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Classroom Series I - Independent Directors - towards good governance
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Updated Considering Draft Rules on 03.01.2014
The concept of independent directors was initially introduced with a view to increase transparency, fairness and independence in decision making and, protect stake holders’ interest. So far only listed public companies were required to appoint independent directors under the Listing Agreement. Now, the Companies Act, 2013 extends such requirement to cover big public companies also. The move may infuse more objectivity in decision making of companies, but it is set to create some turmoil as well.Finding a person who has all the prescribed qualifications will be a challenge.
Independent Directors Under the Companies Act, 2013
- At least 1/3rd of the total number of directors of every listed public company should be independent directors. As per the provisions of Draft Rules prescribed for this section, apart from listed companies following companies to have at least 1/3rd of the number of directors as independent directors:
- Public companies having paid - up share capital of Rs 100 crore or more; or
- Public companies having turnover of Rs 300 crore or more; or
- Public companies which in aggregate have outstanding loans, or borrowings, or debentures, or deposits, exceeding Rs 200 crore or more.
It is to be noted that, the Draft Rules prescribe that the these criteria shall be applicable for the first year and shall continue to apply to that company in the subsequent years during the tenure of the ID even if the paid up share capital or turnover, or borrowings/ deposits, fall below the specified limits.
- Definition of an Independent Director:
√ An independent director is a director other than a managing director or a whole- time director or a nominee director and who
- A person who, in the opinion of the Board, is a person of integrity and possessing relevant expertise and experience;
- Is or has not been a promoter of the company or its holding, subsidiary or associate company and is not related to promoters or directors of the company, its holding, subsidiary or associate company;
- Has or had no pecuniary relation with the company, its holding, subsidiary or associate company, or their promoters, or directors, during the two immediately preceding financial years or during the current financial year
- None of the relatives of such person must have pecuniary relationship or transaction with the company, its holding, subsidiary or associate company, or their promoters, or directors, amounting to two per cent or more of its gross turnover or total income or Rs 50 lakh or more as may be prescribed, whichever is lower, during the two immediately preceding financial years or during the current financial year
- Also, neither he nor his relatives -
- Is or had been a key managerial personnel or is or had been employee of the company or its holding, subsidiary or associate company in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed;
- Is or has been an employee or proprietor or a partner, in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed, of-
(A) A firm of auditors or company secretaries in practice or cost auditors of the company or its holding, subsidiary or associate company; or
(B) Any legal or a consulting firm that has or had any transaction with the company, its holding, subsidiary or associate company amounting to 10% or more of the gross turnover of such firm;
- Holds together with his relatives 2% or more of the total voting power of the company; or
- Is a Chief Executive or Director, by whatever name called, of any non-profit organisation that receives 25% or more of its receipts from the company, any of its promoters, directors or its holding, subsidiary or associate company or that holds 2% or more of the total voting power of the company
- Must possess appropriate balance of skills, experience and knowledge in one or more fields of finance, law, management, sales, marketing, administration, research, corporate governance, technical operations or other disciplines related to the company’s business.
- Other conditions to be met:
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Every independent director is required to give a declaration that he fulfills the criteria of independence provided for in the law, at the first Board meeting in which he participates as a director and thereafter at first Board meeting of every financial year or whenever there is any change in the circumstances that may affect his independence. |
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In order to facilitate availability of Independent Directors, the draft rules provide that an institute or association authorized by Central Government shall create and maintain a data bank of persons willing and eligible to be appointed as independent director and such data bank shall be placed on the website of the Ministry of Corporate Affairs or on any other website as may be approved or notified by the Central Government. and such director shall be one who fulfills the qualifications and requirements as mentioned by the Central Government. Along with the databank, a disclaimer shall also be displayed on the website authorizing the company to carry out its due diligence before appointing any person as independent director. |
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A person desirous of getting his name included in the data bank shall make an application in (draft) Form No. 11.1 to the body, institute or association notified by the Central Government in this regard along with the reasonable fee charged by the body, institute or association at its own discretion. |
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An independent director can hold office for a term of up to 5 consecutive years on the board of a company, and is eligible for re-appointment on passing of a special resolution by the company and disclosure of such appointment in the Board's report. |
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No independent director can hold office for more than 2 consecutive 5 years terms in one company. He will be eligible for appointment after a gap of 3 years of ceasing to be an independent director of the company. Further, during these three years, he shall not be appointed in or be associated with the company in any other capacity, either directly or indirectly. |
