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Independent directors - Independence defined, but not the state of mind

Tina Edwin     April 24, 2014

Chartered accountant J.K. Setna was appointed director on the board of Colgate Palmolive India in September 1978. Setna continues to be a director of the company, but he wears the hat of an independent director now. Bombay Dyeing chief Nusli Wadia was appointed director of Tata Steel in August 1979. He continues to be one, and he too is an independent director. C.M. Maniar, a senior partner at Crawford Bayley & Co, one of India's oldest law firms, has served on the board of Hindalco Industries since March 1982, more recently as independent director.

Setna, Wadia and Maniar are not the only board veterans who became independent directors on the boards they have served continuously for long periods. Such long uninterrupted associations as independent directors will not be possible any more under the new Companies Act that came into effect this financial year.

But Setna, Wadia and Maniar need not resign from the boards of the three companies immediately. If they satisfy all the conditions for appointment of independent directors and have the qualifications prescribed in Companies Act, 2013, they can enjoy another two terms of five years each as independent directors. If they don't satisfy all the conditions, they will need to resign before the next financial year.

The clock started ticking for all independent directors on April 1. Fortunately for them, the Act does not apply retrospectively. So, all independent directors serving on boards of Indian companies can continue to be on the same boards for up to 10 years, irrespective of how long they have sat on these board - provided they satisfy all conditions prescribed in the Companies Act.  After 10 years of continuously serving on the board, an individual needs to disassociate from the company for at least three years to become eligible for reappointment.

Who needs to appoint

Prospective application of the law notwithstanding, demand for independent directors is set to see a big surge in the course of this year. That's because the universe of companies that needs to appoint independent directors has become very large. Besides all listed companies, unlisted public companies with either share capital of Rs 10 crore or more, or turnover of Rs 100 crore or more, or outstanding loans/debentures/deposits exceeding Rs 50 crore have to appoint independent directors.
The Act requires at least one-third of all directors on boards of listed companies to be independent. The additional requirement of complying with Clause 49 of the stock exchanges' Listing Agreement means at least half the directors of listed companies will have to be independent if the chairman is an executive director. A significant number of listed companies already comply with the listing agreement's requirements of appointing independent directors. However, the Companies Act requirements are far more stringent, and that may lead to disqualification of some sitting independent directors.
Unlisted public companies need to appoint at least two independent directors. That's a big relief for private companies, as the draft regulations had proposed that one-third of the directors should be independent.

While companies scramble to find fit candidates for board positions, risk aversion on the part of individuals may prompt many to turn down the proposition. Independent directors can be held liable for wrong deeds of a company, if it's proven they had not objected to those deeds or decisions or that they had not exercised due diligence.  

Who can be an independent director

The demand for independent directors is set to be large and the supply limited. Here's why. Companies need to find independent directors with varied experience. The ministry of corporate affairs rules say the individual should 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. A common practice of appointing friends, relatives, or just any leading light to add heft will not pass muster.

Companies cannot allot stock options to independent directors, according to the Companies Act. They can be paid only sitting fees.
Industry feels this clause will crimp their ability to attract high calibre individuals. Incidentally, the listing agreement allows listed companies to allot stock options to independent directors, after obtaining shareholders consent.

In addition, the board needs to ensure that the independent director is a person of integrity. Among other conditions, the individual must not be a current or past promoter of the company or its holding, subsidiary or associate company and must not be related to the promoters or directors of the company, its holding, subsidiary or associate company. The individual and relatives must not have been key managerial personnel or even employees of the company or its holding, subsidiary or associate company in any of the three financial years immediately.

Persons who have - individually or through relatives - had pecuniary interest in the company, its holding, subsidiary or associate company, or with their promoters, or directors in the preceding two years too cannot be appointed independent directors of the company.

Past and current employees or partners of a firm of auditors, company secretaries, cost accountants, lawyers or consultants that has or had any transaction with the company, its holding, subsidiary or associate company cannot be appointed independent director of the company if that firm earned 10 per cent or more of its gross turnover in the preceding three financial years from that company.

Anyone who together with his/her relatives holds two per cent or more of the total voting powers of the company is not eligible either.

Chief executives and directors of non-profit organizations that receive 25 per cent or more of their funds from a company, any of its promoters, directors or its holding, subsidiary or associate companies or that holds two per cent or more of the total voting power of a company cannot be independent directors in that company. Even relatives of such chief executives and directors are not eligible to be independent directors of companies which support that NGO.

The law has defined independence, and its intentions are good. But, two concerns remain. One, where do you find enough independent directors who fit the bill?  Two, can independence of mind be legislated?

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