Watching the fallout of the giant like Lehman Brothers that led to the destructions and turmoil in many other companies, with the hopes of millions of shareholders being shattered? In India, the Companies Act 1956, being more than half a century old with most of the sections being dormant or obsolete and handful of changes brought about through amendments in the existing framework, it is high time that we go for a new and competent framework. However, due to political instability and lethargic attitudes of politicians, this important legislation is staggering between parliamentary sessions since the last few years. It seems, as if, they are not in a mood to learn even from the Satyam fiasco that occurred lately.

The present article is structured in five sections. The first sections deals with defining the (IDs), reason for having them on company boards, their roles, responsibilities and their importance in the success of the company. The second section, briefly retraces the emergence of IDs in the global world, primarily focusing on the developments in the United States (US) and United Kingdom (UK) .The third section of the article encompasses the Indian historical origin of ID with special reference to the CG Committees formed and their recommendation in this perspective of IDs. Section four elaborately discusses issues related to the institution of IDs in the light of Companies Bill 2009, comparing with present CG framework. The discussion primarily focuses, how well the reforms proposed in the Companies Bill 2009, are good to answer the existing CG problems associated with ID in backdrop of Satyam fiasco and global financial meltdown. Last section makes concluding remarks on IDs in light of Companies Bill 2009.

Independent Directors

a) Definition & Meaning

The general definition of ID is “a non executive director on the board of company, who has integrity, expertise and independence to balance the interest of various stakeholders". Higgs Report (2003) has provides a much clear definition of ID: “that a non- executive director is considered independent when the board determines that the director is independent in character and judgment and there are no relationships or circumstances which could affect, or appear to affect, the directors’ judgment”. The report also enumerates the relationships and conditions under which independence is lost.

ID defined in the corporate books of Listing Agreement through Clause 49 as a person who:

b) Objective, Role and Responsibilities

IDs are basis of sound CG framework. The primary idea of having them on board is to endow with a sovereign, unprejudiced, diverse and experience perspective to the company. The emergence of IDs was initially with the objective of providing a monitoring role on the management, and later, it paved way to enhance the shareholder value and protect the minority shareholders. The Higgs Report has described role of non-executive director (including ID) into two principal components: monitoring executive activity and contributing to the development of strategy. The IDs in role bring objectivity while evaluating the board and the management decisions, creating a balance in the interest of the shareholders. They are shouldered responsibility to provide an oversight mechanism on majority stakeholders controlling the management and to rescue company from their any wrongdoings. They are affirmatively responsible towards the shareholders who appointment them on board to protect their financial interest in the company. The main motive to have IDs on the board is to have check on management and ensuring that decisions align in direction of shareholders value.

Global Developments

The concept of “Independent Director’ entered the corporate world en route through US, though in latent form, as “outside director” supposed to  fulfill the advisory role. The genesis of actual IDs began only in 1970s, as part of CG reforms to fulfill the monitoring role. During this transition period, concept of IDs get widespread currency, and so is, their rise on boards and various mechanisms to enhance the independence criteria. The position of IDs consolidated in the CG framework during hostile takeover period, with recognition of their role in enhancing shareholders prosperity. Subsequently, number of frauds in UK resulted in commissioning of Cadbury Committee on CG in 1992, which provided broadened definition of ID, their role and relation in the company.  In 1997, Hampel committee (UK) and Blue Ribbon Committee (US), further defined and enhanced the role of IDs.

The paradigm shift however, occurred after number of corporate failures like WorldCom and Enron, with passing of Sarbanes- Oxley (SOX) legislation. The act not only it reinvented the role of ID but also made various corporate actions a necessity and increased the legal complexity. The SOX requires all the members of the audit committees to be independent with redefined roles and enforces strict penalties for any transgression. Higgs report (2003) on effectiveness of non- executive directors and Smith Report (2005) on audit committees, after the happenings in US, provided a big thrust to concrete the position of IDs in CG framework of UK.

The Higgs report particularly touched upon many aspects and proposed significant changes, redefined the independence and role non-executive directors, particularly IDs in the corporate board of the company. NYSE comprehensively revised its listing standards after SOX, requiring majority of directors to be independent, and strict independence criteria applied to all such directors, not just the audit committees. In wake of the recent financial meltdown, the role of IDS is under critical analysis in the developed world. A number reports in US and UK reports have looked upon the role of ID in the global financial crisis and pointed many flaws in the present system of IDs. They have stressed on need to strengthen the institution of IDs, so that they can play significant role in the avoiding failures of corporations.

