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Cos Act Ep#5: Independent Directors

Published on Sun, May 25,2014 | 09:54, Updated at Tue, Jun 03 at 16:37Source : CNBC-TV18 |   Watch Video :

The Companies Act 2013 is to governance what voters hope Mr Modi will be to politics – transformational! Whether it’s the Harshad Mehta scam of the 90's or the Satyam fraud of the last decade – they left a deep imprint on the design of this new law prompting India to legislate provisions like director rotation, auditor rotation and minority rights protection, much ahead of the rest of the world. But can good governance be a top down effort?

Find out on this episode of Companies Act as we discuss Chapter 11 - Appointment & Qualifications Of Directors and Chapter 12 - Meetings Of Board & Its Powers with YM Deosthalee, Chairman & MD of L&T Finance Holdings, well known Independent Director Nawshir Mirza, Cyril Shroff - Managing Partner, Amarchand Mangaldas and Bharat Vasani -Chief General Counsel, Tata Group.

The Companies Act 2013 mandates a minimum three directors for a public company, two for a private company and one for an OPC. And maximum 15 directors, beyond which a company needs approval via a special resolution. Government approval is no longer required.

Minimum           Maximum*         
Public                   3                             15
Private                 2                             15
OPC                     1                             15
*Special resolution approval needed for more than 15 directors

A woman director on board is a must for all listed companies and public unlisted companies with a paid up share capital of Rs 100 crore or more or a turnover of Rs 300 crore or more. Compliance time for all of this is one year starting April 1, 2014.

Woman Director
All Listed Companies: Atleast 1
Public unlisted Companies: Atleast 1
Paid up share capital > = Rs 100 cr
Turnover  >= Rs 300 cr

Compliance within 1 year of commencement of Act

That is also the time available for all listed companies to ensure that at least one-third of their boards are independent and for all public companies with a paid up share capital of Rs 10 crore or more or a turnover of Rs 100 crore or more or outstanding debt of Rs 50 crore or more to appoint at least two independent directors on board.

Independent Directors
All Listed Companies: 1/3 of Board
Public Unlisted Companies: Atleast 2    
Paid up share capital >= Rs 10 cr
Turnover >= Rs 100 cr
Outstanding debt >= Rs 50 cr
Compliance within 1 year of commencement of Act

The 2013 Act for the first time recognizes and defines the concept of an independent director- a managing director, whole-time director or nominee director cannot be an independent director. An independent director should be a person of integrity, relevant expertise and experience. The Companies Act 2013 lays down several provisions for an independent director to meet in order to be able to prove his independence.


- Not an MD/WTD/Nominee Director
“nominee director” means a director nominated by any financial institution in pursuance of the provisions of any law for the time being in force, or of any agreement, or appointed by any Government, or any other person to represent its interests.

Section 149 (6)
(a) who, in the opinion of the Board, is a person of integrity and possesses relevant expertise and experience;
(b) (i) who is or was not a promoter of the company or its holding, subsidiary or associate company;
(ii) who is not related to promoters or directors in the company, its holding, subsidiary or associate company;

Doshi: Do you notice any big material changes in the definition?

Vasani: Yes and I can give you the background since I was also part of the Dr Irani Committee. The big debate going on was that should we allow the financial institution (FI) nominees, which are regarded as independent? Clause 49 of the Securities and Exchange Board of India (SEBI) listing agreement allowed FI nominees to be regarded as independent director. Dr Irani at one stage said, “I will quit the committee as a Chairman of the independent committee if they will be regarded as independent”. They are representing the views of only one stakeholder - the institutions are appointing them. So after much debate, it was decided that the FI nominees, which are regarded currently as independent directors, will not be so there it is a very major change.  

Doshi: To be fair, all nominee directors have been dis-included from the definition of independent directors.

Mirza: The result of this definition is that you have an absurd situation where if an independent director of the parent is nominated to the board of a major subsidiary, he will not be regarded as independent because he has been nominated by the parent.

Doshi: So he becomes a nominee director.

Mirza: So you have an absurd situation where the man is considered independent at the parent but not in its 100 percent owned subsidiary.

