Concept of independent directors in India with relevance to increasing Corporate

Governance mechanisms.

Independent directors (ID) play the role of upholding the interests of shareholders and ensuring
that the company runs lawfully which includes its equitable functioning. The need for an in-
house person/s to monitor various facets of the company such as financial statement, auditing,
interest of minority shareholders is imperative. Persons performing this function cannot have
a financial relationship or any other relationship as mentioned (in the companies Act and its
rules & regulations) with the company or its subsidiaries and any other relationship with the
aforementioned should be revealed, for him/her to act true to such role. This has been
incorporated in the Companies Act 2013 and the rules and regulations under the Securities
and Exchange Board of India. It cannot go unsaid that a major chunk of legal concepts has
been borrowed from English law and so the article aims at tracing its origins to establish the
functions and objectives of an independent director.

The UK Corporate Governance Code (the Code) first published in 1992, had provisioned for a
system to control and direct companies. The Board of directors make decisions on behalf of
the stakeholders and are thus answerable to them. It is a pattern that for a board resolution to
come into effect, the approval of shareholders in a general/extraordinary general meeting is
mandatory (in most cases). The Code of 2016 mandates the presence of a senior independent
director in the board committee for clearing the annual report. One may draw a parallel
between the duties and liabilities of an independent director in the Companies Act 2013 to
the role of non-executive director prescribed in the Code. The Code of 2016 mandates the
following:
1) The chairman should hold meetings with the non-executive directors without the executives
present. 2) Led by the senior independent director, the non-executive directors should meet
without the chairman present at least annually to appraise the chairman’s performance and
on such other occasions as are deemed appropriate. 3) Where directors have concerns which
cannot be resolved about the running of the company or a proposed action, they should ensure
that their concerns are recorded in the board minutes. 4) On resignation, a non-executive
director should provide a written statement to the chairman, for circulation to the board, if
they have any such concerns.

Companies Act, 2013 and its Rules

The Companies Act 1956 did not entail the role of an independent director but clause 49 of the
SEBI listing agreement first introduced in February, 2000 stated that the number of
independent directors would depend whether the Chairman is executive or non-executive. In
case of a non-executive chairman, at least one-third of board should comprise of independent
directors and in case of an executive chairman, at least half of board should comprise of
independent directors. The amendment to clause 49 was made on September 2000 wherein,
any institutional directors on the boards of companies (other than Govt. companies) were
deemed as independent directors. The latest amendment to the composition of board via SEBI
circular dated April 7, 2014; mandated the quorum of board with at least one-third being
independent directors in the case of a non-executive chairman of the board; and in case of
not having a regular non-executive chairman at least half the board should consist of
independent directors.
The Companies (Appointment and Qualification of Directors) Second Amendment Rules,
2018 specifies the qualification and responsibilities of an independent director; which was an
 amendment to the 2014 rules. The amendment rules have imposed the additional liability on
the ID to be the guarantor or provide security for the debt of the company to any third person,
its holding company, subsidiary, their promoters and directors. This has led to the triggering
of insolvency proceedings against independent directors as Companies Regulations have
mandated directors to stand as guarantors or provide security to creditors. The Supreme Court
has established that the directors/members of a company are not subject to the moratorium
which is availed by a company. Section 149 of the Companies Act states that every listed
public company shall have at least one-third of the total number of directors as independent
directors and the Central Government may prescribe the minimum number of independent
directors in case of any class or classes of public companies. A listed company should have
an audit committee with a minimum of three directors of which at least 2 of them must be
independent directors as per section 177 Companies Act.

SEBI Regulations and Circulars

The SEBI Listing Obligation and Disclosure Requirement (LODR) Regulations, 2015 confer
responsibility and enable independent directors to carry on their managerial and supervisory
functions. Regulation 4 (3) (14) has the enabling clause for an independent directors to
perform their role as a member of the board of directors and also as a member of the board
of committee of directors. Regulation 16 defines an independent director who is a non-
executive director, other than a nominee director of a listed entity. He must have relevant
expertise and is a person of integrity in the opinion of the board of directors. He should not
be or have been a promoter (defined in Companies Act) of the listed entity, its holding
company, associate companies or subsidiaries. Nor should he/she be related to the promoters
or directors to the aforementioned companies or hold/held the position of key managerial
personnel (KMP) (including his relatives as defined in the regulation) in the aforementioned
categories of companies. [Refer to regulation 16 for exhaustive information on qualifications
of IDs).

Penalty:
SEBI circular vide April 08, 2015 has come up with a fine structure for not having an optimum
combination of executive, non-executive and women directors on the board. This fine is for
the violation by listed entities, of Clause 49 II A (1) of Listing Agreement. There are various
timelines provided under which the type and quantum of fines vary accordingly. But for any
non-compliance beyond September 30, 2015, SEBI may take any other action against
defaulters.

Judicial Ruling:

The need for absolute adherence to these regulations has been declared by the Supreme Court
in the case of SEBI v Shri Ram Mutual Fund1 where in the words of the Hon’ble court “once
the violation of statutory regulations is established, imposition of penalty becomes sine qua
non of violation and the intention of parties committing such violation becomes totally
irrelevant. Once the contravention is established, then the penalty is to follow. It is to be taken
in clarity that the courts/tribunals do not intend to interfere with the decisions of a company
and their discretion. Judicial interference shall be exercised when a company

1
AIR 2006 SC 2287
 obviates/subverts law, engages in activities that is done by people within the company which
cannot be done in their individual positions, violates any constitutional or statutory provision.
In the case of Rustom Cavasjee Cooper v. Union of India2 the court said “It is again not for
this Court to consider the relative merits of the different political theories or economic
policies...”
Even in the case of the Government incorporating a company (under the companies Act), it is
not amenable to Judicial interference including through writ jurisdiction. The decisions taken
by the management of a company shall be immune from judicial interference or else it would
lead to micromanagement and violation of the constitutional provisions under Article 14 and
19. In the case of BALCO Employees Union vs. Union of India (UOI) and Ors3 it was ruled
that the Government could have run the industry departmentally or in any other form. When
it chooses to run an industry by forming a company and it becomes its shareholder then under
the provisions of the Companies Act as a shareholder, it would have a right to transfer its
shares. When persons seek and get employment with such a company registered under the
Companies Act, it must be presumed that they accept the right of the directors and the
shareholders to conduct the affairs of the company in accordance with law and at the same
time they can exercise the right to sell their shares. In tune to this the hon’ble SAT had held
Vas Infrastructures Ltd 4 liable for failing to set up an audit committee as per clause 49 II A
of the Listing Agreement read with section 21 of SCR Act, 1956.

Surmise:

Independent directors play a pivotal role in creating a balance in various departments of the
company and act as whistle-blowers in cases of malfunctioning of the company. This is a
statutorily empowered- internal mechanism to ensure impartial decision making and
adherence to law, which aids in timely adjudication by the National Company law Tribunals
and courts of law. They have powers parallel to that of veto power where fraudulent decisions
that include financial, managerial and operational can be withheld and brought to notice.
Thus one may see the roles of a financial guide, intellectual and business advisor, the Good
Samaritan for public investors and other powers enabled by law being played by an
independent director.

Krishnadas Saiju
4th year, B.A. LL.B (Hons.), NUALS

2
AIR 1970 SC 564
3
AIR 2002 SC 350
4
MANU/SB/0096/2018