Indian Scenario

The term “Independent Director" was first introduced in the Indian corporate arena through the Kumar Manglam Birla Committee, formulated by SEBI, to start up reforms in the area of CG. It soon found entry into corporate books, after Clause 49 was incorporated in Listing Agreement by SEBI. The Birla Report stipulates, “Independent Directors are directors who apart from receiving directors’ remuneration do not have any other material pecuniary relationship or transactions with company, its promoters, its management or its subsidiaries, which in the judgement of the board may affect their independence of judgement”.  In the background of Enron debacle and sequel to SOX in US, Ministry of Company Affairs (MCA, then known as DCA) then constituted, the Naresh Chandra Committee, which give governance some more thought.

Committee recommendations were though much inclined towards audit and auditors; but it did brought some new thoughts to institution of IDs. It recommended IDs should not be less than fifty percent of the board. Nominee directors of lending institutions not be considered as independents. The recommendations encompassing the audit committees were identical to those of SOX, requiring all members of committee to be independent and having written charter for its function. It also provided impetus to ID remuneration, training and recommended to exempt them from criminal and civil liabilities. In 2003, SEBI constituted the Narayana Murthy Committee with terms overlapping with that of Chandra Committee, whose recommendations were incorporated in the Clause 49 by amending it in 2004.

The Murthy report adopted the same definition of IDs as formulated by the Chandra Committee, however, without the condition of nine-year term. It also pondered view on the qualification and remuneration of ID and stressed on the need evaluating performance of non-executive directors. The committee also enhanced the view of previous Chandra Report on audit committee, redefining its role and responsibilities, however, rejected the earlier of treating nominee directors of financial institutions at par with ID. Sequel to implementation of Murthy committee recommendation in Clause 49, MCA constituted another committee in December 2004 under the Chairmanship of Shri J. J. Irani, to give CG a legislative stamp by revamping the Companies Act, 1956.

The Irani Committee came up with several recommendations in relation to the IDs that were in conflict with the extant Clause 49 and/or the views of the Murthy Committee, e.g. (a) providing for several exemptions based on size and extent of public ownership in a mandatory CG framework so as to optimize compliance costs while maintaining a desired level of regulatory rigour; (b) the criteria for “independence” of IDs is proposed to be weakened significantly; (c) the mandatory requirement of IDs to constitute one-half of the Board be weakened to one-third  of the total members of the Board (d) abolition of age limits for IDs. The present CG framework encompassing the ID is through Clause 49 based on the Murthy Report.

Critical Analysis of the Institution of Independent Directors in the light of the Companies Bill, 2009

The IDs for the first time have entered into statue books of Indian legislation with the introduction of Companies Bill 2009. MCA in concurrence with submission of the Irani Report in 2005 has started the process of revamping the Companies Act 1956. The efforts culminated in the introduction of the Companies Bill, 2008 in the Lok Sabha on October 23, 2008 in the 14th Lok Sabha. The bill was subsequently referred to the appropriate Parliamentary Standing Committee on Finance for examination and report.  Before the said Committee could present its report, 14th Lok Sabha was dissolved and the Companies Bill, 2008 lapsed under the provisions of clause (5) of Article 107 of the Constitution of India.  In view of this, the Companies Bill, 2009 has been introduced in Parliament on August 3, 2009.

The present section does a comprehensive review of institution of IDs in the light of Companies Bill 2009, comparing it with present framework and analyzing the provisions with contemporary problems.

a) Board Composition

The Companies bill 2009, through Clause 132 (3) prescribes that board of all listed companies should have mandatory one third of IDs whether the Chairman is executive or non-executive. The provision is in contrast to the present framework provided in the Clause 49, which requires that, in case, where the Chairman of the board is a non-executive director, at least one-third of the board should comprise of IDs and otherwise, at least 50% of the board should comprise of IDs.

The mandate of the Bill is in line with recommendation of Irani Committee, which calls for uniform norm of one-third of IDs for all companies. The is deviation from the views of both  Chandra and Murthy Committees, which have been vocalic for more independence of board and keeping it par with international norms. The provisions of Clause 49 and Companies Bill 2009 contravene each other, and raise conflict between the two regulators, SEBI and MCA. The issue becomes more serious, on SEBI’s strict stand for excusal on non-compliance in this regard. In addition, to avoid any confusion for compliance for companies, there is a need for consistency between Clause 49 and the proposed Companies Bill.

