Independent Directors

A concept beyond legal prescription

PREPARED BY:
JHILIK PRADHAN
ACS-61783
Board of Directors are dominant to the governance of companies. The board play a vital role
in providing direction to the management in terms of strategy and ensuring that the companies
operate in the best interests of the shareholders and other stakeholders. Board independence is
a cornerstone of accountability and the presence of independent directors in the boardroom has
been hailed as an effective deterrent to fraud, mismanagement, inefficient use of resources,
inequality and unaccounted ability of decisions.

The dramatic changes in the recent past in the regulatory environment in India on corporate
governance with the enactment of the Companies Act, 2013 and the impending implementation
of the revised clause 49 of the Listing Agreement has enhanced the role of independent
directors in corporate governance.

The Companies Act 2013 has introduced significant changes in the composition of the board
of directors of a company. This White Paper contains the description of some provisions related
to Independent Directors which have been modified in Companies Act 2013.

APPLICABLE RULES AND SECTIONS:

 Companies Act, 2013 – Section 2(47), 149, 150, 152, 160, 164(1) & (2)
 Chapter XI Rules Viz. Companies (Appointment and Qualification of Directors)
Rules, 2014
 Listing Agreement – Clause 49

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 KEY CHANGES
The following key changes have been introduced regarding composition of the board:

NUMBER OF DIRECTORS (SECTION 149)

MINIMUM MAXIMUM
INDIVIDUALS
DIRECTORS DIRECTORS

• Every Public • Maximum of fifteen • Only individual can be

Company shall have a
minimum number of
three directors. • A company may
• Every Private
Company shall have
two directors in private
company and
• Every One Person
Company shall have
one Director.
directors in its Board of appointed as Directors.
Directors.
appoint more than
fifteen directors after
passing a special
resolution.

Allowing companies to increase the maximum number of directors on their boards by way
of a special resolution would ensure greater flexibility to companies.

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 CLASS OF DIRECTORS

INDEPENDENT
RESIDENT DIRECTORS WOMAN DIRECTORS
DIRECTORS

• Every company • Every listed public • Prescribed class or

shall have at least company shall classes of
one Director who have at least one company shall
has stayed in third of the total have at least one
India for a total number of woman director.
period of not less directors as
than 182 days in independent
the previous directors and CG
calendar year. may prescribe the
minimum number
of independent
directors in case
of any public
company.

CA 1956 did not require companies to appoint an independent director on its board.
Provisions related to independent directors were set out in Clause 49 of the Listing
Agreement (“Listing Agreement”).

The requirement to have a resident director on the board of companies has been viewed as a
move to ensure that boards of Indian companies do not comprise entirely of non-resident
directors. This provision has caused significant difficulties to companies since it has been
brought into force with immediate effect, requiring companies to restructure their boards
immediately to ensure compliance with CA 2013.

The following class of companies shall appoint at least one woman director-

1. Every listed company;

2. Every other public company having-
I. Paid up share capital of one 1,000,000,000 (Rupees One Hundred Crore)
II. Turnover of INR 3,000,000,000 (Rupees Three Hundred Crore)

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 INDEPENDENT DIRECTORS
An independent director is not a managing director or whole time director or a nominee
director.

a) Number of Independent Directors:

In terms of the Listing Agreement, only listed companies were required to appoint independent
directors. The number of independent directors on the board of a listed company was required
to be equal to

 one third of the board, where the chairman of the board is a non-executive director; or

 one half of the board, where the chairman is an executive director.

However, under Companies Act 2013, the following companies are required to appoint
independent directors:

Requirement of
Independent Directors

Certain specified
companies that meet the
criteria listed below are
required to have atleast 2
(two) independent
director:-
Public Listed Company
atleast one third of the
board to be comprised of
IDs

Public companies which

Public Companies which have, in the aggregate,
Public companies which outstanding loans,
have paid up share capital
have a turnover of Rs. debentures and deposits
of Rs. 10 crores or more.
100 crore or more. exceeding Rs. 50 crore

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b) Qualification criteria: Section 149 (6)

CA 2013 prescribes detailed qualifications for the appointment of an independent director on

the board of a company. Some important qualifications include:

 he / she should be a person of integrity, relevant expertise and experience;

 he / she is not or was not a promoter of, or related to the promoter or director of the
company or its holding, subsidiary or associate company;

 he / she has or had no pecuniary relationship with the company, its holding, subsidiary
or associate company, or their promoters, or directors during the 2 (two) immediately
preceding financial years or during the current financial year;

 none of whose relatives have or had pecuniary relationship or transaction with the
company, its holding, subsidiary or associate company, or their promoters, or directors
amounting to 2 (two) percent or more of its gross turnover or total income or INR
5,000,000 (Rupees five million only), whichever is lower, during the 2 (two)
immediately preceding financial years or during the current financial year.

