Appointment and role of Independent Directors under Companies Act, 2013

Introduction

Independent Directors play a pivotal role in maintaining a transparent working environment in

the corporate regime. The Companies Act, 1956 does not expressly provide for Independent
Directors except Clause 49 of the listing agreement that is applicable on all listed companies
which mandates the appointment of Independent Directors on the Board. Independent Directors
constitute such category of Directors who are expected to have impartial and objective judgment
for the proper functioning of the company. Section 149(4) of the Companies Act, 2013 provides
for a special class of Directors called “Independent Directors”.

Corporate Governance is one of the most important differentiators of a business that has impact
on the profitability, growth and sustainability of business. It is a multi-level process that relates
to organization’s culture, policies and code of conduct.

In India, after due deliberated efforts of Kumar Birla committee and consequent recommendation
of Narayan Murthy Committee, Clause 49 of the Listing Agreement was revised with
modifications to adopt Corporate Governance structure. Primarily all listed companies were
mandatorily required to adhere to Corporate Governance structure.

Corporate Governance deals with various stakeholders as described below:

Revised Corporate Governance structure gave rise to reconstitution of board so as to include
high-caliber non-executive independent directors and prevention of the concentration of power in
one individual or a special influence. Now let us critically analyse the position, role, functions,
duties, liabilities etc. of Independent Director as contemplated under the Companies Act, 2013.

DEFINITION:

According to sub-section (6) of section 149 of the Companies Act, 2013 an independent director
in relation to a company, means a director other than a managing director or a whole-time
director or a nominee director,—

(a) who, in the opinion of the Board, is a person of integrity and possesses relevant expertise and
experience;

(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;

(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;

(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 per
cent. 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 two immediately preceding financial years or
during the current financial year;

(e) who, neither himself nor any of his relatives—

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

(A) a firm of auditors or company secretaries in practice or cost auditors of the company or its
holding, subsidiary or associate company; or

(B) any legal or a consulting firm that has or had any transaction with the company, its holding,
subsidiary or associate company amounting to ten per cent. or more of the gross turnover of such
firm;
(iii) holds together with his relatives two per cent. or more of the total voting power of the
company; or

(iv) is a Chief Executive or director, by whatever name called, of any nonprofit organisation that
receives twenty-five per cent. or more of its receipts from the company, any of its promoters,
directors or its holding, subsidiary or associate company or that holds two per cent. or more of
the total voting power of the company; or

(f) who possesses such other qualifications as may be prescribed.

The definition of Independent Director as per Companies Act, 2013 provides quantitative
threshold for evaluation of significance of the relationship and considers all pecuniary
relationship (both material and immaterial).

POSITION OF “INDEPENDENT DIRECTOR” IN BOARD COMPOSITION:

As per sub section 4 of Section 149 of the Companies Act 2013, every listed public company is
mandatorily required to have at least one-third of the total number of directors as independent
directors.

Unlisted public companies must appoint at least two independent directors in the following
circumstances:

i. if the paid up share capital exceeds Rs.10 crores;

ii. if the turnover exceeds Rs.100 crores;

iii. if the aggregate of all the outstanding loans, debentures and deposits exceeds Rs 50 crores.

QUALITIES OF INDEPENDENT DIRECTOR

An independent director shall possess appropriate skills, experience and knowledge in one or
more fields of finance, law, management, sales, marketing, administration, research, corporate
governance, technical operations or other disciplines related to the company’s business.

Broadly one who wishes to qualify as an Independent Director has to possess following
unwritten qualities:

1. Impartiality

2. Loyalty

3. Decision- making (judgment)

4. Professional repute
Manner of selection and other procedural requirement has been provided under Section 150 of
Companies (Appointment and Qualification of Directors) Rules, 2014 which is to be read along
with Companies (Appointment and Qualification of Directors) Amendment Rules 2015.

ROLE AND DUTIES OF INDEPENDENT DIRECTORS :

The role of independent directors is considered to be of a great significance. The guidelines, role,
functions and duties are broadly set out under Code of conduct under Schedule IV of the
Companies Act, 2013. The code of conduct lays down the guidelines of professional conduct as
well as role, functions and duties of independent director.

Role and functions listed under Schedule IV of the Companies Act, 2013 are as under:

The independent directors shall:

(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 standards of
conduct;

(2) bring an objective view in the evaluation of the performance of board and management;

(3) scrutinise 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 all stakeholders, particularly the minority shareholders;

(6) balance the conflicting interest of the stakeholders;

(7) determine appropriate levels of remuneration of executive directors, key managerial

personnel and senior management and have a prime role in appointing and where necessary
recommend removal of executive directors, key managerial personnel and senior management;

(8) moderate and arbitrate in the interest of the company as a whole, in situations of conflict
between management and shareholder’s interest.

