Appointment of Independent Director: A Concept Guide on the Independent Directors in India
At present, the structure of Indian Corporate Law seems to be troubled by a plethora of scams, right from the famous Satyam Computer Services Scandal a decade ago to recent Nirav Modi Scam . Post-Satyam scam , the Indian Government decided to revamp the corporate regulatory framework a bit. Therefore, enacted new legislation, known as the Companies Act, 2013. The Salient feature of this act was to bring clarity on the functions, duties, liabilities and appointment of Independent Director.
Before the enactment of this act, there was a situation of uncertainty because neither the Companies Act, 1956, nor the SEBI (Securities Exchange Board of India) listing agreement provided any regulation about the role of Independent Directors.
Independent Director: Concept
In India, the Independent Director is Director other than an MD (Managing Director),WTD (Whole Time Director) or a Nominee Director, who satisfies all the criteria given under section 149(6) of the Companies Act, 2013, together with Rule 4 and Rule 5 of the Companies (Appointment and Qualification of Directors) Rules, 2020.
In layman terms, an Independent director is a Non-Executive Director who does not have any pecuniary or material relationship with the company, except sitting fees. Further, an Independent Director must possess adequate knowledge, skills and experience in the corporate sector, as he is assigned with the task to supervise and monitor the Board of Directors in a company, which in return, improves the credibility and accountability of that company.
Furthermore, these directors also play a crucial role by acting as a watchdog in several committees constituted by the company to make sure good Corporate Governance and Image in the corporate sector.
Appointment of Independent Director: Companies Eligible to Make Appointment
In India, the companies eligible to make the appointment of Independent Directors can be summarised as:
- Listed Public Company: Every Listed Public Company shall have at least 1/3rd of the total number of directors as Independent Directors.
- Unlisted Public Company: According to Rule 4 of the Companies (Appointment and Qualification of Directors) Rules, 2020, the classes of companies that need to have at least 2 Independent Directors are as follows:
- Any Public Company withapaid-up share capital of Rs 10 crores or more;
- Any Public Company with an annual turnover of Rs 100 crores or more;
- Any Public Company with aggregate deposits, outstanding loans, and debenture exceeding Rs 50 crores.
Appointment of Independent Director: Companies Exempted from Making Appointment
In India, the companies exempted from making the appointment of Independent Directors can be summarised as:
- Private Limited Company: The rules and regulations concerning Independent Director are not applicable to a Private Limited Company;
- The company ceases to fulfill the criteria of Rule 4: Any Company that ceases to fulfil the requirements laid down in Rule 4 of the Companies (Appointment and Qualification of Directors) Rule, 2020, for consecutive three years, it shall not be needed to abide by the provisions of Independent Directors, until it satisfies all the conditions. Further, as per the proviso of Rule 4 of the Companies (Appointment and Qualification of Directors) Rules, 2020, the amount showing on the latest audited financial statements shall be taken into consideration for calculating the Annual Turnover, Paid-up Share Capital or Outstanding Loans.
- Joint Venture: A joint venture, dormant company and a wholly-owned subsidiary company are exempted from appointing an independent director even if they satisfy the eligibility criteria of rule 4.
Independent Directors: Role and Functions
In India, Independent Director acts as a coach, mentor and guide to the Company. The role of an Independent Director includes improving governance standards and corporate credibility by functioning as a watchdog and also help in mitigating risk. Further, these directors are responsible for ensuring better corporate governance by actively involving in several committees set up by the company.
The functions that an independent director needs to perform are as follows:
- To facilitate in refuting pressures from shareholder;
- To assist the Board of Directors especially on issues of performance, strategy, risk management, key appointments, resources, and standards of conduct;
- To evaluate the performance of board and management;
- To scrutinise and examine the performance of management in meeting agreed objectives and goals;
- To monitor the reporting of management’s performance;
- To satisfy themselves on the integrity and reliability of the financial information;
- To convince themselves that financial controls and the mechanism of risk management are robust and defensible;
- To safeguard the interests of all stakeholders, specifically the minority shareholders;
- To settle the conflicting interest of the investors;
- To determine the suitable levels of remuneration for KMP (Key Managerial Personnel) Executive Directors, and Top-level Management;
- To play a crucial role in the appointment and removal of Key Managerial Personnel, Executive Directors and Top-level Management;
- To arbitrate and moderate the interest of the corporation as a whole, in situations of conflict between shareholder’s interest and management.