 He or his relative does not hold the position of KMP or in employment of the company,
its holding, subsidiary or associate company in any of the 3 immediately preceding
financial years.

 He or his relative has not been in employment of firm of auditors, company secretary
or cost auditors of the company or legal consultants of the company.

 He does not hold together with his relatives 2% or more of the total voting power of the
company.

 He or his relative has not be chief executive or director of any non- profit organization
that receive 25% of its receipt from the company, any of its promoters or directors or
its holding, subsidiary or associate company or that holds 2% or more of the total voting
power of the company.

It is evident from provisions of CA 2013 that much emphasis has been placed on
ensuring greater independence of independent directors. The overall intent behind these
provisions is to ensure that an independent director has no pecuniary relationship with,
nor is he provided any incentives (other than the sitting fee for board meetings) by it in
any manner, which may compromise his / her independence. In view of the additional
criteria prescribed in CA 2013, many listed companies may need to revisit the criteria
used in appointing their independent directors.
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c) Manner of selection of independent directors and maintenance of
databank of independent directors:

(1) Subject to the provisions contained in sub-section (6) of section 149, an independent
director may be selected from a data bank containing names, addresses and qualifications of
persons who are eligible and willing to act as independent directors, maintained by any body,
institute or association, as may by notified by the Central Government, having expertise in
creation and maintenance of such data bank and put on their website for the use by the company
making the appointment of such directors:

Provided that responsibility of exercising due diligence before selecting a person from the data
bank referred to above, as an independent director shall lie with the company making such
appointment.

(2) The appointment of independent director shall be approved by the company in general
meeting and the explanatory statement annexed to the notice of the general meeting called to
consider the said appointment shall indicate the justification for choosing the appointee for
appointment as independent director.

(3) The data bank referred to in sub-section (1), shall create and maintain data of persons
willing to act as independent director in accordance with such rules as may be prescribed.

(4) The Central Government may prescribe the manner and procedure of selection of
independent directors who fulfil the qualifications and requirements specified under section
149.

d) Liability of Independent Directors:

In terms of the CA 1956, independent directors were not considered to be “officers in default”
and consequently were not liable for the actions of the board. CA 2013 however, provides that
the liability of independent directors would be limited to acts of omission or commission by a
company which occurred with their knowledge, attributable through board processes, and with
their consent and connivance or where they have not acted diligently.

CA 2013 proposes to empower independent directors with a view to increase accountability

and transparency. Further, it seeks to hold independent directors liable for acts or omissions or
commission by a company that occurred with their knowledge and attributable through board
processes. While CA 2013 introduces these provisions with a view of increase accountability

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in the board this may discourage a lot of persons who could potentially have been appointed as
independent directors from accepting such a position as they would be exposed to greater
liabilities while having very limited control over the board.

e) Position of Nominee Directors:

While the Listing Agreement stated that the nominee directors appointed by an institution that
has invested in or lent to the company are deemed to be independent directors, CA 2013 states
that a nominee director cannot be an independent director. However, the SEBI Circular in line
with the provisions of CA 2013 has excluded nominee directors from being considered as
independent directors.

CA 2013 defines nominee director as a director nominated by any financial institution in

pursuance of the provisions of any law for the time being in force, or of any agreement, or
appointed by the Government or any other person to represent its interests.

The concept of independent director was introduced as part of the CA 2013 with a view to
bring in independent judgement on the board. A director, once appointed, has to serve the
interest of the shareholders as a whole. Directors appointed by private equity investors shall
also be covered under the definition of nominee directors, and would no longer be eligible for
appointment as independent directors.

f) Duties of Independent Directors:

Neither the Listing Agreement nor the CA 1956 prescribed the scope of duties of independent
directors. CA 2013 includes a guide to professional conduct for independent directors, which
crystallizes the role of independent directors.

CA 2013 imposes significantly onerous duties on independent directors, with a view to

ensuring enhanced management and administration. While a list of specific duties has been
introduced under CA 2013, it should by no means be considered to be exhaustive. Independent
directors are unlikely to be exempt from liability merely because they have fulfilled the duties
specified in CA 2013, and should be prudent and carry out all duties required for effective
functioning of the company.