Deosthalee: There is one more point here- it is not necessary that they are nominated by the parent. It so happens when that independent director is on the board of the parent company as well as the subsidiary company. There is no nomination here. For example, in one of our boards, there is X person, we appointed him on the subsidiary company first because we thought that his contribution will be very valuable for that particular business, which that subsidiary runs. Later on, he was appointed on the parent board. Now, it is a situation today that he is on the boards of both the companies but because of this particular provision, he ceases to be independent on the subsidiary company where he was appointed first and he is an independent director on both the companies, will he be construed as a nominee of the parent company under such circumstances?

No longer allows ‘Nominee’ Director to be considered Independent Director

‘independent director’ shall mean a non-executive director, other than a nominee director of the company

Shroff: I think we should look a little deeper. It is not just the mode of appointment but it is conflict of interest principle.

Doshi: Between the parent and the subsidiary?

Shroff: Yes, so if the implication is that when you are representing the interest of another body on the board of another, you are not then truly independent of all conflict but you will always have a bias in favour of your so called parent entrant.

Doshi: In fact the Companies Act has done the right thing by saying that if you are on the board of the subsidiary at the behest of the parent, then you are a nominee director.

Shroff: That is the effect of what has happened. I would step back a little bit and question as to whether there was any necessity of defining independent director separately at all or not. All directors are separate, all are fiduciary, they all are expected to act free of conflict and in the best interest of the company to give this additional label and responsibility of independent…(Interrupted by Anchor)

Doshi: You have to make sure that people knew clearly how you would become an independent director or where you would be disqualified as an independent director.

Shroff: From the Companies Act perspective, I would question whether this was necessary at all or not and that could have been left to things like Clause 49 or the listing agreement.

Vasani: I want to point out that Clause 49 of SEBI requires - a listing agreement requires that for material subsidiaries, you need to have independent directors on the board of a holding company to be on the board of subsidiary.

Parent company’s Independent Director will not be considered “independent’ on subsidiary board

Doshi: What is the net effect of what this new provision in the company law directs?

Vasani: If you need an independent director in the subsidiary company, you would not only have 1 person who is consuming one position, you will have to be independent more to make a further…(Interrupted by Guest)

Mirza: There is another implication of this. Consider a situation where you have a joint venture where the powers between the two partners are quite clearly defined. Now you suddenly introduced two new individuals who are not allowing to either sides and till now there has been a balance. Now suddenly you have an issue on the agenda where depending on which side these two people move, the balance of power moves. So they become extremely crucial in joint ventures.

Doshi: So what you are in effect saying is the whole concept of independent directors should never have been extended to anything which was unlisted.

Vasani: I have a slightly different view on this. In fact this was also debated in the Irani committee. One of the points was that the unlisted companies also have lot of public funds and public resources and effectively the promoter, directors or the director promoters, partners in case of joint ventures- they represent the two interests and I have been on the board of several joint ventures of the companies and I find that the nominees- partner A nominating three directors, partner B nominating three directors, they look at only their parent’s interest, I have never seen them looking independently at company’s interest. So if there are two directors and they are not saying you are one-third of the board but two directors. So I am saying in support of the argument where the substantive public money is involved even if it is an unlisted company..(Interrupted by Guest)

Mirza: Remember, now we have to issue consolidated financial statements. The board of the parent is answerable for a consolidated performance. They are no longer responsible for that performance because big chunks of that performance could well have been determined by a group of individuals who were not listening to them.

Doshi: How do you resolve this situation? My point is if you have a situation that Mr Deosthalee is currently facing, what do you do?

Mirza: I don’t know, it is a little - he is saying he was never nominated.

Deostalee: No, he was appointed on the subsidiary company.

Vasani: This is a new normal.

The Companies Act, 2013 has great expectations from independent directors. Some part of this is evident in Section 166 that lays down the duties of all directors and begins by saying ‘a director of a company shall act in good faith in order to promote the objects of the company for the benefit of its member as a whole and in the best interest of the company, its employees, the shareholders the community and for the protection of the environment. And then there’s Schedule 4- two pages of guidelines of professional conduct, role and functions and duties of independent directors. They range from simple to not so simple.

Director’s Duties
Section 166 (2)
A director of a company shall act in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company,
its employees, the shareholders, the community and for the protection of environment.