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Independent directors are liable only for such acts of omission or commission by a company that had occurred with his knowledge, attributable through board processes, and with his consent or connivance or where he had not acted diligently. |
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The appointment of independent director has to be approved by the company in a general meeting and the explanatory statement annexed to the notice of the general meeting should indicate the justification for choosing the person for appointment as independent director. |
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Companies and their independent directors are required to adhere to the Code for Independent Directors, prescribed in Schedule IV, key features of which are:-
- Guidelines of professional conduct
- Role and functions
- Duties
- Manner of appointment
- Reappointment
- Resignation or removal
- Separate meetings
- Evaluation mechanism
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Separate meetings - Independent directors of the company are required to hold at least one meeting in a year, without non-independent directors and members of management attending it |
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Remuneration to Independent Directors -.Act provides that an Independent director shall not be entitled to any stock option and may receive remuneration by way of fee, reimbursement of expenses for participation in the Board and other meetings and profit related commission as may be approved by the members. |
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Sitting Fees : As per the draft rules, Directors can be a maximum sitting fees upto Rs 1 Lakh per meeting subject to the approval of board of directors or remuneration committee. In order to incentivize the participation of Independent directors, the draft rules also provides that board may pay a different sitting fees to Independent and Non-Independent directors. |
Transitional phase for companies:
Companies existing on or before the date of commencement of this Act are to comply with the requirement of appointing independent director within one year from such commencement or from the date of notification of the Rules in this regard, as may be applicable.
Independent Directors under Present Laws
While the concept of independent directors is new in the Companies Act, 2013 , it was already provided for in the Listing Agreement of the Stock Exchanges. A brief comparison is provided hereunder:-:
S.No |
Companies Act, 2013 |
Listing Agreement |
1. |
Places onus on Board to choose a person who, in its opinion, is a person of integrity and possesses relevant expertise and experience. |
No specific onus on the Board for selection of independent director. |
2. |
Restricts person having any pecuniary relationship with specified person but senior management is not included therein
Mentions of such relationship during the 2 immediately preceding financial years or during the current financial year |
Restricts person having material pecuniary relationship with specified person including senior management
Mentions of such relationship in the current tenure |
3. |
Also provides that none of the relatives of such person should have or have had pecuniary relationship or transaction with the company, its holding, subsidiary or associate company, or their promoters, or directors, amounting to 2%. or more of its gross turnover or total income or Rs 50 lakh or such higher amount as may be prescribed, whichever is lower, during the 2immediately preceding financial years or during the current financial year; |
No such condition prescribed with respect to relatives of proposed appointee |
4. |
Provides that such person should not to be related to promoters or directors in the company, its holding, subsidiary or associate company; |
Provides that such person should not be related to promoters or persons occupying management positions at the board level or at one level below the board |
5. |
Provides that such person should neither himself nor through any of his relatives
- Is or had been a key managerial personnel or is or had been employee of the company or its holding, subsidiary or associate company in any of the 3 financial years immediately preceding the financial year in which he is proposed to be appointed;
- be or have been an employee or proprietor or a partner, in any of the 3 financial years immediately preceding the financial year in which he is proposed to be appointed,of-
- a firm of auditors or company secretaries in practice or cost auditors of the company or its holding, subsidiary or associate company; or
- any legal or a consulting firm that has or had any transaction with the company, its holding, subsidiary or associate company amounting to 10%. or more of the gross turnover of such firm
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Provides that such person
- should not have been an executive of the company in the immediately preceding 3 financial years;
- must not be a partner or an executive or have been a partner or an executive during the preceding 3years, of any of the following:
- the statutory audit firm or the internal audit firm that is associated with the company, and
- the legal firm(s) and consulting firm(s) that have a material association with the company.
- should not be a material supplier, service provider or customer or a lessor or lessee of the company, which may affect independence of the director.
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6. |
The relatives have been specifically covered in the 2% voting power of the company. |
Relatives not specifically covered. |
7. |
It also provides that such person should not be a chief executive or director, by whatever name called, of any non-profit organisation that receives 25%. or more of its receipts from the company, any of its promoters, directors or its holding, subsidiary or associate company or that holds 2% or more of the total voting power of the company |
No such condition prescribed |
8. |
Law may also provide for other qualifications for independent directors. No age has been prescribed as yet. |
The person should be at least 21 years of age. |
9. |
Nominee directors are excluded from the purview of independent directors. |
Nominee directors appointed by an institution, which has invested in or lent to the company, shall be deemed to be independent directors |
10. |
The term associate company here means “associate company”, in relation to another company, means a company in which that other company has a significant influence, but which is not a subsidiary company of the company having such influence and includes a joint venture company.
