The genesis of the institution of Independent Director should be viewed from the ownership of the company vis-àvis management. Board of Directors is an integral part of the company. In layman’s language, they are a group of people who are appointed by owners of the company to look after the interests of the stakeholders which comprises of different people like employees, investors, government, society etc. BOD is credited with the work of looking after the day to day management of the company. It is assumed and expected that the BOD will carry the same functions with transparency and accountability and carry out the affairs in interests of the common good. This is exactly the triggering point for the so called independent behavior of the board. The idea of independence has been a shabby concept and what has been generally seen is that the board often works prejudicial to the interests of the stakeholders motivated by material benefits of few members. This called for the need of an institution which would be really independent and would carry out their functions with absolute accountability.
The Indianized conception of Independent Director has been transplanted from the Anglo-Saxon jurisprudence. The independent director can be regarded as that member of the board who has disseminated himself from the internal affairs of the management of the company. He is expected to monitor the board with a sense of segregation. The Companies Act of 2013 traces the concept of independent director under Sec. 149. It has been a wide advocated concept that the institution of independent director has been major tool of corporate governance.
The article seeks to answers one of the most burning questions of the corporate world i.e. are independent directors really independent? It has been advocated by the concerned article that the institution of independent director has been a sham in India. The concept has been well adopted in theory but lacks practicality. Three prongs have been attacked i.e. nomination, removal and a remuneration which creates hurdle in independency of independent director.
The Definitional Issue of ‘Independence’
There has always an ambiguity worldwide as to what constitutes “independence” of independent director. Policymakers of India have tried continuously setting out different meanings attached to the term “independence”. This dates back to the CII Report which although recognized the importance of the institution of independent director, but abstained from defining the term. The first legit attempt to define the term was made by the Kumar Mangalam Birla Committee report. The committee defined independent directors as “directors who apart from receiving directors’ remuneration do not have any other material pecuniary relationship or transactions with the company, its promoters, its management or its subsidiaries which in the judgement of the board may affect their independence of judgment”. The definition ought to be a narrow approach to determine the independence of independent director. Sole reason for the definition being treated as a narrow test was its pecuniary considerations. These recommendations soon led to a regulatory framework i.e. clause 49 of the Listing Agreement. The concerned clause listed out exclusions to the institution of independent director like individuals who were related to promoter and members of senior management by familial ties. There were some other exclusions as well. However, the provision did not capture certain social relations that would affect director’s independence. These loopholes were done away with Sec. 149 of the Companies Act, 2013. It turned out be a major boost in the corporate governance goal. There were many improvisations which led to an effective independence threshold. It contains a fair list of exclusions. Moreover, it also lays down the overarching subjective requirement of expertise and experience.
The criteria discussed above basically amounts to the fulfillment of objective factors. What the definitional issue of independence lacks is the subjective element. The issue of the subjective element or the practical aspect to the independence of Independent Director has been discussed below.
How much “Independent” are Independent Directors? The theoretical basis for the institution has already been discussed at length. Going through the above discussions it was clear that it is quite possible to come up with satisfactory objective criteria for the attribute or independence but it is also of utmost importance to understand the fact that the business is carried on at a real-time basis and fulfillment of the objective criteria would not serve the real purpose and pacify the ground realities. These subjective element lies in the nomination, removal and the remuneration process that hasn’t been dealt by the legislation so far. This element hits the very core of the independence criteria of independent director.