Schedule IV
Guidelines of professional conduct:
An independent director shall:
(1)    uphold ethical standards of integrity and probity;
(2)     act objectively and constructively while exercising his duties;
(3)     exercise his responsibilities in a bona fide manner in the interest of the company;
(4)     devote sufficient time and attention to his professional obligations for informed and balanced decision making;

Schedule IV
II. Role and functions:
The independent directors shall:
(5) safeguard the interests of all stakeholders, particularly the minority shareholders;
(6) balance the conflicting interest of the stakeholders;
(8) moderate and arbitrate in the interest of the company as a whole, in situations of conflict between management and shareholder’s interest.

Doshi: How do you see roles and responsibilities change?

Mirza: As far as I am concerned, I don't see any need for me to change the way I have always behaved. There are two major changes for independent directors. You may remember Mahatma Gandhi used to have a little figurine on his bedside, the three monkeys – speak no evil, hear no evil and see no evil.

Many independent directors practice a life inspired by those three monkeys. They would refuse to hear anything that was negative about the management or the promoters, they would certainly not speak it and about seeing it is not relevant in this case.

Now the Act compels them to open their eyes, open their ears, open their mouth and to poke their noses into everything and the whole diligence issue which we should discuss into everything that till now they hesitated to do. So that is the first major change and it will see a manifestation in the way these people behave in board meetings where you won't have one individual like me but you will have half a dozen individuals who will all try to put their voice in, have it minuted that he said this or he said that or he objected to this; that is one.

The other significant change I see and many people are still unsure about it, there is a requirement in the fourth schedule and it is in a number of other places which says the company shall balance the conflicting interests of all stakeholders. Till now also this was a requirement but now it is written into the law and you have a situation where essentially environmental groups could well use this to attack a board and say demonstrate to us, you balance these interest.

Schedule IV
II. Role and functions:
The independent directors shall:
(5) safeguard the interests of all stakeholders, particularly the minority shareholders
(6) balance the conflicting interest of the stakeholders
(8) moderate and arbitrate in the interest of the company as a whole, in situations of conflict between management and shareholder’s interest

Let me give you an example, suppose I am on the board of a company that does medical research which includes testing on animals which is a very cruel thing. I could receive a letter from PETA saying demonstrate that your shareholders are making money, it is good for humanity all of that we agree but demonstrate how you balance all of that versus the cruelty to the animals who are the subject of your research.

Doshi: But wouldn’t it be a question you would ask in a board meeting anyways with regards to any company that could have a deleterious impact on the environment on what that company is doing to minimize that impact.

Mirza: You would ask but how would we demonstrate a balancing? When we say balance means we have to have a common measure by saying here is a kilogram and here is a kilogram- by what measure do I strike such a balance?

Doshi: I get what you are saying and I think in that lies the big question that Schedule IV throws up. Do you treat it only as a code and a set of guidelines and if that was the only thing you had to do with it, then that would be fairly easy to deal with because it is a best practice manual so to speak. Or do you treat it as something that comes with a potential liability if you don't follow to the word everything that is in the code?

Vasani: You read Section 149(8)- it says that the company and independent directors shall abide by the provisions. The word is ‘shall’ not ‘may.

Section 149 (8)
The company and independent directors shall abide by the provisions specified in Schedule IV.

Doshi: If that is the case then let me read out some other things in Schedule IV that are equally alarming which is for instance if you look under Section III which is duties, not to unfairly obstruct the functioning of an otherwise proper board or committee of the board. So some of the wording could be interpreted in several different ways.

Schedule IV
(8) not to unfairly obstruct the functioning of an otherwise proper Board or committee of the Board
(12) acting within his authority, assist in protecting the legitimate interests of the company, shareholders and its employees
Schedule IV
Guidelines of professional conduct
(5) not allow any extraneous considerations that will vitiate his exercise of objective independent judgment in the paramount interest of the company as a whole, while concurring in or dissenting from the collective judgment of the Board in its decision making;

Schedule IV
Role and functions
(5) safeguard the interests of all stakeholders, particularly the minority shareholders(6) balance the conflicting interest of the stakeholders
(8) moderate and arbitrate in the interest of the company as a whole, in situations of conflict between management and shareholder’s interest.
Schedule IV
Guidelines Of Professional Conduct
Role & Functions
Manner Of Appointment
Resignation Or Removal
Separate Meetings
Evaluation Mechanism

Vasani: This will get refined over a period of time; I don't think that is a very serious issue.
Mirza: The bigger issue is if it is not minuted, it is not counted that you said it and if you have an objection you want to make sure it is minuted. And when we come to the diligence thing, it says director should be diligent. So they will all want to demonstrate diligence by making sure the minutes capture lots of points.

