LexisNexis

Independent directors: changing roles

Thursday 8 July 2021

Sanjay Buch

Crawford Bayley & Co, Mumbai

sanjay_buch@crawfordbayley.com

Yashvi Shah

Crawford Bayley & Co, Mumbai

yashvi.shah@crawfordbayley.com

Background

Independent directors (IDs) play a vital role in the management and decision-making process of a company. As the name suggests, independent directors are directors who retain their ability to make independent judgements while taking management decisions for a company.

Independence is a state of mind. The institution of the independent director has undergone many changes over the years. With added responsibility and stricter governance criteria, independent directors are now institutionalised and governed by the provisions of the Companies Act 2013 (the 'Act') and the SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015 (the 'Regulations'). However, while the Act and the Regulations provide the legal definition/criteria for independent directors, it can be said that independent directors are directors who are appointed mainly to secure the interest of minority shareholders of a company.

Independent directors are appointed in a company to ensure that there are adequate internal controls and independent judgement in managing the affairs of a company. Moreover, the protection of the interests of minority shareholders lies in the hands of independent directors. In order to ensure adequate balance and representation of minority shareholders on the board of a company, the Act as well as the Regulations provide for the composition of the Board of a company, which requires half of the Board (in cases where the Chairman is executive) or one third of the Board (in cases where the Chairman is non-executive) to consist of independent directors.

The audit committee, nomination and remuneration committee (NRC) and corporate social responsibility (CSR) committee are also required to have independent directors as part of their memberships. These three committees are mainly responsible for overseeing and monitoring a company’s financial transactions, ranging from related-party transactions and remuneration payable to directors and key management persons (KMPs) to donations to be made to trusts, societies and Section 8 companies in view of CSR activities. Therefore, it can be ascertained that the major role of independent directors is to ensure that the funds invested by minority shareholders in the company are not misused or mismanaged by the company.

In view of the above responsibilities, and acknowledging the role played by independent directors in the management of a company, the Act and Regulations have been amended in order to suit current requirements from time to time. On 1 March 2021, the Securities Exchange Board of India (SEBI) issued a Consultation Paper, 'Review of Regulatory Provisions related to Independent Directors'.[1] This consultation paper was released in order to solicit comments and views on the proposals on review of regulatory provisions related to IDs on the boards of listed entities.       

The major changes proposed as part of this Consultation Paper are as follows.

Definition of independent directors

SEBI proposes that KMPs or employees of promoter group companies cannot be appointed as Independent Directors in the company, unless there has been a cooling-off period of three years. The said restriction shall also extend to relatives of such KMPs for the same period.

Further, the prescribed cooling-off period in case of a material pecuniary relationship between a person or their relative and the listed entity/its holding company/subsidiary/associate company shall be harmonised to three years (from the current two-year period).

While the above proposal is aimed to ensure independence while appointing independent directors, it is pertinent to note that KMPs of the promoter group companies are adequately aware of the business and functioning of a company. Therefore, they would be in a better position to take commercial decisions, which would prove beneficial and favourable to the company. Furthermore, KMPs or employees of promoter group companies may not have immediate access to the management of the company.

Adding a restriction on the appointment of KMPs or employees of promoter group companies as independent directors may deprive the company from appointing professional and industry experts as independent directors.

Appointment and re-appointment process of independent directors

SEBI proposes the following changes to the appointment and reappointment process:

‘Appointment and re-appointment of IDs shall be subject to “dual approval”, taken through a single voting process and meeting following two thresholds: –

  1. Approval of shareholders
  2. Approval by ‘majority of the minority’ (simple majority) shareholders. ‘Minority’ shareholders would mean shareholders, other than the promoter and promoter group.

The approval at point (i) above, shall be through ordinary resolution in case of appointment and special resolution in case of re-appointment.

If either of the approval thresholds are not met, the person would have failed to get appointed/re-appointed as ID. Further, in such case, the listed entity may either:

  1. Propose a new candidate for appointment / re-appointment or
  2. Propose the same person as an ID for a second vote of all shareholders (without a separate requirement of approval by ‘majority of the minority’), after a cooling-off period of 90 days but within a period of 120 days. Such approval for appointment/re-appointment shall be through special resolution and the notice to shareholders will include reasons for proposing the same person despite not getting approval of the shareholders in the first vote.’

The proposal seeks to provide for a dual approval in order to ensure that the minority shareholders of the company have a greater say in the appointment or reappointment of the company’s independent directors.

However, it further provides that, if the thresholds are not met, the person shall be eligible for a second vote of all the shareholders by special resolution after a cooling off period of 90–120 days. This would lead to a loss of confidence in the independent director proposed to be appointed. Further, seeking shareholders’ approval for the second time will lead to an additional compliance burden and cost to the company. Therefore, the proposal should not be implemented by SEBI.        

Removal of independent directors

SEBI proposes the following changes to the removal process:

‘Removal of IDs shall be subject to “dual approval”, taken through a single voting process and meeting following two thresholds: –

  1. Approval of shareholders.
  2. Approval of ‘majority of the minority’ (simple majority) shareholders. ‘Minority’ shareholders would mean shareholders, other than the promoter and promoter group.

