All About Independent Directors under Indian Company Law

Article by Laghima Jain.

Independent Directors were introduced in the Companies Act, 2013, after the need for a strong framework of corporate governance arose for better functioning of the company. The Companies Act, 1956 (hereinafter the Act of 1956), never had the provision of introducing an independent director of the company to bring transparency.

However, in 1999 the Kumar Managalam Birla committee constituted by SEBI mentioned to the Board the appointment of such a director who may give some views distinct from others and in favour of the growth of the company. It was followed by filling the seats of independent directors by some related persons of the company.

After considering various loopholes in the 1956 Act, there was a need to update the Act for making it globally complying and for protection of the interest of the investors as well as consumers. Satyam Scam and other loopholes led the government to formulate various corporate regulatory frameworks and the enactment of Companies Act, 2013.

“Independent Directors have the potential to provide the much needed professional expertise as they are having wide experience of the operations of the company as well as they take part in the Boards of other companies, implying that they have an updated knowledge of the latest happening in the corporate sector.”- Lakshay Juneja in his article on Role of Independent Directors

Independent director is defined under Clause 49 of Listing Agreement of SEBI, which deals with corporate governance, and the Companies Act, 2013, adopted the definition of Independent Director from Clause 49.

According to section 2(47) of the Companies Act, 2013, “independent director means an independent director referred to in sub-section (6) of section 149”.

Section 149(8) specifies that Schedule IV of the Companies Act, 2013 provides for the Code for Independent Directors.

The Code establishes the roles, responsibilities, functions, manner of appointment & re-appointment, resignation or removal, and evaluation mechanism of the Independent Directors of the company. The roles and functions of the Independent Director are governed by the Companies Act, 2013, and the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015.

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Appointment & Qualification of Independent Director

Section 149(6) of the Companies Act, 2013, read with Rule 5 of the Companies (Appointment and Qualification of Directors) Rules, 2014, states about the appointment and Qualification of Independent Directors. It is to be noted that the process of appointment of directors is slightly different with that of the independent ones.

Qualities: A person to be appointed as Independent Director in your company has to be, according to the Board, a person of integrity possessing relevant knowledge, skills and experience in either the field of Finance, Law, Management, Sales, Marketing, Administration, Research, Corporate Governance, Technical Operation or any other field related to company’s operation, as provided in Rule 5 of the Companies (Appointment and Qualification of Directors) Rules, 2014.

Restriction: He should neither be a promotor nor related to promotors or directors of your company.

To be appointed as Independent Director, the person or his/her relatives should neither be any of the Key Managerial Personnel (KMP) nor the employee nor the proprietor nor the partner in the company in any of the three financial years immediately before the financial year in which the person is going to be appointed as Independent Director.

The person or his/her relative should not hold two percent or more of the total voting power of the company. Further, the person proposed to be appointed or his/her relatives should not have or had any financial or monetary relationships other than the remuneration of such director or transaction of almost 10% of his/her total income with the company or its promoters or directors during that financial year or the two immediately preceding financial years. He/She is also not entitled to any stock options.

Specific Restriction on the Relatives: Clause (d) of Section 149(6) provides restrictions on the relatives of the proposed Independent Directors.

The relative should not hold any kind of security or interest of more than Rs. 25 Lakhs or 2% of the paid-up share capital (on the face value) in the company; should not be indebted to the company or its promoters or any of the directors; should not have given guarantee or security in connection with the indebtedness of any third person to the company or its promoters or any of the directors during the two immediately preceding financial year or during the current financial year.

He/she does not have any kind of financial relationships with the company for more than 2% of its gross turnover or total income singly or in a combination of the transactions referred to in the clause (d) of section 149(6).

All these qualifications will ensure that such directors are Independent in a real manner and will perform their duties without any prejudice.

Note: The term ‘company’ used under the ‘Restrictions’ and ‘Specific Restriction on the Relatives’ includes the holding, subsidiary, or associate company of that company.