The primary task of independent directors is to adopt an oversight role and to ensure that the
corporate assets are used in the best interest of the company while balancing the interests of all

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stakeholders. The independent director must ask for information about the company’s
operations and finances. If he does not get it, he must take steps to pursue the matter.

General Duties of Directors

The conduct of directors should be in accordance with the articles of association of the
company; but in no case, should contravene the duties specified by the law.

Directors, being trustees of shareholders, have fiduciary relationship with them. As such, the
directors have fiduciary duties towards the company. The Companies Act, 2013 has codified
these fiduciary duties which though were not explicitly stated under the previous law, were
implied in view of the fact that directors are in a fiduciary relationship with the company and
its members.

The following are the duties of a director as specified under section 166 of the Companies Act,
2013:

(1) Subject to the provisions of this Act, a director of a company shall act in accordance with
the articles of the company.

(2) A director of a company shall act in good faith to promote the objects of the company for
the benefit of its members as a whole, and in the best interests of the company, its employees,
the shareholders, the community and for the protection of environment.

(3) A director of a company shall exercise his duties with due and reasonable care, skill and
diligence and shall exercise independent judgment.

(4) A director of a company shall not involve in a situation in which he may have a direct or
indirect interest that conflicts, or possibly may conflict, with the interest of the company.

(5) A director of a company shall not achieve or attempt to achieve any undue gain or advantage
either to himself or to his relatives, partners, or associates and if such director is found guilty
of making any undue gain, he shall be liable to pay an amount equal to that gain to the company.
(6) A director of a company shall not assign his office and any assignment so made shall be
void.

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CODE OF CONDUCT FOR INDEPENDENT DIRECTORS:

Code for Independent directors in Schedule IV of the Companies Act, 2013 specifically lays
down the Guidelines for professional conduct, role, functions and duties of independent
directors.

I. Guidelines of professional conduct:

An independent director shall:

(1) uphold ethical standards of integrity and probity;

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

(3) exercise his responsibilities in a bona fide manner in the interest of the company;

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

(5) not allow any extraneous considerations that will vitiate his exercise of objective
independent judgment in the paramount interest of the company as a whole, while concurring
in or dissenting from the collective judgment of the Board in its decision making;

(6) not abuse his position to the detriment of the company or its shareholders or for the purpose
of gaining direct or indirect personal advantage or advantage for any associated person;

(7) refrain from any action that would lead to loss of his independence;

(8) where circumstances arise, which make an independent director lose his independence, the
independent director must immediately inform the Board accordingly;

(9) assist the company in implementing the best corporate governance practices.

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II. Role and functions:

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) 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 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.

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III. Duties:

The independent directors shall—

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

(2) seek appropriate clarification or amplification of information and, where necessary, take
and follow appropriate professional advice and opinion of outside experts at the expense of the
company;

(3) strive to attend all meetings of the Board of Directors and of the Board committees of which
he is a member;

(4) participate constructively and actively in the committees of the Board in which they are
chairpersons or members;

(5) strive to attend the general meetings of the company;

(6) where they have concerns about the running of the company or a proposed action, ensure
that these are addressed by the Board and, to the extent that they are not resolved, insist that
their concerns are recorded in the minutes of the Board meeting;

(7) keep themselves well informed about the company and the external environment in which
it operates;

(8) not to unfairly obstruct the functioning of an otherwise proper Board or committee of the
Board;

(9) pay sufficient attention and ensure that adequate deliberations are held before approving
related party transactions and assure themselves that the same are in the interest of the
company;

(10) ascertain and ensure that the company has an adequate and functional vigil mechanism
and to ensure that the interests of a person who uses such mechanism are not prejudicially
affected on account of such use;

(11) report concerns about unethical behaviour, actual or suspected fraud or violation of the
company‘s code of conduct or ethics policy;

(12) acting within his authority, assist in protecting the legitimate interests of the company,
shareholders and its employees;

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(13) not disclose confidential information, including commercial secrets, technologies,
advertising and sales promotion plans, unpublished price sensitive information, unless such
disclosure is expressly approved by the Board or required by law.

IV. Process of appointment:

(1) Appointment process of independent directors shall be independent of the company

management; while selecting independent directors the Board shall ensure that there is
appropriate balance of skills, experience and knowledge in the Board so as to enable the Board
to discharge its functions and duties effectively.

(2) The appointment of independent director(s) of the company shall be approved at the
meeting of the shareholders.

