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ILS LAW COLLEGE, PUNE

SEMINAR PAPER

TITLE- INDEPENDENT DIRECTORS

SUBJECT- PRINCIPLES OF CORPORATE LAW

SUBMITTED TO- MS. SWATI KULKARNI

SUBMITTED BY-

SAMHITA BANERJEE

LLM-I

730
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ABSTRACT

This paper discusses the role of the independent directors in corporate governance. Since the
1990s there has been a growing recognition on legal and regulatory measures for strengthening
the board of directors for effective supervision and monitoring of the top management of
companies. Since many internal and external mechanisms for monitoring the management of
corporations has not been generally effective and hence several task forces and committees in
USA, England, Canada, and Europe have focused on highlighting the role of the non-executive
or outside independent directors. However, corporate boards in general have the required
number of such directors but have been found devoid of minimum contribution to governance
process. Further the growing trend of Independent Director is another set of contribution by
SEBI in the field of Corporate Governance. However no law is complete in itself and certain
loopholes remains to be corrected. Under the concept of Independent Directors too there are
several loopholes because of which this law cannot be termed to be completely devoid of
corruption and hence a part of good corporate governance. The present study identifies some
opportunities for enhancing the role efficacy of the independent directors in companies in India.
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INTRODUCTION

The Cadbury committee in 1992, which itself was setup following the corporate scandals
involving BCCI, Poly Peck and Maxwell, provided respectability to the concept of Independent
Directors, by focusing on independent directors as a part of the new practices for better
governance. Independent Directors function as an oversight body monitoring the performance
and should raise red flags whenever suspicion occurs. They are expected to be more aware and
question the company on relevant issues in their position as trustees of stakeholders. The
institution of independent directors is a critical instrument for ensuring good corporate
governance and it is necessary that the functioning of the institution is critically analyzed and
proper safeguards are made to ensure efficacy. Companies Act 2013 mandates appointment of
Independent Directors by Listed Companies and other class of companies. It also prescribes
other aspects such as maximum tenure of independent directors, separate meeting of independent
directors, tenure, their qualification, liability, appointment; remuneration etc. The central
Government has exempted section 8 companies from the requirement of appointment of
Independent Directors.

WHO CAN BE INDEPENDENT DIRECTORS?

Section 149(6) provides for Independent Directors in relation of a company which when defined
states any director other than a managing director or a whole time director or a nominee director-

a) Who in the opinion of board, is a person of integrity and possesses relevant expertise and
experience.

In case of Government company, instead of Board, the Ministry or Department of the Central
Government which is administrative in charge of the company.

b) i) who is or was not a promoter of the company or its holding, subsidiary or associate
company.

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. In government companies, the criteria are not
required to be followed.

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
percent 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 current financial year.

e) Who, neither himself nor any of his relatives-

i) Holds or has held the position of key managerial personnel or is or has been employee of
the company or its holding, subsidiary or associate company in any the three financial years
immediately preceding 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

iii) Hold together with his relative 2% or more of the total voting power of the company

iv) is a chief executive or director of any NPO that receives 25% or more of its receipt from
the company, any of its promoters, director or its holding subsidiary or associate company or that
holds 2% or more of the total voting right of the Company

f) Who posses such other qualifications as may be prescribed.1

1
DR. G.K.KAPOOR & DR. SANJAY DHAMIJA, COMPANY LAW PG NO. 339-340( 21T ED,2018)
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ORIGIN OF ‘INDEPENDENT DIRECTORS’

The concept of independent directors can be traced to the developed economies of the West with
the United Kingdom and the U.S.A sharing credit for its evolution during 1950s, even before
legislation mandated the induction of independent directors to ensure that the only work of the
corporate entities were not only with the profit motive but also providing insight into other
values, ethical social and moral which ultimately gave rise to the concept of Good Corporate
Governance.