POSITION OF INDEPENDENT DIRECTORS IN COMMITTEES:

As a part of Corporate Governance, the companies meeting some threshold criteria are required
to constitute/ reconstitute board. The Companies Act 2013 has also emphasized on the
appointment of an Independent Director as a member and as a chairperson in various
committees.

Let’s understand the same in a tabular form:

In case of Stakeholders Committee, the Board of Directors of the Company which consist of
more than one thousand shareholders, debenture-holders, deposit-holders and any other security
holders at any time during a financial year shall constitute a Stakeholders-relationship
Committee consisting of a chairperson who shall be a non-executive director and such other
members as may be decided by the board. As a good Corporate Governance practice the
Companies Act, 2013 raised need to establish Vigil (Whistle Blower) Mechanism which aims to
provide a channel to the Directors and employees to report genuine concerns about disreputable
behaviour, actual or suspected fraud or violation of the Codes of Conduct or policy.

INDEPENDENT DIRECTORS’ MEETINGS:

The Companies Act, 2013, requires all Independent Directors to meet at least once in a year. The
meeting must be convened without the attendance of non-independent directors and members of
the management. In fact all the independent directors of the company are required to be present
at such meeting to:

(a) review the performance of non-independent directors and the Board as a whole;

(b) review the performance of the Chairperson of the company, taking into account the views of
executive directors and non-executive directors;

(c) assess the quality, quantity and timeliness of flow of information between the company
management and the Board that is necessary for the Board to effectively and reasonably perform
their duties.

REMUNERATION:

The Companies Act, 2013 expressly disallows independent directors from obtaining stock
options and remuneration other than sitting fees and reimbursement of travel expenses for
attending the board and other meetings. Sitting fees to be paid to Independent Directors for
attending the Board Meetings pursuant to Section 197(5) which is maximum of Rs.1,00,000/- per
meeting is to be decided by the Board. Profit related commission may be paid to independent
director subject to the approval of the shareholders.

As per General Circular 14/2014, an Independent Director would not be considered to have a
pecuniary relationship under section 149(6)(c) for transactions with a company, its holding,
subsidiary or associate company, or their promoters, or directors, provided such transactions are
in the ordinary course of business and are on an arm’s length basis.

TERM OF OFFICE OF INDEPENDENT DIRECTOR

An independent director shall hold office for a term up to 5 consecutive years on the Board of a
company, but shall be eligible for reappointment on passing of a special resolution by the
company and disclosure of such appointment in the Board’s report. As per MCA Clarification
vide General Circular 14/2014, an Independent Director even if appointed for a lesser period
than of 5 years will be held as appointed for one term.

No independent director shall hold office for more than 2 consecutive terms, but such
independent director shall be eligible for appointment after the expiration of 3 years of ceasing to
become an independent director provided that he shall not, during the said period of 3 years, be
appointed in or be associated with the company in any other capacity, either directly or indirectly.

Retirement of directors by rotation shall not be applicable to appointment of independent

directors.

LIABILITY:

The Companies Act, 2013 restricts and limits the liability of Independent Directors only in
respect of acts of omission or commission by a company which had occurred with his
knowledge, attributable through board processes, and with his consent or connivance or where he
had not acted diligently.

HOW TO OFFER CANDIDATURE AS INDEPENDENT DIRECTOR

One who wishes to offer the candidature as Independent Director may enroll the name at The
Independent Directors repository. The Independent Directors repository is a joint initiative of the
three professional statutory bodies namely “The Institute of Chartered Accountants of India,
The Institute of Company Secretaries of India and The Institute of Cost Accountants of
India” under the active encouragement of the Ministry of Corporate Affairs, Government of
India. This repository has been developed to facilitate the individuals who are eligible and
willing to act as Independent Directors and also to facilitate Companies to select the persons who
are eligible and willing to act as Independent Directors under section 150 of the Companies Act,
2013 and Rules made there under.

It is discretionary for the companies to choose suitable persons for the position as an
“Independent Director” from the Independent Directors repository. The responsibility of
exercising due diligence before selecting a person from the data bank referred to above, as an
independent director lies with the company making such appointment.
PROCEDURAL REQUIREMENT FOR APPOINTMENT, RESIGNATION AND
REMOVAL OF INDEPENDENT DIRECTOR

APPOINTMENT

1. The Independent Director has to submit the Consent to act as Director in FormDIR-2 to the
Company.

2. The Independent Director has to submit a declaration that he/ she is not disqualified to be
appointed as a Director as per provisions of Section 164(1) & (2) of the Companies Act, 2013 in
Form DIR-8 to the Company.