(3) The explanatory statement attached to the notice of the meeting for approving the
appointment of independent director shall include a statement that in the opinion of the Board,
the independent director proposed to be appointed fulfils the conditions specified in the Act
and the rules made thereunder and that the proposed director is independent of the management.

(4) The appointment of independent directors shall be formalized through a letter of

appointment, which shall set out:

(a) the term of appointment;

(b) the expectation of the Board from the appointed director; the Board-level
committee(s) in which the director is expected to serve and its tasks;

(c) the fiduciary duties that come with such an appointment along with accompanying
liabilities;

(d) provision for Directors and Officers (D and O) insurance, if any;

(e) the Code of Business Ethics that the company expects its directors and employees
to follow;

(f) the list of actions that a director should not do while functioning as such in the
company; and

(g) the remuneration, mentioning periodic fees, reimbursement of expenses for

participation in the Boards and other meetings and profit related commission, if any.

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(5) The terms and conditions of appointment of independent directors shall be open for
inspection at the registered office of the company by any member during normal business
hours.

(6) The terms and conditions of appointment of independent directors shall also be posted on
the company‘s website.

V. Re-appointment:

The re-appointment of independent director shall be on the basis of report of performance

evaluation.

VI. Resignation or removal:

(1) The resignation or removal of an independent director shall be in the same manner as is
provided in sections 168 and 169 of the Act.

(2) An independent director who resigns or is removed from the Board of the company shall
be replaced by a new independent director within a period of not more than one hundred and
eighty days from the date of such resignation or removal, as the case may be.

(3) Where the company fulfils the requirement of independent directors in its Board even
without filling the vacancy created by such resignation or removal, as the case may be, the
requirement of replacement by a new independent director shall not apply.

VII. Separate meetings:

(1) The independent directors of the company shall hold at least one meeting in a year, without
the attendance of non-independent directors and members of management;

(2) All the independent directors of the company shall strive to be present at such meeting;

(3) The meeting shall:

(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.

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VIII. Evaluation mechanism:

(1) The performance evaluation of independent directors shall be done by the entire Board of
Directors, excluding the director being evaluated.

(2) On the basis of the report of performance evaluation, it shall be determined whether to
extend or continue the term of appointment of the independent director.

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 COMPANIES ACT 2013 VS
LISTING AGREEMENT

CA 2013 proposes to significantly intensify the independence requirements of independent

directors, when compared to the Listing Agreement:

 While the Listing Agreement provided that an independent director must not have any
material pecuniary relationship or transaction with the company, CA 2013 states that
an independent director must not have had any pecuniary relationship with the
company.

 The Listing Agreement stipulated earlier that an independent director should not have
had such transactions with the company, its holding company etc., at the time of
appointment as an independent director, while CA 2013 extends this restriction to the
current financial year or the immediately preceding two financial years.

However, this provision in the Listing Agreement has been aligned with the CA 2013
by means of the circular issued by the Securities and Exchange Board of India
(“SEBI”) dated April 17, 2014 titled Corporate Governance in Listed Entities-
Amendments to Clauses 35B and 49 of the Equity Listing Agreement (“SEBI
Circular”)1. The SEBI Circular has brought the provisions of the Listing Agreement in
line with the provisions of CA 2013, and would be applicable from October 01, 2014.

 Further, the disqualification arising from any pecuniary relationship in the previous 2
(two) financial years under CA 2013 may be unreasonably restrictive, as there may be
situations where a pecuniary transaction of the proposed independent director may
safely be considered to be of a nature which does not affect the director’s independence,
for instance, a person proposed to be appointed as an independent director may be the
promoter or director of a supplier (or a counter-party to an arm’s length transaction)
which has in the past (either during or for a period prior to the two immediately
preceding financial years) been selected by the company through an independent tender
process.

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PREVIOUS CLAUSE 49, THE COMPANIES ACT, 2013, AND THE REVISED CLAUSE 49 –
A COMPARATIVE STUDY