In India, the concept of independent directors was first introduced through voluntary guidelines
issued by the Confederation of Indian Industry (‘CII’). The Report suggested that any listed
company with a turnover of Rs. 100 crores and above should have professionally competent,
independent, non-executive directors, who should constitute at least 30 per cent of the board if
the chairman of the company is a non-executive director or at least 50 per cent of the board if the
chairman and managing director is the same person. This CII recommendation was later on
incorporated in SEBI’s Kumar Mangalam Birla Committee Report. The Kumar Mangalam Birla
Committee Report recommendation led SEBI to include clause 49 in the Listing Agreement in
the year 2000.2

ROLE OF INDEPENDENT DIRECTORS

1. Help in bringing an independent judgment to bear on the Board’s Deliberations especially

on issues of strategy, performance, risk management, resources, key appointments and
standard of conduct.
2. Bring an objective view in the evaluation of the performance of board and management
3. Scrutinize the performance of management in meeting agreed goals and objectives and
monitor the reporting of performance
4. Satisfy themselves on the integrity of financial information and that financial controls and
the systems of risk management are robust and defensible
5. Safeguard the interests of stakeholders, particularly the minority shareholder.
6. Balance the conflicting interest of stakeholders.

2
SEBI, REPORT OF THE KUMAR MANGALAM BIRLA COMMITTEE ON CORPORATE GOVERNANCE, 1999: (2000) 2 COMP LJ
23 (JOURNAL).
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SEBI AND INDEPENDENT DIRECTORS

The Securities Exchange Board of India have issued guidelines under clause 49 of the SEBI
(listing obligations and disclosure requirements) 2015 for the appointment of the independent
directors and the code of conduct they should follow in a company. As per SEBI the term
Independent directors refers to the non-executive director of a company who does not have any
material pecuniary relationship or transaction with the company, with its promoter, directors or
its senior managers. However Independent directors must not be related to the promoters or
persons occupying management positions at the board level or one level below the board or have
been the executive of the company in preceding three financial years.

REMUNERATION TO THE INDEPENDENT DIRECTORS

As per the Companies Act 2013, “remuneration” means any money or its equivalent is given or
passed to any person for services rendered by him and includes perquisites as defined under the
Income-Tax Act, 1961

Independent Directors devote their valuable time to addressing the strategic issues in the course
of the Board and Committee meetings and use their expertise while guiding the management of
the Company from time to time. Independent directors, who are truly independent, can be an
effective barricade against corporate frauds. However, active oversight and prudent judgment
may suffer when remuneration comes into the picture, as it is an important factor which needs
consideration. The extent of remunerating Independent Directors determines their retention and
motivation to discharge their duties without cloudy judgments.

The remuneration of an Independent Director is restricted to the following emoluments: 3

1. Sitting Fee: Sitting fee to an Independent Director may be paid for attending meetings of
the Board or committees thereof, such sum as may be decided by the Board of directors
of and shall not exceed INR 1, 00,000 per meeting of the Board or committee thereof.
The sitting fee to be paid to Independent Directors shall not be less than the sitting fee
payable to other directors.

3
PAVAN KUMAR VIJAY WHY QUESTION BEING RAISED ON INDEPENDENCE OF THE INDEPENDENT DIRECTOR?(
SEPTEMBER 27 2018, 6.45 PM)https://www.businesstoday.in
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2. Commission: The Act allows a company to pay remuneration to its Independent