Explanation. - For the purposes of this clause, “significant influence” means control of at least 20% of total share capital, or of business decisions under an agreement; |
The term associate company here means an enterprise in which the investor has significant influence and which is neither a subsidiary nor a joint venture of the investor.
Hence, while an ‘enterprise’ is covered here, Companies Act relates to ‘Company’ itself. |
So it is clear that there will be a drastic change in the eligibility criteria for independent directors with the introduction of the Companies Act, 2013, where the relationship of these individuals not only with the company but also with its holding, subsidiary and associate companies has to be checked in the beginning and also subsequently. This will make the task of finding an independent director who meets all the criteria very difficult for companies.
From the point of view of stakeholders it is certainly a very good move, provided that companies do not face problem in finding such persons.
Facts and Figures
A total of 7,521 individuals occupy a total of 9,811 independent directorship positions on 2,827 BSE-listed companies, as on 15th July 2012, according to Directors Database website, an initiative of the Bombay Stock Exchange (BSE) and Prime Database.
Independent directors of following companies have been associated with the company for more than 10 years.
Company |
Term of long serving Independent Director (Years) |
Infosys |
13 |
Reliance Industries Limited |
33 |
DLF Limited |
22 |
Company |
Director |
Date of Appointment |
Years as Independent Director |
Infosys |
Deepak M. Satwalekar |
10/10/1997 |
13 |
Reliance Industries Limited |
MANSINGH LAXMIDAS BHAKTA |
27/09/1977 |
33 |
DLF Limited |
BRIJINDER BHUSHAN DEORA |
16/11/1988 |
22 |
Industry Impact & Concern Factors
While the Independent Director would focus on safeguarding stake holders’ interest, there are some concerns that implementation will not be easy.
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Firstly, the eligibility criteria could create some issues: |
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Not only the proposed incumbent, but also the relatives of such incumbent should not to have any pecuniary relationship over the specified limit, with the company, its holding and subsidiary company and also with its associate companies, not just in the current year but also in the immediately preceding 2 financial years. So a lot of diligence will have to be exercised by big companies to identify the right candidate. |
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The proposed candidate not to have any pecuniary relationship with the company, its holding, subsidiary or associate company, or their promoters, or directors, during the 2immediately preceding financial years or during the current financial year. This means that even a small transaction can make a person ineligible for appointment. |
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Restriction of being KMP or even employee of the company and related entities for specified time frame |
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Restriction on any relationship even with service providers |
Moreover, the Board is also required to qualify that the proposed appointee fulfils all the eligibility conditions. This would mean that the audit or concurrence system for such independent directors should be so strong that the Board is able to get comfort that qualification conditions are fulfilled.
- Secondly, there is a limit on the term of an Independent Director. A person can be appointed for a term of 5 years and thereafter for 5 more years, beyond which, he would not be eligible to be appointed as such until 3 years have lapsed, during which the person should not have any association with the company. This implies that a person may be appointed as an independent director of a company for a maximum of 10 years at a stretch. This has both negatives and positives , negative would be that many companies will have to part with persons of integrity who have done a good continuous job as independent directors on its Board and positive , it will reduce the chances of development of any nexus between the independent director and the promoters.
- Thirdly, with regard to liability of independent directors, it has been provided that they would be responsible only for such acts of omission or commission by a company which had occurred with their knowledge, attributable through Board processes, and with their own consent or connivance or where they had not acted diligently. This means that on any Board decision on which they have consented, even after acting with complete diligence and in good faith, they would be held liable for default, if it occurs. The liability of such directors has always been the cause of concern and will continue to be.
Though the concept tries to create objectivity and fairness in decision making of a company and the qualification criteria is meant to minimize chances of any nexus between the company and independent directors, it would be interesting to see how much of this is implementable and more so, how strong a database the government is able to create so that such desired independent directors are easily available to companies. Moreover, what is also required is drastic shift in the mind set of promoters to acknowledge the independent directors on their board and allow them the freedom to contribute.