Nomination & Election Process
The law does not provide special provision for the nomination of independent director. However, Clause 49 of the Listing agreement lays down as to who would nominate the said independent directors. Above clause lays down that Nomination and Remuneration Committee of the board will do the needful. It specifically mentions that Nomination and Remuneration Committee of the board will formulate the criteria for determining qualifications, positive attributes and independence of a director and will identify and recommend to the board their appointment. This is certainly followed by board approving or disproving such recommendations and takes them to general meeting for final approval. Section 152(2) says that “every director shall be appointed by the company in a general meeting.” Now, it is of utmost relevance to mention here that the Nomination and Remuneration Committee only nominates candidate for the post of independent director and still the decision making power rests with the board. The fact that the committee only “nominates” and it is commonly seen that the committee nominates people acquainted with the promoters or the directors. This process leads to the independent director who is appointed is left out with a sense of indebtment to the promoters or directors. This is the triggering point where the independence of the director is hit brutally. The present law does not lay down specific procedure as to the appointment or the nomination of independent director. The appointment of independent director in India takes place through the usual process where each director is to be voted on individually at a shareholders’ meeting by way of a separate resolution. It is seen that the appointment of such independent directors are at the petty of the controlling shareholders.
One of the main functions of independent director is protection of the interests of the minority shareholders but under the present matrix of appointment and removal leads to the fact that the sole purpose of independent director gets disbursed. Above fallacy can be remedied by the increasing the participation of minority shareholders. Effective independence of independent director could be achieved by two schemes namely by the case of cumulative voting by shareholders and secondly by election by a majority of minority. By the process of cumulative voting, minority shareholders could be given their chance to elect the independent director in proportionate to their shareholders. This would ultimately lead to reduction in dominance of controlling shareholders. In this scheme, individual shareholder is given the power to exercise to respective number of votes determined as the product of the number of shares held by the shareholder and the number of independent directors to be elected. This scheme for the nomination of independent director would ensure effective independence because it would involve participation of both the minority shareholders and controlling shareholders to elect independent directors depending on the proportion of their respective shareholding. Alternatively, the process of voting by majority of minority can also certainly boost the element of independence of independent director. This type of nomination will run on premise where only minority shareholders would be given a chance to appoint the independent director. Each independent director will remain elected as long as it enjoys the majority support of the minority shareholders. Non-participation of the controlling shareholders will certainly lead to boost in the independence of independent director. This scheme is useful because it will bring out the true representation of the minority shareholders and will instill accountability in the minds of independent director towards minority shareholders.
Removal
We have already discussed as to the loophole in the appointment process which diminishes the independence threshold. Now, the question arises as to whether the same is similar with the removal process. The answer is affirmative. Section 115 of the Companies Act, 2013 says shareholders can give a special notice to move a resolution. Section 100 lays down that shareholders collectively owning 10 percent of paid-up equity can call for an EGM. Moreover, Section 169 lays down that any director can be removed by passing an ordinary resolution at a general meeting. Perusal of the above provisions quite clearly reveals that there is certainly no distinction between the removal of “independent” and “nonindependent” director. Thus, the process of removal of independent director is quite lucid i.e all directors need to do is aimed to provide a special notice to commence a resolution, followed by an EGM and finally passing that resolution. It is generally seen that majority Indian promoters have substantial amount of shareholdings in their company, so the removal of independent director on their whims and fancies is not mere a possibility but reality. This is another reason what affects the independence of independent director.
Issue of Remuneration
The Companies Act, 2013 specifically proscribes any kind of business or pecuniary relationship between the independent director and the company. However, Sec. 149(9), 197(5) and 197(9) of the Companies Act, 2013 talks on remuneration. Combined reading of the above provisions reveals that “independent directors can be paid a sitting fee and related reimbursements for attending the board/committee meetings and profit-related commissions as approved by the members.” This is where the problem lies and this problem jeopardizes the independence of independent director. The general practice prescribes that commissions which are related to some profit, the proposal is initiated in the board and followed by a general meeting for approval by shareholders. Since the process involves the participation of dominant shareholders, it very much strikes the core of the independence value of the independent directors.
Concluding Remarks
Above deliberations lead to the conclusion that there still persists some problems which strikes the very core of the independence of independent director. The issues of nomination, removal and remuneration needs to be addressed probably by an amendment because it erodes the very institution of the independent director. Independent director has been a tool for corporate governance and if these problems are remedied, it will emerge a very effective institution. The present institution of independent direct is in dire need of the overhaul change to make it a robust and an effective one.