Doshi: But isn’t it lovely.

Deosthalee: Just to comply with this, the fear is there will be comments made in the board. Second important point is looking at it from an objective perspective-I think it is very essential for Independent Directors to get exposed to many of the aspects because all these years I am not sure whether all Independent Directors were really looking at risk management or strategy or contributing in the affairs of the company in the right sense. So it is very essential for them to really get oriented in a much objective manner.

Secondly there is also an evaluation process which has been defined. So if they are going to evaluate it based on these factors, what is their contribution on strategy, what is their contribution on performance etc, then in that case all what he said is I commented on this performance, I pointed out this, this is what I said on the new business line which you want to get into. So whether it is real value addition or not, I think it is a process, it will take some time. Overall if it is done well, it will definitely improve the effectiveness of the board.

Performance evaluation of independent directors shall be done by the entire Board of Directors
To determine whether to extend/continue Independent Director term

Vasani: Within one month, this Act has been able to have a very profound impact on the psyche of the independent directors. Suddenly I find that perception is being created that I am more accountable, I am more answerable, I am more liable and I am more empowered.

Doshi: That’s a good thing.

Deosthalee: That is a good thing But if they concentrate on the issues, strategies, performance etc that’s a very good thing. But, if they focus on vigil mechanism…(Interrupted by Anchor)

Doshi: But that’s also a part of their job.

Deosthalee: I understand but in the process if they start introducing processes in the organization where lot of data is collected and presented to them on what's happening in the company, who is doing what. So, this watchdog concept has to be properly understood.

For directors and employees to report genuine concerns
A responsibility of Audit Committee manned by majority Independent Directors

Doshi: This conversation that we are having on roles and responsibilities is little incomplete if I don’t bring up the issue of liability and just for the purposes of making clear what the independent director liability is I will read out that section of the Act which goes on to say that a non-executive director not being promoter or key managerial personnel (KMP), shall be held liable, only in the respect of such acts of omission or commission by a company which had occurred with his knowledge. So that is limiting of liability attributable through board processes or further limiting of liability and with his consent or connivance yet another limit to the liability but then it goes on and becomes free for all as Mr Mirza will say because it is just all where he had not acted diligently.

Independent directors & Non-Executive Directors ‘shall be held liable, only in respect of such acts of omission or commission by a company which had occurred with his knowledge, attributable through board processes, and with his consent or connivance or where he had not acted diligently.’

Shroff: Firstly, this is just a partial savior to the sort of fear that many independent directors had about being harassed by criminal proceedings that are filed against the board.

Doshi: But many of them are under other Acts.

Shroff: The limited protection that this offers is only in relation to offenses under the Companies Act. As far as all other Acts are concerned, nothing has changed and the only way that could have been changed would have been to amend the Criminal Procedure Code and provide some procedures and safeguards over there but that has not happened.

But, I can step back a little bit and see the concept of liability in a slightly broader context apart from just penal proceedings in this. And there is a big sort of looming event on the horizon as well which is class actions and that would perhaps override a lot of the discussion that we just had whether it is have you acted diligently, have you acted without conflict, have you balanced various interest or not? The place where it will finally get tested is in the class action and that will be a very US style of discussion that will take place because there it is much more qualitative in terms of its analysis, in terms of whether the board acted properly or as a reasonable person would and that’s where you see all these things coming.

Another section which should have been probably discussed is Section 166. Nawshir mentioned it implicitly but that is where the whole concept of balancing the interest of the owners, the employees, the community and the environment - these are all very big concepts which are actually impossible to balance. My guess is it will eventually come down to whether you have applied your mind adequately to all these factors or not rather than questioning a decision have you avoided extremes or not.

