ESG:

What Independent Directors must know about ESG:

Tightening the screws on Independent Directors – Assessing the Independence of Independent Directors

What is an independent director?

Generally speaking, an independent director is a member of the board of a company, who does not have any direct or indirect relationship with the company or its promoters and is not involved in active day to day management.¹ The primary object of independent directors is to act as a watch dog and oversee the functioning of the senior management of the company from a neutral perspective.

Every listed public company is required to have at least one-third of the total number of directors as independent directors. In addition, an unlisted public company is also required to appoint two independent directors if such public company has a paid-up share capital of INR 100,000,000, or a turnover of INR 1,000,000,000, or an aggregate outstanding loans and deposits of more than INR 500,000,000.

An independent director is required to give a declaration each year or whenever there is any change in the circumstances which may affect his status as an independent director, that he meets the criteria of independence as provided. It is a continuing obligation.

Independent Directors and ESG

With the thrust on improved corporate governance and increasing adoption of ESG best practices worldwide, the role of the independent director in a company is coming under increasing scrutiny. From an ESG perspective, an independent director’s voice is usually the first unbiased opinion that a company hears to a crisis. In India, the role of an independent director continues to evolve. More importantly, the mindset with which an independent director is nominated and appointed to the Board of Directors continues to evolve too. Significant players in corporate India now expect independent director to play an active role in governance and not merely be cronies of the promoter group. The seeds of change have begun to sprout.

History and background

It has been more than a decade since the Satyam Computer accounting scam (read our analysis here²) exposed the plight of corporate governance in India. The scam led to a comprehensive revamp of the corporate governance regime, which also included the beginning of the process of strengthening the institution of independent directors³, which process continues even today.

Systemic lapses and liability issues

Despite the seeming strides forward in the setting up of a legal framework with regards to the appointment, duties and responsibilities of independent directors, in practice, contravention of these norms and guidelines has been a regular occurrence, with instances of non-appointment⁴, unsuitable appointments⁵, collusion and prejudice⁶ still being rife.

Moreover, section 169 of the Companies Act, 2013, which provides that a company may remove a director by an ordinary resolution i.e. 51% of the shareholders, brought the independent directors directly in the line of fire by the majority shareholders and hence, amenable to be influenced.

Further, the extent of liability placed on independent directors was also enlarged by the courts and adjudicating bodies treating the independent directors at par with other directors of the company. Accordingly, the independent directors which were initially thought to act as a watch-dog in the scheme of corporate governance themselves came under the scanner and got embroiled in protracted civil and criminal litigations. India Inc. saw a rise in cases of independent directors being hauled up for operational non-compliances of the company.

For instance, SEBI in In re, Inter Globe Finance Limited⁷, pronounced that the Securities Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR”), pertaining to the responsibilities of the board of directors, do not envisage a distinction between independent directors and other directors⁸. More specifically, SEBI held that the regulations warrant directors to be fully informed, act in good faith, as well as maintain ethical standards with respect to all stakeholders connected with the company⁹. A similar stance was also taken by the NCLAT in Shailesh Chawla v. Vinod Kumar Mahajan¹⁰, wherein the tribunal held that the claim of the appellants of being “sleeping directors”, i.e., they did not partake in the day-to-day management and affairs of the company, did not exempt them from liability¹¹. The tribunal also placed independent directors on an equal footing to other directors, by virtue of them being integral constituents of the board.¹²

Not surprisingly, this led to widespread resignations and flight of talented pool from the board.¹³

Safe harbour for independent directors

Interestingly, the law in India affords a special protection to the independent directors as compared to other directors. For example, Section 149(12) of the Companies Act, 2013, (and Regulation 25(5) of LODR in case of publicly listed companies), stipulate that an independent director 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”¹⁴. In fact, the Ministry of Corporate Affairs also issued a General Circular No. 1/2020, which clarified that Section 149(12) is a non-obstante clause, and consequently, independent directors cannot be roped in any civil or criminal proceedings under the Companies Act unless the contravention committed by the company has occurred with the knowledge of such independent directors, attributable through board processes.¹⁵

In Chintalapati Srinivasa Raju Vs Securities and Exchange Board of India,¹⁶ the Supreme Court also recognised the role of independent directors, holding they are not responsible for the conduct of the business of the company. The apex court again, in Sunil Bharti Mittal Vs Central Bureau of Investigation¹⁷, held that where statute is silent, the directors of the company can be held responsible for the wrong done by the company only where there is sufficient evidence to prove an active role and a criminal intent or if the relevant statute has specifically imposed liability on them, such as labour and environmental law statutes.

Regrettably, while the law expressly provides safe harbour provisions to ring-fence independent directors from liability, such provisions appear to have largely remained oblivious to the investigating agencies and the adjudicatory bodies.

SEBI enforces enhanced transparency

In an endeavour to set independent directors as the flagbearers of ethics, integrity, moral resoluteness and objectivity in a company’s operations, a comprehensive code of conduct for independent directors was also prescribed under the Companies Act, 2013.¹⁸ After seeing almost 7 years of the new regime, the Securities and Exchange Board of India (“SEBI”) on June 29, 2021, issued several directives to bolster the institution of independent directors¹⁹, which will become effective from January 1, 2022 and promise to go a long way in plugging the loopholes that have shown up over the years. These directives on independent directors (effective from January 1, 2022²⁰), which have been introduced as amendments to LODR, include:

1. Appointment, reappointment and removal of independent directors must be confirmed by a special resolution of the shareholders with 75% of votes in favour of the appointment.

2. Two-thirds of the Nomination & Remuneration Committee (tasked with selecting candidates as independent directors) be comprised of independent directors (substituting the existing simple majority requirement). This committee is also required to disclose the suitability and skillset of candidates, in furtherance of the justification for selection.

3. Two-third of the members of the Audit Committee shall be independent directors. Approval to every related party transaction is also compulsorily required to be given by independent directors forming part of this committee.

4. Full disclosure of the contents of the resignation letter upon an independent director’s resignation by the listed company to the stock exchange(s). The disclosure shall also include a list of the directors present membership/directorship in any board committees.

5. The top 1000 listed entities by market capitalization shall have to mandatorily take Directors and Officers insurance (D&O insurance) for all their independent directors.

Conclusion

The institution of independent directors is an indispensable and ever-evolving construct in scheme of corporate governance. As with any governance mechanism, the emergence of certain pressure points such as excessive promoter influence, risk of liabilities, etc., which undermined the credibility of the institution, came to be discovered. Constant monitoring and intervention of the legislature and regulators is required to plug the loopholes from time to time.

While the above SEBI directives are a step in the right direction and aim to ensure better transparency, accountability and risk management, much work needs to be done towards sensitising the various investigative agencies and adjudicatory bodies about the liability of independent directors. Independent directors of companies get rounded up and proceeded against for contraventions simply on account of being a director.

Unless the lower courts and investigation agencies are properly sensitised about how the law contemplates liability qua independent directors, the office of independent directors would continue to get embroiled in regulatory investigations and needless litigations. This will make it harder to retain the right talent as independent directors for India Inc. and also place impediments to ease of doing business in India.