Aspect covered Previous Clause 49 The Companies Revised Clause 49

(effective till Act, 2013 (effective from
30.9.2014) 1.10.2014)
Proportion of 1/3rd in case of non- 1/3rd in every listed 1/3rd in case of non-
independent executive chairman; company and at least executive chairman;
directors on the ½ in other cases two director on ½ in other cases
Board [Clause 49(I A)(i) board in companies [Clause 49(II A)]
&(ii)] as prescribed in rules
[Section 149(4) read
with rule 4 of
Companies
(Appointment and
Remuneration of
Directors) Rules,
2014
Definition and Less stringent than Very stringent Same as that under
scope that under the (Section 149(6)] the Act. [Clause 49
Act[Clause 49 (I (II B)]
A)(iii)]
Age limit Atleast 21 years Not specified Atleast 21 years
[Clause 49 (I [Clause (II B) (f)]
A)(3)(f)]
Appointment of No provision Voluntary No provision
Independent appointment of
Directors by director by small
minority shareholder. Such
shareholders director is deemed to
be independent
director.[Section
151]
Formal letter of No such stipulation Required [Schedule Required [Clause 49
appointment IV(IV)(4)] (II B)(4)]
Formal training of Non-mandatory Required [Schedule Required [Clause 49
independent requirement of IV – (III A) It is the (II B)(7)]
director training of all the duty of Independent
board members; no Directors to
specific stipulation undertake
for independent appropriate
directors.[Annexure induction and
ID – (5)] regularly update and
refresh their skills,
knowledge and
familiarity with the
company.

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Performance Non-mandatory Evaluation by entire Required [Clause 49
evaluation requirement of directors excluding (II B)(5)]
performance director being
evaluation of non- evaluated [Schedule
executive directors. IV – (VIII)
[Annexure ID- (6)]
Treatment of Nominee directors Any nominee Alignment with the
nominee director as appointed by public director excluded Companies Act,
Non Independent financial institutions from the definition 2013 [Clause 49 (II
Director are deemed of independent B) (1)]
independent director.[Section 149
directors. [Clause 49 (6)]
(I A) (iv)]
Maximum tenure Not specified. Non- 2 consecutive terms 2 consecutive terms
mandatory of 5 years each, a of 5 years each;
requirement-9 years cooling off period of where already
[Annexure ID- (1)] three years has been served for 5 years or
provided for; term more as on October
already served till 1, 2014, the person
commencement date is eligible for a
to be ignored. single term of 5
(Section 149(10) & years only. [Clause
(11)] 49 (II B) (3)]
Disclosure of No provision Reasons to be Reasons to be
reasons of disclosed in the disclosed by the
resignation initiation to company in its
Registrar.[Schedule intimation to the
IV- (VI) read with stock exchanges.
section 168] [Clause 49 (VIII F)
Remuneration Stock options may Sitting fees, Stock options shall
be granted – reimbursement of not be
shareholders’ expenses for granted.[Clause 49
resolution should participation in the (II C)]
specify the limits for Board and other
the maximum meetings and profit
number of stock related commission
option that can be as may be approved
granted to non- by the members.
executive directors, Stock options cannot
including be granted.[Section
independent 197(5) & (7)]
directors, in any
financial year and in
aggregate.[Clause 49
(I B)]
Separate meetings No provision At least once a year At least once a year
of Independent [Schedule IV of [Clause 49 (II B)(6)]
Directors companies act 2013
– (VII)

18
Restriction on the Not specifically for Not specifically for 7 listed companies;
number of Independent Independent in case a whole time
independent Directorships. Directorships. director in any listed
directorships company, 3 listed
companies.[Clause
49 (II B)(2)]
Committee Committee Not specified Committee
memberships membership in 10 membership in 10
companies; companies;
Committee Committee
chairmanship in 5 chairmanship in 5
companies [Clause companies [Clause
49 (I C)(ii)] 49 (II D)(2)]
Replacement on Not specified Within 180 days At the earliest but
removal/ from the date of not later than the
resignation resignation/ immediate next
removal. [Schedule Board meeting or
IV of companies act three months from
2013 - (VI)(2)] the date of such
vacancy, whichever
is later [Clause 49(II
D)(4)]
Liability Not specified An Independent An Independent
Director shall be Director shall be
held liable for acts held liable for acts
of omission or of omission or
commission by a commission by a
company which had company which had
occurred with his occurred with his
knowledge, knowledge,
attributable through attributable through
Board processes, and Board processes, and
with his consent or with his consent or
connivance or where connivance or where
he had not acted he had not acted
diligently. [Section diligently. [Clause
149(12)] 49(II E)(4)]

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CONCLUSION

The Companies Act, 2013 has conferred greater authorization upon the Independent Directors
to ensure that the management and affairs of a company are run fairly and smoothly. At the
same time, greater accountability has also been placed upon them. The new Act empowers the
Independent Directors to have a definite ‘say’ in the management of a company, which would
thereby immensely strengthen corporate governance.

___________________________________END____________________________________

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