Sub-section 10 of section 149 talks about the appointment of Independent Director subject to the provisions of Appointment of Directors under section 152 of the Companies Act, 2013. To become an Independent Director, the conditions to become a director must be fulfilled, for instance acquiring a Director Identification Number (DIN), etc.

He/she can hold the office as an Independent Director upto 5 years consecutively (1 term) and shall be re-appointment only after passing of a special resolution under the company and after the disclosure of such re-appointment in the report of the Board.

Further, Sub-section 11 of section 149 provides that an Independent Director cannot hold the office for 10 years consecutively, but after the expiration of 3 years after his/her term of holding the office, he/she becomes eligible to be appointed as an Independent Director in the same company unless during the 3 years he is appointed or associated with the company in any other capacity.

It is to be noted that sub-section 6 and 7 of section 152, which talks about the retirement of directors by rotation, is not applicable to the Independent Directors.

Mandates on Companies

The Companies Act, 2013, mandates every listed public company to appoint an Independent Director on its Board, which shall be at least 1/3rd of the total number of directors of the company. For example, suppose a Public listed company has 15 directors on its Board.

Then according to the provisions of the Companies Act, 2013, the company should have 1/3rd of them as independent directors, i.e., 5 out of 15 will be Independent Directors.

The reason, as stated above, is to bring transparency and provide for independent judgement and mindset, which shall not be influenced by such parties who are influenced in the transactions of the company or its functioning and to promote and establish better corporate governance.

Further, Independent Directors are meant to be in a better position to make decisions in the best interest of the company, its stakeholders without any fear or favour.

The Central Government also has the power to prescribe a minimum number of Independent Directors in certain classes of companies as provided under Rule 4(1) of the Companies (Appointment and Qualification of Directors) Rule, 2014. Such a public company, having a paid-up share capital of Rs.10 Crore or more or turnover of Rs. 100 Crore or more or; having, in total, outstanding loans, debentures deposits of Rs. 50 Crore or more, as on the last date of the latest audited financial statements, should compulsorily have at least two directors in their company, as provided in Rule 4 of the Companies (Appointment and Qualification of Directors) Rules, 2014.

Clause 49 of the SEBI Listing Agreement, applicable to those companies who wish to be listed on the Stock Exchange, states that when the Chairman of the Board is a non-executive director, then at least 1/3rd of the Board should be comprised of Independent Directors.

On the other hand, if the Chairman of the Board is an executive director, the Board should contain at least half of independent directors.

Mandates on Proposed Independent Directors

Section 149(7) of the Companies Act, 2013 lays down the requirement of compulsorily giving a declaration of independence by the Independent Director at the first meeting of the Board in which he takes part as an Independent Director and thereafter at the first Board meeting of every financial year or whenever there is any alteration in the situations affecting his status as an Independent Director.

This declaration of independence should specify that he has fulfilled all the criteria specified in subsection (6) of Section 149.

Section 150 of the Companies Act, 2013 read with rule 6 of the Companies (Appointment and Qualification of Directors) Rule, 2014 provides that the selection of the Independent Director, unlike the appointment of other types of directors, is done from a databank which contains the particulars of Directors who wishes to act as Independent Director through filling applications.

An Institute or Association constituted by Central Government maintains such databank (Indian Institute of Corporate Affairs- India).

Roles & Responsibilities

Independent Directors are Non-Executive Directors who have the task of maintaining an appropriate balance of skills, experience, independence, and updated knowledge of the corporate sector and have roles and responsibilities to monitor and direct the Board for risk assessment and management for maintaining and improving corporate credibility and accountability.

Such a director also monitors various committees of the company for ensuring good Corporate Governance. Independent Directors are required to help in bringing the independent judgment to various company issues and managing the company affairs.

They are also necessary for monitoring the report of performance for achieving the primary as well as the secondary objectives of the company.