3. The Independent Director has to submit a declaration of independence as per Section 149(6) of
the Companies Act, 2013 before his/her appointment. Such declaration has to be placed before
the 1st Board Meeting in which he/ she participates as a director and the subsequent first board
meeting in each financial year.

4. As per Schedule IV(IV)(4) to the Companies Act, 2013 the Company will have to issue the
appointment letter to Independent Director. Also the terms and conditions of Independent
Director’s appointment have to be posted on the company’s website.

5. Lastly the Company has to file the consent of Independent Director with Registrar of
Companies within 30 days of his/her appointment in Form DIR-12;

RESIGNATION:

1. An Independent Director may resign from his/her office by giving a notice in writing to the
Company.

2. Within 30 days from the date of receipt of such notice the Board shall file same with Registrar
of Companies in Form DIR- 12.

3. The director shall also forward a copy of resignation along with detailed reasons for the
resignation to the Registrar of Companies within 30 days of resignation.

REMOVAL:

1. A Company may, by ordinary resolution, remove a director, before the expiry of his period
after giving a reasonable opportunity of being heard.

2. A special notice is required for any resolution, to remove a director under this section, or to
appoint somebody in place of a director so removed.

3. The vacancy shall be filled within a period of not more than 180 days.

INTERMITTENT VACANCY OF AN INDEPENDENT DIRECTOR:

Any intermittent vacancy of an Independent director shall be filled-up by the Board of Directors
at the earliest but not later than immediate next board meeting or 3 months from the date of such
vacancy, whichever is later.

Conclusion:

The concept of the institution of Independent Director is of utmost importance for Corporate
Governance. Independent Director is expected to act as the trustees of stakeholders. Thus the
Companies Act, 2013, has sought to balance the wide nature of the obligations, functions and
duties imposed on Independent Directors. The Act restricts and limits the liability of Independent
Directors only in respect of acts of omission or commission by a company which had occurred
with his knowledge, attributable through board processes, and with his consent or connivance or
where he had not acted diligently.

Who can become an Independent Director (ID)?

As per Section 149(6) of the Companies Act, 2013 an ID in relation to a company means a
director other than a managing director or a whole-time director or a nominee director-

1) who is a person of integrity and possesses relevant expertise and experience;

2) who is 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

3) who has no any pecuniary relationship with the company, its holding, subsidiary or associate
company or their promoters or directors amounting to 2% or more of its gross turnover or total
income or INR 50 lakh, whichever is lower during the two immediately preceding financial
years or during the current financial year,

4) Who neither himself nor any of his relatives-

i) holds the position of a Key Managerial Personnel (KMP) or has been an employee of the
company or its holding, subsidiary or associate company in any of the 3 financial years
immediately preceding the financial year in which he is proposed to be appointed;

ii) is an employee or proprietor or a partner in any of the 3 financial years immediately preceding
the financial years in which he is proposed to be appointed of-

a) a firm of auditors or company secretaries in practice or cost auditors of the company or its
holding, subsidiary or associate company; or

b) any legal or a consulting firm that has any transaction with the company, its holding,
subsidiary or associate company amounting to 10% or more of the gross turnover of such firm;
iii) holds together with his relatives 2% or more of the total voting power of the company

iv) or is a Chief Executive or Director of any non profit organization that receives 25% or more
of its receipts from the company or holds 2% or more voting power of the company

Which companies must appoint an Independent Director?

Section 149 (4) provides that at least 1/3rd of total number of Directors shall be ID’s in case of:

i) Public listed companies having a paid up share capital of INR 100crores or more; or

ii)Public companies which have outstanding loans or borrowings or debentures or deposits

exceeding INR 200 crores;

Qualifications, Remuneration and Tenure of IDs

A) An ID shall possess appropriate balance of skills, experience and knowledge in the fields of
finance, law, management, sales, marketing, administration, research, corporate governance,
technical operations and other disciplines related to company’s business

B) An ID shall not be entitled to any stock option and may receive remuneration by way of fee,
reimbursement of expenses for participation in Board and other meetings and profit related
commission as approved by the board of members (Sections 197 & 198).

C) An ID shall hold office for a period of 5 years consecutively on the Board of a company and
is eligible for reappointment on passing of a special resolution by the company (Section 152).

D) No ID shall hold office for more than 2 consecutive terms. Provided he shall be eligible for
reappointment after the expiration of 3 years of ceasing to be an ID. Further, such an ID shall not
be appointed or associated with the company in any capacity either directly or indirectly in those
three years.

