Explained: Independent Directors On Company Boards And Their Role In The Organisation

The office of independent directors on company boards have come into the news in light of developments in the Tata group. After Cyrus Mistry was removed as chairman of Tata Sons on 24 October, the top management now want him removed as chairman from all group companies too. But for the listed firms, this means the independent directors on the board of each must fall in line, which has not happened in each instance.

Independent directors of three companies – Tata Chemicals, Tata Motors and Indian Hotels Co – have voted in favour of a resolution that supports Mistry. But those on the board of Tata Global Beverages and Tata Consultancy Services (TCS) voted in favour of a resolution that sought Mistry’s removal as chairman. Faced with rising rebellion by independent directors, the Tata management has decided to replace Nusli Wadia, who sits as an independent director on the boards of Tata Motors, Tata Steel and Tata Chemicals through extraordinary general body meetings.

The last time the role of independent directors made headlines was in 2009, in the wake of the Satyam scandal. Founder-chairman Ramalinga Raju disclosed a Rs 7,000 crore accounting fraud. The independent directors were criticised for not being vigilant enough. In 2014, a hefty fine was imposed by the courts on one independent director of Satyam, for conflict of interest in providing professional services to the company and remaining on the board as an independent director, as well as for failing to get the government's nod for providing professional services. A fine of Rs 20,000 each was also levied on all the other former independent directors of Satyam.

The Satyam episode prompted market regulator Securities and Exchange Board of India (SEBI) to come out with an enhanced role for independent directors, and then the Companies Act was amended to include the concept and role of these directors. As per the definition of their role by SEBI, and in the Companies Act, independent directors must not serve conflicting interest of shareholders of a company, nor should they have any considerations other than protecting the interests of minority shareholders of the company.

A quick look at the office of independent directors and the role they play.

1. How did the office of independent directors get institutionalised?

J N Gupta of proxy advisory firm Stakeholder Empowerment Services (SES) says this term originated in the West, but began to be used in India in the 1990s, after SEBI came into existence.

Till 2013, market watchdog SEBI's listing agreement was the only regulation which sought compulsory appointment of independent directors on the boards of listed companies. But their role was not clearly defined. In April 2014, Clause 49 of the Listing Agreement under the Companies Act was amended; this clause defines who is eligible to become an independent director, what is the tenure of such directors, what code of conduct should such directors follow and so on.

The nominations committee of the board approaches suitable candidates for appointment as independent directors, but the names then have to be approved by shareholders at an AGM.

2. Who can be an independent director on the board of a listed company?

The term ‘Independent Director’ refers to a non-executive director (but not the Managing Director of a company, nor any whole time director) who, in the opinion of the Board, is a person of integrity and possesses relevant expertise and experience. He or she is not a promoter of the company or its associate companies, should not be related to the promoters or directors of the company and receives only a pre-determined remuneration as a director on board – has no other pecuniary relationship with the company. So listed companies cannot appoint relatives or friends of promoters, and independent directors should not even be related to the promoters of associate companies, subsidiaries and so on. Across the Tata Group companies, independent directors comprise experts from vastly different fields and each is an eminent personality in his or her own right. Nusli Wadia (Tata Steel, Tata Motors and Tata Chemicals) is the promoter of the Bombay Dyeing Group; Vijay Kelkar (TCS) is a well known economist; Deepak Parekh (Indian Hotels) is a banking and financial sector expert.

3. How many independent directors should there be on the board?

The Companies Act 2013 mandates listed firms to have at least one-third of the total number of directors as independent directors. But there is also a limit on the number of directorships a single person can hold as an independent director. If he or she is not a whole-time director on any listed company, then the person can be an independent director at a maximum of seven listed companies. This limit becomes three companies if the person is a whole-time director in even one.

4. What is the tenure of independent directors?

The maximum tenure is five consecutive years. They are eligible for re-appointment for another term of up to five consecutive years through a special resolution by the company.

5. Who pays the independent directors, and how are they paid?

An independent director gets a sitting fee and profit-related commission if approved by shareholders. Independent directors are not entitled to employee stock options. Also, after 2014, every listed company is required to set up a Nomination and Remuneration Committee with an independent director as chairman. Among other functions, this committee also decides the remuneration of all the directors of the company and the criteria used to decide this have to then be made public in the annual report.

6. What are the key responsibilities of independent directors?

Independent directors are required to meet at least once a year among themselves, without the presence of non-independent directors and management, to review the performance of non-independent directors and the chairperson of the company. Proxy advisory firm Institutional Investor Advisory Services (IiAS) said in a recent note to clients that “the institution of independent directors is a key construct of a company’s corporate governance framework. Independent directors have a fiduciary responsibility towards the minority shareholders and are expected to act independently, irrespective of the directives of the controlling shareholders.”

Independent directors are required to be objective in evaluating board members and management, safeguarding the interest of all stakeholders but particularly those of minority shareholders and balancing the conflicting interest of stakeholders.

7. Do promoters have the right to seek removal of an independent director?

The IiAS said under section 169 of Companies Act 2013, any director on the board can be removed by passing an ordinary resolution at a general meeting. For shareholders to propose such a resolution, they must collectively own 10 per cent and call for an extraordinary general meeting, or EGM, by giving a special notice under Section 100 of Companies Act 2013.

8. Can independent directors prevent mismanagement of a company?

Not quite. Even upright independent directors cannot prevent large-scale fraud or mismanagement in a company. Also, independent directors suffer from having inadequate knowledge about the company and rely largely on what the management tells them. “What’s happening in a company, financial statements etc – for all these, the CFO, management, auditors are responsible. Independent directors do not have the bandwidth to look at all these aspects in detail.”