Directors either by way of a monthly payment or a specified percentage of the net profits
of the company or a combination of both. Further, it states that where the company has
either a managing director or whole-time director or manager, then a maximum of 1% of
its net profits can be paid as remuneration to its Independent Directors. In case there is no
managing director or whole-time director or manager, then a maximum of 3% of net
profit can be paid. Thus, the basis of payment to the Independent Directors is the net
profit of the Company. The Company is however not obligated to remunerate its
Independent Directors. Hence the Company may pay profit related commission to the
Independent Directors with prior approval of the members. Given this, the commission
should be profit-linked only and not revenue based. The Act does not eliminate profit-
related commission which could create a conflict of interest since the commission is
linked to the company’s performance.
3. Consulting Fee: The remuneration of Independent Directors has been restricted to sitting
fees, reimbursement of expenses for participation in the board and other meetings, and
profit-related commission. Therefore, it can be noted that Consulting Fee is not allowed
to be paid to Independent Directors.
4. ESOP: The Act and SEBI (Listing Obligations and Disclosure Requirements)
Regulations 2015 prohibit the issuance of stock options to Independent Directors, in a bid
to address the concern that it might be causing a conflict of interest and will affect their
independence. An alternative option could have been to place restrictions either on the
total amount of issue of stock options or put a time limit on exercising stock options,
rather than having a complete prohibition.
5. Sweat Equity: The Company may opt to remunerate its Independent Director by way of
issuing sweat equity shares. However, such issuance shall be in accordance with the
procedure prescribed under the Act. The total percentage of voting power of such
independent director together with his relatives shall not exceed more than two percent.
6. Refund of excess remuneration paid: If the Independent Director draws or receives,
directly or indirectly, by way of fee/remuneration any such sums in excess of the limit as
prescribed or without the prior sanction, where it is required, such remuneration shall be
refunded to the Company within two years or such lesser period as may be allowed by the
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company and until such sum is refunded, hold it in a trust for the Company. The
Company shall not waive the recovery of any sum refundable to it unless approved by the
Company by special resolution within two years from the date the sum becomes
refundable.

DO WE REALLY NEED INDEPENDENT DIRECTORS?

The very first reason to state for inclusion of Independent Director on board is definitely the
‘independent’ characteristics of them. An independent director is not as closely tied to the
company as executive and investor board members; this can allow the independent director to
be more impartial and objective. Therefore the major work of the independent director is to
look after the well-being of the company and shareholder’s interest in the firm.

In a cluster of board of directors having varied outlooks and view point there has to be the
presence of a neutral person handling the decisions and hence bring focus and depth of
perspective in the company. However SEBI as well as The Companies Act 2013 via
Amendment 2017 have not provided absolute power of indulgement of the independent
directors.

However with the introduction of independent directors as among the board the key conflict
are been easily dissolved. This unique role played by the independent directors drives the
company faster towards the goal.

COMMITTIES AND SUGGESTIONS

The Report of the Kumar Mangalam Birla Committee of 1999 on Corporate Governance has
critised the conventional practice of hand-picking of Independent directors because such
system by itself takes away the ‘independence ‘of directors. This loophole is still to be
addressed raises the most important question that how can directors be independent when
they themselves are selected by the promoters of the company.

The Report of the Birla Committee highlighted the short comings of the provision relating to
the remunerations of the independent directors. The committee was of a view that adequate
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remuneration must be provided to the independent directors so that their position becomes
financially attractive to draw talent and ensure integrity in their workings.

BENEFITS OF KEEPING INDEPENDENT DIRECTORS

The Potential Benefits of an Independent Director are well known. Independent Directors are
usually leaders with few reasons to be beholden to the CEO. Boards dominated by
independent directors are better able to oversea the CEO and protect the interest of other
shareholders and the stakeholders. Increasing their number can foster better board
performance by enhancing company’s access to external resources and conclusions. A larger
number of Independent directors also allow a board to ensure that its members are not
overburdened with over sight responsibilities to the detriment of strategic counseling. A fully
independent board enables a company to reap these benefits without enlarging its board,
thereby avoiding the potential disadvantage of a large board.

WHY INDEPENDENT DIRECTOR NEEDS TO BE REMOVED (IF)?