Doshi: What happens if you are found not to be diligent?

Vasani: There is some guidance available in one of the Supreme Court judgment I think- Justice Tendulkar had delivered it years back but if you are wilfully shutting eyes in terms of what is presented to the board and you still choose not to raise the issue.

Mirza: Let me give you an example, I am on the board of a property developer. Everybody knows property development involves black money. Have I been diligent and asked in the board meeting that how are you accounting for the black money in our business. So, this is diligence.
Shroff: I think we are making too much out of it because without this language I don’t think there was any excuse for not acting diligently. Even the common law as well as the old Act was good enough. So, this only restates the obvious.

Deosthalee: One has to look at diligence is what I am doing which is understood by common man, common people whether you are doing an investigation.

Doshi: Everybody on this panel with the exception of the independent director seems comfortable with this. So, I am going to ask the independent director to tell how life has changed for you after this new description of your roles and responsibilities, this new description of your liability?

Mirza: Essentially that you need to prepare yourself much more, you need to read beyond what is the material supplied to you by doing whatever research you need to before you appear in the board meeting or committee meeting and then in those meetings to ask and be satisfied with all the explanations you receive. Be satisfied it is not just sufficient just to receive an explanation that’s not believable- like, the example, you are told there is no black money in our property development business, there are businesses like that. So you got to be reasonably satisfied that it is that kind of business and it is not one of the others where maybe there is.

Doshi: And you have got to make sure that all your views, opinions and these discussions are all minuted in all board meetings so that if tomorrow somebody asks you a question- either a judge or in a class action- that you are able to show the minutes its proof of you behaving diligently. Would that be a fair assessment of how your life has changed?

Mirza: You have got to be balanced and behave with some maturity and I don’t think I would expect that on the 47 points I make in the course of a board meeting that each of them should figure in the minutes; maybe one should or two should.

Shroff: What I am saying is that there are certain important corporate transactions like M&A transaction for instance. They are in the level of discussion. So, I don’t think on those kind of things behavior has changed as much.

Doshi: So you don’t think the liabilities of the independent directors have increased?

Shroff: I think there is a general feeling that our liabilities have gone up because firstly, the have got codified, there is so much of a spotlight on independent directors. But, if you look at it from purely a legal liability perspective, I don’t think much has changed because these liabilities always existed.

In a unique first measure for India and probably the world, the Companies Act 2013 restricts the tenure of an independent director to a term of up to five consecutive years, after which a special resolution approval is needed for reappointment for another term of up to five years. Thereafter a three year cooling off period is required before any reappointment. This provision is prospective i.e. that is it does not count any previous term served.

Section 149
Term up to 5 consecutive years
Eligible for reappointment via special resolution
Shall not hold office for more than 2 consecutive terms
Can be re-appointed after 3 year cooling off period

Maximum Term: 5years + 5 years + 3years cooling off….
Applies prospectively

Vasani: After considering the entire provisions of not only 149, which deal with the independent directors, but also 465 which is not notified which is the repeal and savings clause- there is no choice the corporates have but to appoint all their independent directors.

Doshi: Again

Vasani: At this Annual General Meeting (AGM) - the first AGM season of 2014.

Doshi: Even if they have not finished five years?

Vasani: Even if they have not finished the previous term, because the term is not saved. Second thing Sec 149 contemplates entirely new shastra for independent directors- the manner of appointment, how they will be appointed, the explanatory statement, appointment letter to be issued. Their entire nature of appointment exchange they no longer will be retiring by rotation.

Deostalee: There is no retirement available.

Vasani: That concept was not there in the 1956 Act. IN the 1956 Act appointment which you would have been saved under 465 (2)(d), has not been saved. You have no choice but to appoint and have consulted two senior counsels who are expert on company law and they concur with my view. It’s a better and safer view to take that all of them have to be appointed at this AGM again. Now the complexity has been created by the Security Exchange Board of India (Sebi) circular of April 17, 2014 which says on completion of its present term, so if you appoint them now for five years..(Interrupted by Anchor)

2013 Act:  Maximum 20 (includes Private companies)
-    Including maximum 10 public company board positions
-    Includes directorship in private holding/subsidiary companies of a public company

