Who is an Independent Director?
An Independent Director (“ID”) is a director other than a managing director or a whole-time director or a nominee director, who, in the opinion of the board, is a person of integrity and possesses relevant expertise and experience, not being a promoter of such company of its affiliates, not being a relative of promoters or directors of the company or its affiliates, is an independent director. Such individual cannot have any pecuniary relationship with that company, its promoters, senior management or affiliate companies, during the past two years or the current year. Moreover, the independent director cannot be related to promoters or the senior management and should not have been an executive with the company, partner or executive director of the auditors, lawyers, consultants of the company in preceding three years. It has been witnessed that IDs are rarely chosen based on qualification and/ or experience of the candidate, but mostly through close associates or nomination basis.
A Databank of Independent Directors
Recently, on October 22nd, 2019, the Ministry of Corporate Affairs (“Ministry”) brought about the Companies (Appointment and Qualification of Director) Fifth Amendment Rules, 2019, Companies (Creation and Maintenance of databank of Independent Directors) Rules, 2019 and Companies (Accounts) Amendment Rules, 2019 (“Rules”) under the Companies Act, 2013 (“Act”). The Rules came into force on December 1, 2019, with exception to Rule 2 and 5 of Companies (Creation and Maintenance of databank of Independent Directors) Rules, 2019. The objective of these Rules is to create a databank of people who are currently serving as ID or plan to serve as ID and, are eligible to be appointed as ID in a company. Such databank will be available on the website of Indian Institute of Corporate Affairs. It must be noted that government has now identified as an institute to make Section 150 of the Act relevant. Further to their registration in the databank, such present and prospective IDs will have to pass an online proficiency self-assessment test which will be conducted by the Institute and such test will examine their capability to act as an ID on the board of company.
Qualification of IDs
In order to qualify for the online proficiency selfassessment test, such IDs must secure atleast 60%, within 12 months from the date of registration in the databank maintained by the Indian Institute of Corporate Affairs. There is no restriction on the number of attempts an individual may take to pass the online proficiency self-assessment test. The only exceptions to the online proficiency selfassessment test are given to individuals who hold minimum experience of ten years as a director or key managerial personnel in a listed public company or in an unlisted public company having a paid-up capital share capital of Rs. 10 crores or more. For the purpose of calculation of the period of 10 (ten) years, any period during which an individual was acting as director or key managerial personnel in two or more than two entities at the same time shall only be counted once. As per Companies (Appointment and Qualification of Director) Fifth Amendment Rules, 2019, every ID is now required to provide a declaration that their respective names are appearing on the database of IICA when they declare their independency as per Section 149(7) of the Act.
What Questions must an ID ask before joining a company’s board
An individual must be very careful before deciding to join a company’s board as an ID, especially without any due diligence. An ID must ask several questions to the management of the company before joining its board along with independent due diligence. Due diligence is a process by which an individual gathers important business information about a target. In this case, the target will be the company a person wishes to join as an ID. Some of the key issues which must be taken care of include – financial position of the company, operational capabilities of the company and most importantly any probable risk which may lead to company engaging in illegal or fraudulent activity. As a part of due diligence exercise, company’s indemnification process and director’s liability insurance must be reviewed in the event any obligation falls on director when there is a litigation against the company. Company’s charter documents and public filings and press releases which are available in the public domain must also be reviewed along with byelaws to get a clear picture of obligations which ID may have to follow. Such scope and qualifications of such documents/policies must be reviewed by a legal professional along with identification of red-flags in the due diligence process so that any gap can be identified on time. A prospective director must carry out his own due diligence process in order to gather maximum information about the Board, their processes and commitments. Additionally, any possible conflict of interest to the company and other board members must be checked because ACT identifies certain eligibility criteria which must be met by an ID. It is also important to know the company’s policy on mitigating risks in case company faces an allegation or has a possible risk of running into a litigation.
Does an ID owe a duty of care & disclosure?