Further, they perform certain functions to satisfy the interests of the stakeholders (minority as well as the majority) and balance the interests of minority and majority stakeholders.

Also, they are required to keep a check on the present and future related party transactions to get an assurance that the particular transaction is in the interest of the company and its various stakeholders.

Section 149(8) read with Schedule IV of the Companies Act, 2013, bound the company and the Independent Director to the Code, which provides for the duties and responsibilities of the company and the Independent Director. “The Code is the guide to the professional conduct for Independent Directors.”

It will help the company and the directors to promote confidence among various stakeholders and regulators.

Some of the important duties of the Independent Director is to attend the General Meetings held at regular intervals, having the knowledge of the operations of the company, its various departments and its external environment, reporting concerns without any fear or prejudice about the unethical behaviour, be it actual or suspected behaviour which is against the company’s code of conduct and policies., to ensure that there is adequate vigil mechanism which is not prejudicially affected harming the interest of the person involved in such mechanism, etc.

However, there are many instances where the Independent Directors have failed to perform their duties the Executives and the Independent Directors were connected through one of the other means and the Executives used to control the actions and functions of the Independent Director leading to unhealthy corporate governance and defeating the interest of shareholders, especially the minority shareholders.

One of the high profile scams for which there was a need for legal reform in the Corporate Sector with respect to Corporate Governance and the role of Independent Director arose was the Satyam Scam. Satyam scam and other corporate scams have shown that often Independent Directors doesn’t stick to their roles and responsibilities and Executive consider the Independent Directors as a Board Room Decorations by-passing their say in the company affairs.

Section 149(8) read with Schedule IV under the Companies Act, 2013, improved the roles of Independent Directors in a company, which will result in a better structure of corporate governance, protecting the interest of stakeholders of the company and of small and medium-sized investors.

The legal reform in the roles of Independent Director shows the legislative intent of the policymakers, i.e., the role of Independent Director is to ensure that high levels of Corporate Governance is maintained in the company.

The Companies Act, 2013 enunciates that the role of the independent director is two-fold:

By working and contributing towards the company’s strategic growth by guiding the KMPs, Senior Management, and other directors
Acting as a watchdog: keeping the information related to every transaction and every decision for balancing the interest of all the stakeholders and the company.

In the recent years, corporate mismanagement and lack of corporate governance have witnessed a significant backlog in the corporate sector questioning the accountability of the Independent Directors.

The Independent Directors have started to resign from the Board of the company when there is an anticipation of any fraudulent activities instead of reporting the concerns related to any fraud or violation of the company’s code and policies.

They choose to run away from their duties instead of reporting it to the Board for protecting the interest of minority shareholders. On the other hand, some of the Independent Directors have raised their voice and reported the fraudulent activities or failure in maintaining the corporate governance in the company considering it to be their duty and responsibilities towards the stakeholders of the company.

It can be observed that the Independent Director holds and enjoys the perk of high position in a company, and he should perform all his functions and duties without any prejudice, fear of oppression, etc. He / She is a Non-executive director and the Executive Directors should not interfere in their functioning.

Resignation and Removal of Independent Directors

Section 168 of the Companies Act, 2013 provides for the resignation of directors, which include the resignation of Independent Directors.

A notice has to be provided in writing to the company, and its Board regarding the resignation and on the reception of such notice, within 30 days the company will inform the Registrar of the Companies in the manner provided under rule 15 of the Companies (Appointment and Qualification of Directors) Rule, 2014.

The Board shall also place the information regarding the resignation of such director in the report of directors immediately after the General Meeting. However, there is no information under the Companies Act, 2013 regarding the particulars of resignation and the requirement of the reason for resignation.

One of the proposed amendments by the Ministry of Corporate Affairs in 2018 stated that the resignation of Independent director should be with proper detailed reasoning and the resignation should not come into effect until the 30 days of receipt of the notice by the company.