Whole industry and particularly Public Sector units (PSUs) have always in disharmony with SEBI’s mandate on ID requirement that have always faced difficulty in attracting quality IDs. The Companies Amendment Bill (2003) having provisions on IDs was withdrawn due to stiff opposition from industry in this regard. The PSUs have long demanded that nominee directors appointed by government to be treated as ID, as an alternative. The clause 132 of the proposed Bill is in line with their demand, though it needs to be regulated through the SEBI and stock exchanges. Nominee directors are excluded from the IDs. This is in concordance with SEBI stance to treat them at par with normal directors.

b) Defining Independence

Clause 132(5) lays the definition of ID similar to that of framework provided in Clause 49; however, both have certain inadequacies. The Bill defines ID as “a non-executive director who in opinion of the board is a person of integrity and experience and poses relevant experience and expertise”. While clause 49 of listing agreement fixes the minimum age for the ID to be 21 years, the Clause 132 of the Bill does not prescribes so, in analogy with Irani Committee commendations. However, this contravenes with primary definition of ID itself, how a person who even does not possess a graduate degree (person below 21 years) can bring expertise and experience, and much more that an independent thinking on the board that can help company in achieving its objective.

Clause 49 defines ID as “ apart from receiving director’s remuneration , does not have any material pecuniary relationship or transactions with the company, its promoters, its directors, its senior management or its holding company, its subsidiaries and associates which may affect the independence of the director”. Though this description encompasses all the pecuniary relationship between company and ID but it does not defines the term “material”. This has been left to the board and company, to define this term and disclose it to the shareholders. However, the same can be point of subjective analysis in the legal framework and interpretation of it can vary for different companies.

The Bill while defining ID, also states that IDs (or their relatives) should not have pecuniary relationship or transactions with company, its holding, subsidiary or associate company, or its directors amounting to 10 % or more of its gross turnover or total income during the two immediately preceding financial years or during the current financial years. This way defining of IDs seems very absurd, in the light of the economy of scale at which the corporations are doing business in this globalized world. The turnover of companies has now reached thousand of crores and if director is having transaction in hundred of crores, the foremost question that arises is, will he truly be independent in genuine sense. Permitting an ID to have financial transactions with company up to such a large extent has potential of conflict of interest. Such type provision can be detrimental to shareholders, particularly minority shareholders in the long stride. Effort to reform the CG in country will not be of substance until such a lacuna is plugged in.

c) Retiring Age

The Bill prescribes maximum age limit for key managerial personnel to retire at age of 70, however for IDs, no retiring age is stipulated based Irani Report. Earlier, DCA based on Joshi Committee (1997) in Companies Amendment Act, 2003 proposed to a have retiring age for director by inserting new section 280 in Companies Act 1956, which stipulates that no person shall be eligible to hold office as MD/ WTD or other director or manager of company if he has attained of 75 years. However, same could not be implemented on industry resistance. Murthy committee also has reservations on retirement age of IDs, but SEBI was also not able to incorporate it, reasoning it would differ from company to company and Companies Act is also not having such provisions.

When we look at current picture, a study done by primedirectors database reveals that, a very 3033 individuals or 48% of the total IDs are above age of 60, the typical retirement age. Out of these, as many as 1380 are 70 above, 190 are 80 plus and 8 are even beyond 90. All this be horrifying when we look at the failure of giant Lehman Brothers, whose four of ten board members were over 75 years of age. The most of professionals at end of their career, take of this lucrative positions of IDs in many companies. The real question is if these people are fit enough, to burden themselves with responsibilities of protecting the minority shareholders as IDs serving on many boards. In light of this, when US is reviewing the same, Indian legislatures should also give rethink on the given issue.

d) Qualification and Experience

The Companies Bill 2009 does not necessitate ID to possess any educational qualification and experience. Even Clause 49 and present Act not requires so.  According clause 132 (5), any person can be appointed as ID  (a) who, in the opinion of the Board, is a person of integrity and possesses relevant expertise and experience; (c) who possesses such other qualifications as may be prescribed. Both, present act as well the bill, only the disqualifications and conditions that does not allow any person to become an ID. 