How to select an Independent Director?

Section 150 provides the manner of selection of ID’s. It states that-

i) An ID may be selected from a databank containing names, addresses and qualifications of

persons who are eligible and willing to act as ID’s maintained by any body, institute or
association as prescribed by the Central Government [Section 150 (1)].

ii) The appointment of ID’s shall be approved by the company in the general meeting [Section
152(2)]

iii) The data bank [Section 150(1)] shall consist of the following particulars regarding persons
willing and eligible to be an ID’s. Those are:-
  DIN (Director Identification Number);
 Name and surname in full;
 PAN number;
 Father’s / Spouse’s name (if married);
 Gender;
 Nationality;
 Occupation;
 Full address with PIN code (present and permanent);
 Educational and professional qualifications;
 Details of experience and expertise;
 List of LLP’s in which he was a designated partner consisting of names of the LLP,
nature of industry and duration with dates;
 List of companies in which he was a director consisting of the name of the company,
nature of industry, nature of directorship and duration with dates etc.

iv) Any person who is desirous of getting his name included in the data bank of ID’s shall make
an application to the body, institute or association as notified by the Central government.

v) Such data bank posted on the website shall-

 be publicly accessible in the specified website,

 be substantially identical to the physical panel or data bank;
 be presented in a format convenient for both printing and viewing online and
 contain a link to obtain a software required to view/ print the particulars free of charge.

vi) The Central government has the power to prescribe the manner of selection of ID’s who
fulfills the qualifications and requirements under section 149.

Code for Independent Directors

Guidelines for professional conduct:

1) To uphold ethical standards of integrity and probity;

2) To act objectively and constructively while exercising his duties;

3) To exercise his responsibility in a bonafide manner in the interest of the company;

4) To devote sufficient time to his professional obligations for informed and balanced decision
making;

5) To avoid abusing his position to the detriment of the company and refrain from any action that
would lead to the loss of his independence;

6) To assist the company in ensuring best corporate governance practices.

Functions of ID’s:

1) To bring an independent judgment on issues of strategy, performance, risk management,

resources, key appointments and standards of conduct;

2) To scrutinize the performance of management in meeting agreed goals and objectives;

3) To safeguard the interests of all stakeholders, esp. minority shareholders;

4) To balance the conflicting interests of all stakeholders;

5) To moderate and arbitrate in the interest of the company as a whole.

Duties of ID’s:

1) To undertake appropriate induction and regularly update and refresh their skills, knowledge
and familiarity with the company;

2) To strive to attend all meetings of the Board of Directors and of the Board Committees of
which he is a member;

3) To keep themselves well informed about the company and the external environment under
which it operates;

4) To ensure adequate deliberations are held before approving related party transactions and
assure that the same are in the interest of the company;

5) To report concerns about unethical behaviour, actual or suspected fraud of the company’s code
of conduct;

6) Not to disclose confidential information including commercial secrets, technologies,

advertising and sales promotion plans etc. unless such disclosure is approved by Board or by law.

Manner of appointment of ID’s:

1) The appointment process of ID’s shall be independent from the company management where
the Board ensures that there is appropriate balance of skills, experience and knowledge in the
Board for proper and effective discharge of its functions.
2) The appointment of ID’s shall be approved at the meeting of the shareholders.

3) The explanatory statement attached to the notice of the meeting shall include a statement that
the ID proposed to be appointed fulfills the conditions mentioned in the Act.

4) The appointment of ID’s shall be formalized through a letter of appointment which states the

 term of appointment,
 expectation of the Board from the Director and fiduciary duties and liabilities
accompanying it,
 code of business ethics that the company expects its Directors and employees to follow,
 list of actions that the directors should not do while functioning as such in the company
 remuneration, periodic fees, reimbursements of expenses for participating in the Board
meetings etc.

5) The terms and conditions for appointment of ID’s shall be posted in the company’s website.

Resignation or removal of ID’s:

1) An ID who resigns or is removed from the Board shall be replaced by a new ID within a
period of 180 days from the date of such resignation.

2) The resignation and removal of an ID shall be carried out in accordance with Sections 168 and
169 of the Act (168- resignation of Directors, 169- removal of Directors by the Board)

Conclusion:

The mandatory insertion of ID’s in specified classes of companies is highly anticipated to pave
the way for transparent and accountable corporate governance. One of the core objectives of
appointment of ID’s is to safeguard the interests of the minority shareholders. ID’s as a
regulatory authority is vested with the sole responsibility to monitor the proper conduct and
impartial judgment owing to the interests of the investors. Hence, inclusion of ID’s is expected
to act as a strong instrument to check intended corporate scandals in the future.