The particular proposed amendment under section 168 is not yet incorporated under the Act.

The proviso of sub-section 1 of section 169 provides for the removal of the Independent Director. Such a director can be removed only during the second term, i.e., after the first term of 5 years of holding the office consecutively, where they have been re-appointed. Their removal is possible only by passing a special resolution during the second term as an Independent Director.

Liabilities of Independent Directors

Section 149(12) clearly provides the liabilities of the Independent Directors. An Independent Director of your company shall be liable only when he/she has the knowledge, attribution through the conduct or process of Board and with his/her consent or where it fails to act diligently for such acts of omission or commission by the company.

In Chitra Sharma v. Union of India, the Supreme Court took a drastic step in restraining the Independent Directors from transferring any of their personal assets. If this order is violated, then they could be prosecuted as a criminal act and the act of contempt of court.

It is observed that the personal assets of Independent Director of the defaulting companies are attacked by the Court for protecting the interests of the stakeholders.

Wrapping It Up

The concept of having an Independent Director is a positive step towards corporate governance in India.After the Satyam Scam, SEBI became rigid towards the implementation of Clause 49 of the Listing Agreement along with the norms of disclosure for transparency and better accountability.

The provisions of Companies Act gave a statutory backing to Clause 49 by making clear and unambiguous process of appointment, resignation, removal and liability of the Independent Director. The Companies Act, 2013 has conferred empowerment upon Independent Directors for fair, smooth, and transparent functioning of the management & affairs of a company.

It also makes them accountable for the acts of the company as the Companies Act, 2013 empowers the Independent Directors to have a say in the management of a company for strengthening corporate governance. They do not perceive the role of a watchdog of a company; instead, they act as strategic advisors to the promoters of a company.

This can be well established from the Code of Independent Directors under the Schedule IV of the Companies Act, 2013. The real questions are: Are they actually promoting Corporate Governance in the company and protecting the interest of the small shareholders?

The role of the Independent Director was a big issue during the time of the Satyam Scam.

Till today, whenever any scams or frauds are brought out, the first question is about how the Independent Directors were performing their functions. On the one hand, it is stated that in reality, the Independent directors often take the side of the management or the Executive by-passes the actions and roles of Independent Director for their individual benefit and ignore the interest of the stakeholders, especially the minority shareholders; small investors and the company as a whole leading to imbalance.

On the other hand, it is observed that with the increase in frauds, scams, proxy firms influencing decisions, the importance of Independent Director has also been increased as they perform the function of balancing interests in the company by raising their voice against the fraudulent or unethical activities of the company.

Further, the responsibility attached to the Independent Directors for monitoring and having the whole knowledge about the operations of the company would imply keeping a full-time check on the duties and working of the employees and other directors, establishing good corporate governance.

Such an arduous responsibility cannot be fulfilled merely by attending four to six meetings in a year; rather, it can be fulfilled only by keeping a regular check on the operations of a company. Also, recent incidents of scams and frauds in India by various companies have raised an issue related to the involvement of Independent Directors going away from their crucial responsibility of maintaining transparency for good corporate governance.

Therefore, the Independent directors are the key to maintain transparency and a balance between the minority and majority stakeholder. Along with monitoring, they have different roles and responsibilities to perform. They must be given the freedom to express themselves even if it is against the majority view.

The Independent Director’s primary focus should be in the betterment of a company as a whole while protecting the interest of all the stakeholders.

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Author Bio: Laghima Jain is a B.Com LLB (Hons.) student from the Institute of Law, Nirma University. She is currently interning at WinSavvy. Connect with her on LinkedIn.

Adhip Ray

Adhip Ray is the founder of WinSavvy. He has a legal, finance and data analytics background and has provided marketing consultancy to startups for over 5 years. He has been featured at multiple publications in multiple niches including HubSpot, Addicted2Success, Manta, FitSmallBusiness, Databox, IndiaCorpLaw, Bar and Bench and more!

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