The approval at point (i) above, shall be through ordinary resolution in case of removal in the first term and special resolution in case of removal in the second term.

If either of the approval thresholds are not met, the person would have failed to get removed as an ID. In such case, the removal of such ID may again be proposed through a second vote of all shareholders (without a separate requirement of approval by ‘majority of the minority’), after a cooling-off period of 90 days but within a period of 120 days. Such approval for removal shall be through special resolution and the notice to shareholders will include reasons for proposing the removal again despite not getting approval of the shareholders in the first vote.’

This proposal seeks to provide for a dual approval in order to ensure that the minority shareholders of the company have a greater say in the removal of independent directors of a company. However, it further provides that, if the thresholds are not met, the person shall be eligible for a second vote of all the shareholders via special resolution after a cooling off period of 90–120 days. This would lead to a sense of disharmony and conflict in the board.

Further, seeking shareholders’ approval for the second time will lead to an additional compliance burden and cost to the company. Therefore, the proposal should not be implemented by SEBI.

Enhancing and bringing in more transparency in the role of NRC

SEBI proposes the following changes to the nomination and remuneration committee:

‘The following procedure shall be followed by NRC for selection of candidates for the role of ID -

a. Process for shortlisting of the candidate

  1. For each appointment, the NRC shall evaluate the balance of skills, knowledge and experience on the board. In the light of this evaluation, a description shall be prepared of the role and capabilities required for a particular appointment.
  2. The person who is recommended to the Board for appointment as ID should have the capabilities identified in this description
  3. For the purpose of identifying suitable candidates, the committee may:
  • Use services of an external agencies
  • Consider candidates from a wide range of backgrounds, having due regard to diversity and
  • Consider the time commitments of the appointees

b. Disclosures to be made to shareholders

The notice for appointment of director shall include the following disclosures:

  1. Skills and capabilities required for the appointment of the ID and how the proposed individual meets the requirement of the role.
  2. Channels used for searching appropriate candidates. In case, one of the channels is ‘recommendation from a person’, the category of such person (viz. promoters, institutional shareholders, directors (non-executive, executive, ID) etc) shall be disclosed.

Composition of NRC may be modified to include 2/3rd IDs instead of majority of IDs.’

The above proposal creates additional obligations for the NRC while appointing independent directors. It seeks to provide that the NRC shall prepare a description of the role and capabilities required for a particular appointment, which shall include skills, knowledge and experience on the board. This would ensure that the independent director has the requisite skills and knowledge, and the board as a whole has proper balance and adequate capability to ensure smooth functioning and take management decisions for the company.    

Prior approval of shareholders for independent director appointment

SEBI proposes the following changes:

‘Independent Directors shall be appointed on the board only with prior approval of the shareholders at a general meeting.

In case, a casual vacancy arises due to resignation/removal/death/failure to get re-appointed etc., the approval of shareholders should be taken within a time period of 3 months.’

This proposal seeks to ensure that shareholders have a greater say in the appointment of independent directors. However, prior approval or approval within the stated time period would lead to hardships on the company. Further, such a process would result in an additional compliance burden on the company, which will be against the interest of the company.

If the company intends to avail itself of the professional services of an independent director, it would have to call for an extraordinary general meeting or wait for the annual general meeting of the company to take place. This would lead to an unnecessary delay in obtaining the services of the independent director and would lead to additional costs for the company.  

Resignation of independent directors

SEBI proposes the following changes:

‘The entire resignation letter of an ID shall be disclosed along with a list of his/her present directorships and membership in board committees.

If an ID resigns from the board of a company stating reasons such as pre-occupation, other commitments or personal reasons, there will be a mandatory cooling-off period of 1 year before the ID can join another board.

It is proposed that there should be a cooling-off period of 1 year before a director can transition from an ID to a whole-time director.’

An independent director’s present directorships and memberships in board committees of listed entities are available on the website of Ministry of Corporate Affairs and through the annual reports of various companies.

Therefore, highlighting this while disclosing the resignation letter does not lead to disclosure of any new information. Further, if an independent director has acquired a skillset and knowledge about the company during the course of their directorship with a company, which then proves to be beneficial if they are appointed as a whole-time director, then that independent director should be permitted to be appointed as a whole-time director.  

Composition of the audit committee

SEBI proposes the following changes:

‘Considering the importance of the Audit Committee with regard to related party transactions and financial matters, it is proposed that audit committee shall comprise of 2/3rd IDs and 1/3rd Non-Executive Directors (NEDs) who are not related to the promoter, including nominee directors, if any.’

Considering that the overall role of an independent director is ensure the interests of minority shareholders of a company, and that financial matters are of utmost importance, the composition of Audit Committee should be as proposed by SEBI.

Conclusion

As discussed above, SEBI has proposed various amendments to the governing norms of independent directors which provide greater say to the minority shareholders.

While most of these amendments are favourable and in the interest of minority shareholders, some of these proposed amendments would lead to an additional compliance and cost burden on companies.