Independent Directors – Urgent Need To Strengthen the Institution

[2022] 134 taxmann.com 78 (Article)

Envisaged Role of Independent Directors

Corporate Governance reforms, globally, have laid enormous emphasis on the functioning of a Company’s Board of Directors and Board Committees in improving its corporate governance practices . The broad thrust has been to establish balance between management and the board so that the former runs the Company while the latter contributes to its strategic and operational development and provides the oversight needed to meet the interests of all stakeholders. The rationale of having independent directors on the Board of a company is with an idea to keep a special eye on the finances and the governance practices of a Company.

Recent corporate happenings have thrown up some interesting corporate governance challenges about the Independence of Independent Directors. If one probes the evolution of the institution of independent directors there will no two opinion on the fact that it has been one of the noteworthy reforms, which has been initially buffeted by big corporate frauds. The recent corporate events in India betray the near collapse of this institution.

What the Law on Appointment and Removal of an Independent Director says?

The Indian Companies Act and/or the SEBI, Listing Obligations and Disclosure Requirements, 2015 does not contain any specific procedure for nomination and appointment or removal of independent directors , except that the Nomination and Remuneration Committee plays a recommendatory role in selection of Directors. The process of appointment of an Independent Director occurs in the same manner as it does for any other director. It therefore requires us to explore the provisions of the Indian Companies Act to examine how directors are appointed and the various factors that play out in that regard.

Schedule-IV to the Companies Act, 2013 contains the code for independent directors. Clause VI of this code says that the resignation or removal of an independent director shall be in the same manner as provided in Section 168 and Section 169 of the Companies Act, 2013. As far as resignation of an independent director is concerned, there is no difficulty in complying with Section 168 of the Companies Act, 2013. The difficulty arises when removal of an independent director is also in the same manner as provided in Section 169 of the Companies Act, 2013 for ordinary directors. Under Section 169 of the Companies Act, 2013 as was the case under Section 284 of the Companies Act, 1956; a director could be removed by an ordinary resolution. An ordinary resolution in law can be passed with a 51% majority, which in other words, means a simple majority.

The Stark Reality in Terms of Implementation

In India, the appointment of each director is to be voted on individually at a shareholders’ meeting by way of a separate resolution. Each director’s appointment is to be approved by a majority of shareholders present and voting on such resolution. Hence, controlling shareholders, by virtue of being able to muster a majority of shareholders present and voting on such resolution can control the appointment of every single director and thereby determine the constitution of the entire board. Similarly, controlling shareholders can influence the reappointment (or otherwise) of the term of directorship. More importantly, shareholders possess significant powers to effect the removal of a director. All that is required is a simple majority of shareholders present and voting at a shareholders’ meeting. The only protection available to directors being subject to removal is that they are entitled to the benefit of the principles of natural justice, with the ability to make a representation and explain their own case to the shareholders before the meeting decides the fate of such directors. The removal can be for any reason, and there is no requirement to clearly establish “cause,” thereby making it a potential weapon in the hands of controlling shareholders to wield against directors (particularly those directors that the controlling shareholders see as errant to their own perceptions regarding the business and management of the company).

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