In all matters affecting company, directors and their fiduciary duties to the company include honesty and good faith as well as the duty of care, duty of loyalty and a duty of disclosure. The duty of care requires the director to perform their duty with the same standard of care that a prudent person would use in order to further the best interest of the company and also exercise good faith, as per the facts and circumstances of that particular company. The duty of loyalty requires that there should be no conflict between duty owed to the company and self-interest of a director. The duty of disclosure requires the director to provide complete and materially accurate information to the company. In such case, the role of ID becomes even more important as he or she has to satisfy himself that such obligations on directors are stringently followed to the maximum extent. A director’s responsibilities and obligations in the event of a potential transaction depends on the facts and circumstances of such transaction. From an economic angle, if a transaction is not that material or only marginally material to the company, the level of involvement and scrutiny facing the board of directors may get lowered down and only the basic business judgment rule will apply in such a case. For instance, where a company’s growth strategy is based on acquisition-based model, the ID should ideally set out the strategy and parameters for potential target acquisitions but leave the completion of the acquisition and transaction largely with the executives and officers.
The law focuses on the process, steps and considerations made by the ID, as opposed to the actual final decision. More expansive that the due diligence process is, the better it becomes for both the company and its stakeholders, and it also provides the protection to the directors in the face of scrutiny or investigation by any authority. Courts will consider facts and evidences like appearance at Board meetings, the number and frequency of such meetings, knowledge of the director on subject matter, time spent in taking decisions, suggestions taken from third-party experts like lawyers, requests for information from the management and requests for and review of documents and contracts by the Board and external experts. In the performance of their obligations and fiduciary responsibilities, an ID may, and should, seek the advice and counsel of third parties, such as attorneys, investment bankers, and valuation experts. Moreover, it is generally a best practice to obtain a third-party expert fairness opinion in any transaction undertaken by the company. Furthermore, most of these experts like corporate lawyers will prepare an opinion in form of due diligence report for such transactions. In addition to added protection to the ID, the fairness opinion is often relied upon by charted accountants and auditors in concluding or certifying the valuations in a merger and acquisition transaction, especially in a case where a related party is involved in the transaction.
Is corporate social responsibility also an ID obligation?
Big companies which fall under certain thresholds are additionally responsible for addressing some of the social issues and some of these issues may also concern economic development, environment and issues impacting public at large. Accordingly, companies must involve themselves in understanding such issues by involving stakeholders and taking their views on corporate social responsibility (“CSR”) issues. CSR is defined under Section 135 of the Act which prescribes involvement of ID in CSR committee. The role of ID in such decisions will enable board and management to make informed decisions and may enhance the business intelligence. Further, better decisions which reduces any business risk, build brand value and help in gaining long term shareholder value will benefit company. A CSR action may work for company in return as it shows responsibility of a business and its contribution to the society. A key part of ID’s responsibility is to ensure that an effective and structured corporate governance has been put in place and followed upon. Such corporate governance structure must also ensure that reasonable financial and growth targets are set, and such targets are achieved along with risk identification and management are carried out parallelly. IDs are responsible for taking into account interests of shareholders, customers, employees, creditors and general public. Due to the position an ID holds, it must also keep Board advised to regular basis, of any interest that could potentially conflict with CSR and in case there is a conflict, as a best practice, such ID or any director possibly in conflict must not receive any relevant documents of that meeting including minutes of meetings and must abstain himself from any discussion in that regard. IDs have an additional role to play as per Section 178(1) of the Act in which they shall be a part of Nomination and Remuneration Committee consisting of three or more non-executive director out of which not less than onehalf shall be IDs.
Suggestions and Conclusion
Considering the important role of an ID for a better Corporate Governance, the amendment in the rules by the legislature is indeed a welcome move by the Legislature to conduct a screening test to filter out the non-deserving candidature for the position of becoming ID’s and to develop a stout mechanism to handover some of the important decision making of the Company in the hands of more experienced and worthy ones in order to cater to better Corporate Governance.
However, the author feels that with respect to the qualifications and eligibility criteria to become an ID, amongst all other exemptions, certain additional exemptions may be granted to Professionals like Corporate lawyers, Company Secretary, Chartered Accountant to become ID’s with relevant years of experience in handling corporate governance. Additionally, there may be restrictions with respect to the number of attempts to clear the self assessment test in order to pave in some robust mechanism for the purposes to minimize chances of various governance misadventures by letting the more capable and deserving ones leading from the front on the important decision making.
Ambika Pratiyush is a Managing Associate at L&L Partners Law Offices (Formerly Luthra and Luthra Law Offices) and Siddhant Grover is a mentee at L&L Partners.