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Section 149: Company to have Board of Directors |
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(1) |
Every company shall have a Board of Directors consisting of individuals as directors
and shall have— |
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a minimum number of three directors in the case of a public company, two directors
in the case of a private company, and one director in the case of a One Person Company;
and |
(b) |
a maximum of fifteen directors: |
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Provided that a company may appoint more than fifteen directors after passing a
special resolution: |
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Provided further that such class or classes of companies as may be prescribed, shall
have at least one
woman director. |
(1A) |
Every company existing on or before the date of commencement of this Act shall within
one year from such commencement comply with the requirements of the provisions of
sub-section (1). |
(2) |
Every company shall have at least one director who has stayed in India for a total
period of not less than one hundred and eighty-two days in the previous calendar
year. |
(3) |
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. |
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Explanation.—for the purposes of this sub-section, any fraction contained
in such one-third number shall be rounded off as one. |
(4) |
Every company existing on or before the date of commencement of this Act shall,
within one year from such commencement or from the date of notification of the rules
in this regard as may be applicable, comply with the requirements of the provisions
of sub-section (3). |
(5) |
An independent director in relation to a company, means a director other than a
managing director or a whole-time director or a nominee director,— |
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(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; |
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(ii) |
who is not related to promoters or directors in the company, its holding, subsidiary
or associate company; |
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(c) |
who has or had no pecuniary relationship with the company, its holding, subsidiary
or associate company, or their promoters, or directors, during the two immediately
preceding financial years or during the current financial year; |
(d) |
none of whose relatives has or had pecuniary relationship or transaction with the
company, its holding, subsidiary or associate company, or their promoters, or directors,
amounting to two per cent. or more of its gross turnover or total income or fifty
lakh rupees or such higher amount as may be prescribed, whichever is lower, during
the two immediately preceding financial years or during the current financial year; |
(e) |
who, neither himself nor any of his relatives— |
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(i) |
holds or has held the position of a key managerial personnel or is or has been employee
of the company or its holding, subsidiary or associate company in any of the three
financial years immediately preceding the financial year in which he is proposed
to be appointed; |
(ii) |
is or has been an employee or proprietor or a partner, in any of the three financial
years immediately preceding the financial year in which he is proposed to be appointed,
of |
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(A) |
a firm of auditors or company secretaries in practice or cost auditors of the company
or its holding, subsidiary or associate company; or |
(B) |
any legal or a consulting firm that has or had any transaction with the company,
its holding, subsidiary or associate company amounting to ten per cent. or more
of the gross turnover of such firm; |
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(iii) |
holds together with his relatives two per cent. or more of the total voting power
of the company; or |
(iv) |
is a Chief Executive or director, by whatever name called, of any nonprofit organisation
that receives twenty-five per cent. or more of its receipts from the company, any
of its promoters, directors or its holding, subsidiary or associate company or that
holds two per cent. or more of the total voting power of the company; or |
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who possesses such other qualifications as may be prescribed. |
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Every independent director shall at the first meeting of the Board in which he participates
as a director and thereafter at the first meeting of the Board in every financial
year or whenever there is any change in the circumstances which may affect his status
as an independent director, give a declaration that he meets the criteria of independence
as provided in sub-section (5). |
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Explanation.—For the purposes of this section, “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. |
(7) |
The company and independent directors shall abide by the provisions specified in
Schedule IV. |
(8) |
Notwithstanding anything contained in any other provision of this Act, but subject
to the provisions of sections 197 and 198, an independent director shall not be
entitled to any stock option and may receive remuneration by way of fee provided
under sub-section (5) of section 197, reimbursement of expenses for participation
in the Board and other meetings and profit related commission as may be approved
by the members.” |
(9) |
Subject to the provisions of section 152, an independent director shall hold office
for a term up to five consecutive years on the Board of a company, but shall be
eligible for reappointment on passing of a special resolution by the company and
disclosure of such appointment in the Board's report. |
(10) |
Notwithstanding anything contained in sub-section (9), no independent director shall
hold office for more than two consecutive terms, but such independent director shall
be eligible for appointment after the expiration of three years of ceasing to become
an independent director: |
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Provided that an independent director shall not, during the said period of three
years, be appointed in or be associated with the company in any other capacity,
either directly or indirectly |
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Explanation.—For the purposes of sub-sections (9) and (10), any tenure of
an independent director on the date of commencement of this Act shall not be counted
as a term under those sub-sections. |
(11) |
Notwithstanding anything contained in this Act— |
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(i) |
an independent director; |
(ii) |
a non-executive director not being promoter or key managerial personnel, 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. |
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(12) |
The provisions of sub-sections (6) and (7) of section 152 in respect of retirement
of directors by rotation shall not be applicable to appointment of independent directors. |
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