Murthy Committee though has recommendations on experience and qualification, but it could not be implemented in Clause 49 because of industry deterrence on the issue. It is high time for Indian legislatures and corporates to have debate on this issue, as this is one major reason for the recent financial crisis, quoted by many reports of developed world. The basic education qualification and expertise in the relevant field must be prescribed, so that as member of board and other committees, they are better equipped and competent enough in risk management and handling strategic direction of company.

e) Appointments

Clause 133 of the Bill, which corresponds to the sections 254,255 and 264 of the Companies Act 1956, lays down how directors including ID would be appointed. The clause 133 provisions are analogous to present Act- every director other than first directors will be appointed in general meeting of company, after furnishing DIN and declaration for non disqualification. In addition, clause also requires board to give a report in the general meeting that every ID appointed fulfils the conditions specified for his appointment. The Clause 49 in similar manner prescribes the appointment of IDs.

It is clear that that new Bill does nothing novel in direction of appointment of ID, apart from board affirmation that  independence criteria is fulfilled as prescribed in Clause 132 (5). In this practice, the majority shareholders (promoters) can easily dictate the appointments terms of IDs. All the shareholders even though can vote on the selection of directors, but the supremacy of majority ensures that their nominees triumph. It is established fact that most of Indian companies are family controlled, further marked by cross-holdings, pyramid structures and tunnelling. According to a study of broad base BSE 500 set of companies, “the average promoter owns roughly 49%, and fewer than 9 % of promoters have stakes below 25%”. Independents have to owe their loyalty to promoters for appointments and their continuation.

Independence in genuine sense means, not to be controlled in any sense. It is erroneous to expect an ID to exercise his mind impartially against the wishes of majority shareholders (promoters), when his tenure depends on their wishes. All this undermines the whole idea to appointing the ID on the company board, who is largely entrusted by minority shareholders to guard their interest. If the Indian legislators in reality want to have ID on the board, the whole practice of appointing needs to be given a fresh glance while getting in to root cause of the problem. A more transparent and fair process for appointing the IDs needs to be taken, so that, they can discharge their duties without fear or favour.

f) Remuneration

The remuneration that can be paid to the ID is given by clause 132 (6), according to which an ID is not entitled to any remuneration, other than sitting fee, reimbursement of expenses for participation in the board and other meetings and profit-related commission and stock options as may be approved by the members. Further, clause 176 (1), that corresponds to existing section 309 of Companies Act, specifies that  any director who is neither WTD or MD can be paid remuneration only in form of fee for attending board meeting  and profit related commission. The clause 176(2) also states that if any director draws or receives directly or indirectly by way of remuneration, any sum in excess of the amount under sub-section (1), he shall refund such sum to the company within thirty days.

The Clause 49 prescribes that IDs can be paid any fee and stock options fixed by board with prior approval of shareholders in general meeting. Approval for sitting fees in not required if made within limits of Companies Act, 1956. As per current stipulation of Companies Act, an ID earn up to Rs. 10000 or Rs. 20000 depending upon company, as sitting fee for each meeting of board of committee thereof. Under Sec 309, commission to non-executive directors including independent, cannot exceed 1 percent of net profit if company has MD/ WTD/ Manager, otherwise the limit is 3 percent.

 The new Bill now allows the company and its shareholders to fix sitting fees and profit related commission paid to IDs without any capping. As for stock options – there is no limit, just approval of board members. However, the remuneration paid directors be disclosed in annual return of company, as per Clause 82 (g).These current provisions provided in Bill are welcome note, as adequate compensation is must to attract new talent and quality participation. But how much is too much?, so that real independence is not compromised. Combine Code of UK may be give some answer, where compensation to IDs is also linked to their time commitments.

g) Term

The current Bill does not sets any fix term for IDs. They are eligible for re-appointment of the board after their term over, subject to board recommendation and shareholders approval in the general meeting of the company. Clause 49 has non mandatory  requirements stipulates that ID after  9 years ( 3 terms of 3 years each) association with company will cease to independent. When reckoning the international standards, Higgs Report (2003) stipulates, “a non executive director should normally be expected to serve two three year terms, although a longer term is exceptionally be appropriate”.

The unveiled fact however is, IDs continue to serve on the board of the companies for more than decades, as currently Indian law does not prescribe any limit. In such settings, where already present so called IDs on the board that are family friends, the remaining outside directors will get in cozy relationship with promoters, the real question will then arise if there will be any independent thinking on board or it will be only for the sake of compliance.