1956 Act:  Maximum 15 (excluded Private companies)
-    Included directorship in private holding/subsidiary companies of a public company
SEBI New Clause 49: Maximum Independent Directorships = 7 listed companies
Doshi: Then you got five years plus another five years; you technically got 10 years.
SEBI Clause 49
Maximum Term: 5 years + 5 years + 3 years cooling off
Applies retroactively*

*Proviso: Independent Director who has already served 5 years or more in a company as on October 1, 2014 shall be eligible for appointment, on completion of his present term, for one more term of up to 5 years only

Vasani: Because AGM season will get over on 30th September. Sebi says on 1st October this new provision will apply, I believe Sebi has now realized that this may be misused, they intended that persons who have completed five years, should not get 5+5; so they may clarify that the present term which they meant in the circular, was the term which was existing on the day of the Sebi circular that is 17 April 2014. I don’t think that the corporates have a choice but to get all the directors appointed in the manner prescribed in Section 4 of Schedule IV in the manner they are laid down.

Shroff: It may be that you can start, just in order to avoid any doubt, if like you can start a fresh term of five years from now.

Deosthalee: Isn’t it safer?  

Shroff: Its only facts specific, I don’t disagree that may be one way of doing it.

Vasani: But safer way of doing it.    

Shroff:  Merely because I think the test would be if somebody has not been reappointed and continues with his normal terms - will you say that his appointment is defective. The other way of doing it is perhaps don’t try to reappoint him because why meddle with that term, just mention it and have it noted at the AGM, that this is sort of containing for the balanced term.

Vasani: Just answer me how do we comply with 149 which has come into effect from 1st April if you don’t do anything. The old directors who were appointed under old clause 49 which does not match with Sec 149 and continue, then they will not be regarded as independent directors under Sec 149; technically it will be a violation of Sec 149 that you have not gone through the process.

Shroff: There should have been a provision that should say that all appointments will have to been freshly done.

A director can hold up to 20 directorships including a maximum 10 on public company boards. In aggregate that is less than what the 1956 Act permitted. Also a company can via a special resolution further restrict the number of directorships.

2013 Act:  Maximum 20
-    Including not more than 10 public company board positions
-    Includes private companies
-    Includes directorship in private holding/subsidiary companies of a public company

1956 Act:  Maximum 15
-    Excluded private companies
-    Included directorship in private holding/subsidiary companies of a public company

The 2013 Act introduces new grounds for director disqualification including permanent debarment. It punishes absentee directors by forcing them to vacate office and it requires for the first time a director to resign in writing and send detailed reasons to registrar.

New Grounds
-Convicted of offence dealing with Related Party Transaction
-Not obtained Director Identification Number

Permanent debarment of director sentenced to 7 years or more of jail
Section 167
(1) The office of a director shall become vacant in case -
(b) he absents himself from all the meetings of the Board of Directors held during a period of twelve months with or without seeking leave of absence of the Board

Section 168
Resignation in writing to the company and Board
Resignation to be included in Director’s Report
Director to forward resignation letter copy with detailed reasons to Registrar

Mirza: Bigger issue is, I chair a few nomination committees, that you bring on an unknown person as an independent director. Unknown in the sense he is not previously been there. I am now looking at a brand new person and you bring him for five years and you don’t know how he is going to behave. You have the choice of in the course of evaluation in the second year. Third year asking him to go. But now there is a requirement that if any one resigns he has to give reasons for resignation.

Doshi: Yes of course.

Mirza: Which independent director is now going to write that in the course of the evaluation process I was just found to be incompetent and asked to go? Now there is another issue even if you were to give false reasons, the reason has to be put up by the company on the website. So the company then becomes a party to that deception because the company is aware why he is being asked to go.

Doshi: You are too honest for this Act. You have to say we disagree or due to personal reasons - that’s the best thing; all directors use that.

Mirza: Then Section 447 gets activated that were you a party to a deception?

Section 447
‘…any person who is found to be guilty of fraud, shall be punishable with imprisonment for a term which shall not be less than six months but which may extend to ten years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to three times the amount involved in the fraud’

Nest week on Companies, Act!

- Board Committees
- Inter-Corporate Loans & Investments
- Related Party Transactions


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