example, In the opinion of the BOD, Mr. S who is proposed as an Independent Director should possess relevant experience and should be trustworthy.

Section 149 (b) (i) who is or was not a promoter of the company or its holding, subsidiary or associate company.

For example, if Mr. S is proposed to be an Independent Director of XYZ Ltd. He should not be a promoter or director of the C.A.S.H., that is the Company, it’s Associate, it’s Subsidiary and it’s Holding Companies.

Section 149(6) (b) (ii) who is not related to promoters or directors in the company, its holding, subsidiary or associate company;

For example, if Mr. S is proposed to be an Independent Director of XYZ Ltd., but Mr. H (brother of Mr. S) is a promoter or director in C.A.S.H. Then, Mr. S cannot be appointed as the Independent Director of XYZ Ltd.

Section 149(6)(c) who has or had no pecuniary relationship, other than remuneration as such director or having transaction not exceeding ten per cent. of his total income or such amount as may be prescribed, with the company, its holding, subsidiary or associate company, or their promoters, or directors, during the two immediately preceding financial years or during the current financial year;

The term pecuniary means relating to or consisting of money.

For example, If Mr.S is receiving remuneration from XYZ Ltd. or the transaction he entered with the company is less than 10% of the total income of Mr. S, he can become an Independent Director of XYZ Ltd. If the total income of Mr. S is ₹50 lakhs, the transactional amount with the C.A.S.H. or its promoters or directors should not be more than ₹5 lakhs (10% of 50 lakhs). If more than ₹5 lakhs he will not be able to become an Independent Director.

If Mr. S is having a franchise of fridge manufactured by XYZ Ltd. Mr. S cannot become an Independent Director with C.A.S.H.

Mr. S is having any pecuniary relationship with its promoters or directors, during the two immediately preceding financial years or during the current financial year, then also Mr.S cannot become an Independent Director.

Section 149(6)(d) none of whose relatives—

(i) is holding any security of or interest in the company, its holding, subsidiary or associate company during the two immediately preceding financial years or during the current financial year:

Provided that the relative may hold security or interest in the company of face value not exceeding fifty lakh rupees or two per cent. of the paid-up capital of the company, its holding, subsidiary or associate company or such higher sum as may be prescribed.

For example, if the paid-up capital of XYZ Ltd. is ₹100 lakhs. Mr. H (brother of Mr S who is proposed to be an Independent Director) holds 3% of shares. In such a case, Mr. S cannot become an Independent Director in C.A.S.H.

Section 149(6)(d) none of whose relatives—

(ii) is indebted to the company, its holding, subsidiary or associate company or their promoters, or directors, in excess of such amount as may be prescribed during the two immediately preceding financial years or during the current financial year;

For example, if Mr. H (brother of Mr. S who is proposed to be an Independent Director) owes money (indebted) to XYZ Ltd. (C.A.S.H.) during immediately preceding 2 financial year or current financial year, then Mr.S cannot become an Independent Director.

Section 149(6)(d) none of whose relatives—

(iii) has given a guarantee or provided any security in connection with the indebtedness of any third person to the company, its holding, subsidiary or associate company or their promoters, or directors of such holding company, for such amount as may be prescribed during the two immediately preceding financial years or during the current financial year; or

For example, if Mr. H (brother of Mr. S who is proposed to be an Independent Director) has given a guarantee of indebtedness of any third person to XYZ Ltd.during the two immediately preceding financial years or during the current financial year, in such a case, Mr. S cannot become an Independent Director of C.A.S.H.

Only giving a guarantee of indebtedness is to be taken into consideration. Receiving a loan is acceptable.

Section 149(6)(d) none of whose relatives—

(iv) has any other pecuniary transaction or relationship with the company, or it’s subsidiary, or its holding or associate company amounting to two per cent. or more of its gross turnover or total income singly or in combination with the transactions referred to in sub-clause (i), (ii) or (iii);

For example, If the gross turn over of XYZ Ltd.is ₹100 crores. Mr.S wants to become an Independent Director in XYZ Ltd. Mrs. S has a pecuniary relationship of more than ₹2 crores with C.A.S.H. In such a case Mr.S is not eligible to become an Independent Director. The pecuniary interest can be of any form like loan, guarantee or security.

Section 149(6)(e) who, neither himself nor any of his relatives—

(i) holds or has held the position of key managerial personnel or is or has been employee of the company or its holding, subsidiary or associate company in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed;

Provided that in case of a relative who is an employee, the restriction under this clause shall not apply for his employment during the preceding three financial years.

For example, if Mr. S is/was an employee or KMP of XYZ Ltd. (C.A.S.H) or Mr.S’s father or any relative is an employee or is/was a KMP of XYZ Ltd. (C.A.S.H), Mr.S cannot become Independent Director in XYZ Ltd.(C.A.S.H). If Mr. S’s father was an employee two years before and in the current year Mr.S wants to become an Independent Director. He can.

Section 149(6)(e) who, neither himself nor any of his relatives—

(ii) is or has been an employee or proprietor or a partner, in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed, of—

(A) a firm of auditors or company secretaries in practice or cost auditors of the company or its holding, subsidiary or associate company; or

(B) any legal or a consulting firm that has or had any transaction with the company, its holding, subsidiary or associate company amounting to ten per cent. or more of the gross turnover of such firm;

For example, (A) If Mr.S is or has been an employee/proprietor/partner in the firm of auditors, company secretaries or cost auditors engaged by XYZ Ltd (C.A.S.H.), then Mr.S cannot become an Independent Director in the C.A.S.H.

(B) Mr. S is a partner of PQR Legal firm. The firm earns more than 10% of its turnover from XYZ Ltd. (C.A.S.H). Mr. S cannot become an Independent Director in C.A.S.H.

Section 149(6)(e) who, neither himself nor any of his relatives—

(iii) holds together with his relatives two per cent. or more of the total voting power of the company;

For example, If Mr.S holds voting power of more than 2% in XYZ Ltd.(C.A.S.H.), it will be dealt in under section 149(6)(d)(i).

But here, if Mr. S together with his spouse or any relative is specified here.

If they hold less than 2% of voting power in XYZ Ltd. (C.A.S.H), Mr.S can become an Independent Director in XYZ Ltd. (C.A.S.H).

Section 149(6)(e) who, neither himself nor any of his relatives—

(iv) is a Chief Executive or director, by whatever name called, of any nonprofit organisation that receives twenty-five per cent. or more of its receipts from the company, any of its promoters, directors or its holding, subsidiary or associate company or that holds two per cent. or more of the total voting power of the company;

For example, Mr. S runs an NGO/NPO. Mr. R is a director of XYZ Ltd. He donates ₹35 lakhs to the NGO. Total receipts of the NGO for the current financial year or ₹1 crore. As the NGO received more than 25% of its receipts from XYZ Ltd., Mr.S will not be eligible to become an Independent Director of C.A.S.H.

Section 149(6)(f) who possesses such other qualifications as may be prescribed.

Conclusion:

Independent directors act as a mentor to the company. Their roles vastly include enhancing corporate credibility and governance standards, functioning as a watchdog and playing a significant role in risk management. Independent directors play an active role in various committees set up by the company to ensure good governance.

Independent directors should make up at least two-thirds of the directors in the audit committees of listed companies to oversee the financial reporting process and disclosure of the company’s financial information, ensure compliance with listing and other legal requirements, disclosure of related party transactions and qualification in the draft audit report, among other things.

From the above, we can conclude that Independent Directors have a crucial role to play in corporates.