The major reason Independent Director can be praised on is its Independence and the major
reason it can be critised on is also its independence. While, in principle, it is a good idea to have
many independent directors on the board, this in itself does not guarantee that minority
shareholders’ interests are protected. At the end of the day, independent directors are appointed
by executives of the company. So even if these directors are competent, they do not question the
management. This, therefore, raises questions regarding the wisdom in according increasing
focus on the number of independent directors. It is possible, for example, if the company
appoints more independent directors after a disappointing performance. One cannot expect the
performance of such firms to improve overnight. Independent directors can suffer from having
inadequate knowledge about the company. Satyam is a case in point. So, one cannot expect much
from these directors. Independent directors may indeed be inefficient. Even when they are
efficient, as they are appointed by the management, they may prefer to support the management.
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LACCUNA IN THE FIELD OF THE INDEPENDENT DIRECTORS

In reference of THE SATYAM FRAUD- Some of the lacuna which limits the working of the
independent directors is that most of them are reluctant to disturb the collegiality and
conviviality of the collective decision making. The biggest example of this lacuna lies in the
example in the Satyam Scandal.

The Satyam episode has brought out the failure of the present corporate governance structure.
The present corporate governance structure hinges on the independent directors, who are
supposed to bring objectivity to the oversight function of the board and improve its effectiveness.
Stakeholders place high expectation on them.

An individual independent director cannot play an effective role in isolation. Even if a particular
independent director is highly committed, she can only ‘watch’ wrong doing and at best initiate a
discussion, but alone she cannot stop a decision even if it is detrimental to the interest of
shareholders or other stakeholders. Neither can she blow the whistle outside the board room (e.g.
to regulators) because board proceedings are considered confidential.4

The only way independent directors can stop wrong decisions is by acting collectively. Even
then they can seldom be expected to stop ‘management fraud’ since turning independent
directors into policemen in the board room will have excessive detrimental effects on the
independence of directors, the freedom of enterprise of the managers and the costs of
governance.

Independent directors may not be in a position to stop management fraud perpetrated at the
highest level, but with high level of commitment and due diligence they should be able to
identify signals. The independent directors on the board included Vinod K Dham (famously
known as 'father of Pentium’ and an ex-Intel employee), M Rammohan Rao (Dean of Indian
School of Business), U S Raju (former director of IIT Delhi), TR Prasad (former union cabinet

4
supra note 3
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secretary), M Srinivasan (retired professor from many US universities) and Krishna Palepu
(Professor at the Harvard Business School).5

The company in its corporate governance report for 2007 did not name Palepu as independent
director, perhaps because he received Rs 87 lakh from the company towards consultancy fees.
Each individual director received around Rs 13 lakh for the year 2007 for say 100 hours of work
(a survey in US reveals that independent directors in large companies devote 50-100 hours per
annum to carry out board responsibilities).6 Keeping in view the compensation levels in India,
the compensation should be considered good. In Satyam it can be said that the independent
directors showed lack of commitment.

CONCLUSION AND SUGGESTION

However at the end it can be said that the objectives of corporate governance can be effectively
met without the inclusion of Independent directors in the larger scheme of things. With the
growth of business there is a rise in expectation that the Indian companies would abide by the
Indian standards of corporate governance.

Clause 49 should come as a reminder to the directors that they are the fiduciaries of the
shareholders and not that of the management. This fiduciary relationship strives for affirmative
action on the part of the Independent directors.

Clause 49 of the listing agreement makes the entire exercise of independent directors limited to
legally-defined numbers. All companies follow the norm.

But unless independent directors give their independent views at board meetings, it will not serve
any purpose in having them.

Though on paper, shareholders decide whether a particular person should be appointed as a

director or not, usually, all resolutions get passed in the AGM. Since not much information is
available about most independent directors, minority shareholders also cannot take an

5
Ibid
6
Ibid
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independent view. In such a case, the view of proxy firms or some independent rating agency
would prove to be useful to all the minority shareholders in the country.

SELECT BIBLOGRAPHY

Books-

Company law by D.r. G.K Kapoor & D.R Sanjay Dhamija

Websites-

1. www.jstore.org

2. www.sebi.gov.in

3. www.bseindia.com