h) Number of Directorship

 The clause 146 of Bill that corresponds to the section 275 of the Companies Act, no person can become director in more than fifteen public limited companies. The Clause 49, on the contrary mandates that a person can become member of ten committees or at maximum chair five and has to disclose his commitments with other companies in annual report of company. The Companies (Amendment) Act 2000 previously reduced number of directorship from 20 to 15 a person can hold, but current Bill is liberal in not altering it. This is far below the standards of developed like US, NYSE recommends directors its listed companies not to sit boards or committees of more than three companies. Though, Combine Code (UK) does not limit the number of directorships, but it is under strict consideration (Treasury committee 2009). Though India is facing shortage of IDs, but one cannot compromise on the quality. Most of the IDs in addition to public limited companies are also on the board of private companies. If an ID is associated with so many companies, the question arises would he fully committed and would his independence is not compromised in any case.

i) Duties/ Responsibility/ Liabilities

The new clause 147 (1 to 6) of the Bill lays down duties of a director (including ID). According to provisions of 147 (3), an ID should exercise his duties with due and reasonable care, skill and diligence. The clause 158, which corresponds to some provisions of the 292A of present Act, requires ID should form the majority and chair the audit and remuneration committee. The Chairman of stakeholders committee should also be non-executive director. In the light of this, the responsibilities of the IDs have enormously increased; he is also liable for financial penalties in failing to do so. Under provisions of the Bill, if a person who has given his consent to become the ID cannot relinquish from his responsibilities.

Further, if we look at definition of “officer in default” provided in the clause 2 (zzi) of the Bill corresponding to the section 5 of the Companies Act, the IDs are included in same. By virtue provisions of same clause: “(vi) every director, in respect of a contravention of any of the provisions of this Act, who is aware of such contravention by virtue of the receipt by him of any proceedings of the board or participation in such proceedings without objecting to the same, or where such contravention had taken place with his consent or connivance”. They are subject to liable for criminal and financial penalties according to clause 120 (7) of the Bill.

In Companies Act 1956, on careful analysis, it can be observed that IDs are included in the definition of “Officer in default” under section 5. On referring to section 292A on audit committees, the IDs are highly liable for both financial and criminal penalties, as being “officer in default” for any misdeed.  However, the accused ID can be granted relief by court, if they can satisfactorily prove that they have performed their functions honestly and exercised it with due diligence, care and caution. In most of cases, however, the director has to face the trial and has to proof in front of court that he has performed his care and diligence and he is not involved in the given accusation. The relief to prosecution is not automatically granted to ID under the present framework. The listed cases torch light on the discussed issue:  

1) Supreme Court: N.K. Wahi v. Sekhar Singh and others (2007) 2 LJ 10 (SC);
2) Rajasthan High Court: Alim Ahuja v. Registrar of Companies (2005) 62 SCL 110 ( Raj);
3) Supreme Court: SMS Pharmaceuticals Limited v. Neeta Bhalla [2005] 6 CLJ 144 (SC);

The Satyam fiasco has raised questions over the responsibilities and liabilities of the IDs. Serious Fraud Investigation Office (SFIO) has filed seven cases against eleven ex-directors (including IDs) of Satyam. Followed by this, AP government move to arrest the ID of Nagarjuna Finance in alleged involvement of repayment of public deposits has worsened the situation. All this created a fear psychosis in the mind of ID. According a report, nearly 340 IDs have resigned from their post. Many people are now not advent to accept the post of ID and tarnish their reputation.

Conclusion

IDs have their origin in the monitoring role to the management and they found prominent place in the CG books with passage of time. They have found entry into statue books of company law of the developed world long before as basis for sound governance and as a check on management to curb any corporate fraud. In India, IDs entered into corporate lexicon via Clause 49 of Listing Agreement, based on recommendations of Birla Committee of SEBI. Chandra and Murthy Committee Reports further strengthened the role of IDs. MCA, after much of the effort has been successful to introduce the concept of ID in Indian statue books via Companies Bill 2009. The first objective of this bill stipulates: “to segregate substantive law from the procedures to enable a clear framework for good CG that addresses the concerns of all stakeholders equitably”. However, it seems that objective is given only in letter but not in spirits. The contemporary scenario of world is looking to reinforce this institution of ID, making boards more independent. India is it seems to move backward in this direction, by hampering the independence of boards.

In India, we have just imported the concept of IDs from developed world. We just prefer form over substance and structure over process. The concept developed aboard needs to be validated in home conditions, to be work successfully. SEBI tried to impose conditions of IDs over companies, but it has not worked very well in Indian conditions, companies have adopted it only in form but problem has remained. The practice has remained the alike. MCA is making effort to incorporate idea into law books with much deliberation, but only to add false vows to both IDs and minority shareholders. The problem of IDs lies mainly in the appointment process of ID and the present Bill does nothing new to change that.