The curious case of missing independent directors

A year after the new Companies Act came into effect, there is a sharp increase in the removal of independent directors from PSUs

Harvinder Singh and Monica Benjamin | April 2, 2015


#independent directors   #companies act   #PSUs  

The concept of independent directors (IDs) was first introduced in India by the Securities Exchange Board of India (Sebi) in February 2000, as part of its standards on corporate governance for listed public companies. This was done by incorporating Clause 49 in the listing agreements of stock exchanges. Prior to that and even subsequently, there was no such concept under the Companies Act, 1956.

Later, the need for stricter requirements for IDs was realised in the wake of Satyam scandal in 2009.

The Companies Act, 2013, adopted the concept of IDs to bring it in line with Clause 49 and also introduced additional eligibility criteria for IDs. The 2013 Act aims to provide a more systematic process of appointment of IDs by way of special resolution, provisions of maximum tenure and maximum terms, cooling-off period before an ID is reappointed and code for IDs. Greater clarity relating to classes of public companies to which the new provisions for IDs would apply, the eligibility of such directors, as well as creation of a database of such directors, was also provided by the 2013 Act along with rules for the same.

After the 2013 Act came into effect, Sebi also amended Clause 49 in the following year and brought it in line with the 2013 Act. It further added restrictions on appointment and compliances for IDs.

It is too early to comment on how far the changes made by the 2013 Act will yield the desired result, but recently many IDs of public sector undertakings (PSUs) have quit, primarily due to the fear of being held liable for any illegal acts undertaken by their companies. To take note, ever since the NDA came to power, many IDs, who were earlier appointed by the UPA government, have been removed.

IDs in PSUs

Unlike other public companies, where directors are appointed by the board of directors and shareholders, directors of PSUs are appointed by the central government as per the guidelines issued by the department of public enterprises (DPE). DPE’s guidelines took into account Sebi’s amendments to Clause 49, and have been amended several times. These guidelines also lay down additional eligibility criteria for IDs in PSUs.

PSUs mainly appoint retired personnel from other PSUs or companies as IDs. The primary reason for this is the age requirement under DPE’s guidelines, which is 45-65 years with an additional relaxation extending up to 70 years for eminent professionals.

Alongside age, experience is an important factor: only retired persons with minimum 10 years of experience as government officials at joint secretary level or above can be hired. A list of profiles that are considered for hiring extends across ex-CMD/MDs of other CPSEs, academicians/directors of institutes/heads of department/professors with more than 10 years of teaching/research experience, reputed professionals with more than 15 years of relevant domain experience, ex-CEOs of private companies which are either listed on stock exchanges or unlisted but profit-making and have a minimum annual turnover of '250 crore and eminent persons with proven track record from industry, business, agriculture or management. Serving CEOs and directors of listed private companies may be considered for appointment only under exceptional circumstances.

No wonder, PSUs in India, like NTPC, MMTC, IOCL, Concor, mostly have bureaucrats and former executives of PSUs as IDs. Most of these appointments are political in nature and change in central government typically leads to a shuffle. 

Possible threat of prosecution

The 2013 Act provides that an ID shall be held liable, only in respect of such acts of omission or commission by a company which have occurred in her/ his knowledge, attributable through board processes, i.e., board agendas, board meeting notices and minutes, and with his consent or connivance or where he had not acted diligently.

In a bid to remove the ambiguity and confusion around the liability of IDs, the 2013 Act has completely blocked the escape route for IDs. If an ID has attended or participated in board meetings or has merely received minutes of such meetings and has failed to record his concerns or objections, then such n ID cannot easily wriggle out from prosecution claiming that decision was not taken with his concurrence and knowledge.

In order to insulate themselves, it is very important for the IDs to use all the powers made available to them under the 2013 Act, including obtaining advice of independent professionals, wherever necessary, so as to rescue themselves from unknown risks. 

With unlimited liability and no rewards, nobody would like to act as an ID; this is one of the major reasons why IDs are exiting PSUs and the companies are already facing shortage of IDs.
 
Extensive managerial role


The 2013 Act has broadened the role of IDs and mandates that IDs be compulsorily appointed to the company’s audit committee and nomination and remuneration committee besides having to adhere to a detailed code of conduct and carrying out additional duties and functions under the 2013 Act. These two committees regulate several internal affairs of the company, from which IDs cannot escape. Such deep involvement and accountability in the day-to-day functioning of the companies without a corresponding compensation is another reason for them to resign.

Performance evaluation

Another counter-productive additional regulatory requirement is that IDs’ performance is evaluated, in her/his absence, by the entire board of directors of companies. Re-appointment of IDs will further be subjected to the evaluation report submitted by the board of directors.

Interestingly, it should be noted that IDs are also under a duty to evaluate the board of directors. It, therefore, goes without saying that there would likely be inter-personal tensions to diffuse on matters of difference of opinion. In such cases, it would be unlikely for the IDs to prevail considering that their re-appointment is in the hands of the board. Only an honest and trustworthy board of directors could be expected to make this arrangement work for the benefit of their company as well as its stakeholders.

Caps on directorships

Another reason causing the IDs to exit, is the cap put by Sebi’s 2014 amendment to Clause 49, on the number of independent directorships which a person can hold. Currently, this figure is seven independent directorship. However, if the person is a whole-time director of a listed company, then he can hold independent directorships only in three companies. These limits automatically result in several IDs resigning where they held independent directorships in excess of such limits.  

Can this work?

There appears to be an onslaught of various regulatory changes being introduced for IDs in a short span of time. Incidentally, two databases with details of persons who may be appointed as IDs of companies, have already been created in compliance of the 2013 Act, for both PSUs (by the DPE) and for other companies by the Institute of Chartered Accountants of India. Whether this process will wean out unfit IDs from companies, especially in PSUs, remains to be seen. The concept of IDs is laudable, but the whole trend of desertion immediately after first sign of sickness is worrisome. A significant onus of investor protection is on IDs and PSUs will have to ensure that an appropriate induction programme to make IDs familiar with the business of the company and a programme to update their skills and the environment in which they operate, is adopted to set the right tone and to encourage fearless independent functioning of IDs.

Singh is partner and Benjamin is associate, corporate and M&A practice, HSA Advocates.

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