Independent Directors: Duties
In India, the independent director needs to fulfill the duties as follows:
- Need to regularly undergo appropriate training to update and refresh their knowledge, skills, and familiarity with the company;
- Need to seek necessary clarification on financial information and, where essential, can take professional advice from the outside experts at the expense of the company;
- Need to attend all the meetings of BOD (Board of Directors);
- Need to participate in all the meeting of the Board committees of which he is a member;
- Need to actively participate in the working of the Board Committees in which he is a member;
- Need to attend the General Meetings of the company;
- Need to keep themselves updated about the company’s internal and external environment in which it functions;
- Need to never unfairly obstruct the functioning and working of Board and Committee;
- Need to pay sufficient attention and make sure that adequate discussions are held before approving RPT (Related Party Transactions);
- Need to satisfy themselves that the related party transactions are in the interest of the company;
- Need to ascertain that the company has a proper and functional vigil mechanism;
- Need to make sure that the interests of a person are not pre-judicially affected after using such a vigil mechanism;
- Need to report concerns about unethical behaviour, fraud, or violation of the company’s ethics policy or code of conduct;
- Need to act within his authority;
- Need to assist in safeguarding the legitimate interests of the shareholders, company and its employees;
- Need not to disclose any confidential information, comprising of unpublished price sensitive information, commercial secrets, advertising, technologies, and sales promotion plans,unless such disclosure is explicitly approved by the BOD (Board of Directors).
Appointment of Independent Director: Tenure
The tenure of the appointment of Independent Director can be summarised as:
- As per section 152 of the Companies Act, 2013, an independent director shall hold office for a period of five successive years on the Board of a company. Moreover, as per section 149 (10), an independent director is eligible for reappointment after passing an SR (Special Resolution) and disclosing the same in the Board Report.
- As per section 149 (11) of the Companies Act, 2013, an independent director shall not hold office for more than two consecutive periods. However, such director is eligible for appointment after the expiry of three consecutive years of ceasing to become an independent director. Provided such director shall not, during the tenure of three years, be associated or appointed in the company in any capacity, either directly or indirectly.
Appointment of Independent Director: Qualification
According to Rule 5 of the (Appointment and Qualification of Directors) Rules, 2020, an Independent Director must possess skills, knowledge, and experience in one or more fields as follows:
- Marketing and administration;
- Corporate Governance;
- And technical assistance and operations.
Appointment of Independent Director: Manner
The manner of the appointment of Independent Director in India can be summarised as:
- The process of appointment of independent directors shall be independent of the company management. This means that the board of directors need to consider the facts, like skills, knowledge and experience, while selecting independent directors. These facts are considered to make sure that the Board will discharge its duties and functions effectively and efficiently;
- The shareholders of the company need to approve the process of appointment of independent directors;
- The explanatory statement annexed to the Notice of the Board meeting for approving the appointment of independent director needs to include a declaration that the is of the opinion that the proposed independent director fulfills the prescribed conditions and is independent of the management;
- The directors of the company shall formalise the appointment of independent directors through the letter of appointment;
- During business hours, all the members or shareholders of the company are eligible to inspect the terms and conditions of appointment of independent directors kept at the registered office of the company.
- The company needs to post all the terms and conditions of appointment of independent on its website.
Appointment of Independent Director: Procedure
The steps involved in the procedure of appointment of independent directors can be summarised as:
- Select a person as Independent Director: The directors of the company need to diligently select a person proposed to be appointed as an independent director. They also need to make sure that the said person possesses appropriate skills, knowledge, and experience in the Board as per Rule 6 of the Companies (Appointment and Qualification of Directors) Rules, 2020. Further, the company needs to select the proposed person from the Independent director’s data bank maintained by any institute or association authorised by the Central Government.
- Fulfills the criteria of section 149 (6) and Rule 5: The directors of the company need to make sure the proposed person to be appointed as Independent director fulfils the conditions and criteria specified in Sec 149(6) of the Companies Act, 2013 and Rule 5 of the Companies (Appointment and Qualification of Directors) Rules, 2020.
- No Disqualification as per Section 164 and 165: The company must make sure that the proposed independent director is not disqualified under section 164 and 165 of the Companies Act, 2013.
- Furnish Director Identification Number: As per section 152 (4) of the Companies Act and Rule 14 of the Companies (Appointment and Qualification of Director) Rules, 2020, the person appointed as Independent Director needs to furnish his DIN (Director Identification Number) to the company along with a declaration in Form DIR-8 stating that he is not disqualified for becoming an independent director.
- Consent in Form DIR- 2: The company needs to obtain the consent of the person being appointed as Independent Director in Form DIR-2.
- Issue Notice for Board Meeting: According to Section 173 (3) of the Companies Act, 2013, the company needs to send the notice and agenda of the Board meeting in writing to every director at his registered address with the company.
- Hold Board Meeting:The directors of the company needs to hold a board meeting and ascertain the quorum needed under section 174 of the Act, to pass the resolution as follows:
- The Independent Director will hold office for a period of five years, subject to the approval of shareholders in the company’s general meeting;
- To authorise a CS (Company Secretary) or Director to fill, sign the relevant form and to perform such acts as may be necessary to give effect to the resolution passed;
- To fix a date, day, time, and venue for holding a general meeting of shareholders;
- To approve the draft notice together with the explanatory Statement annexed with the notice, as per the conditions laid down under section 102 of the Companies Act.
- To authorise a CS or Director to sign and issue the notice and agenda of the general meeting.
- Hold a General Meeting: The company needs to hold the general meeting on the date fixed to pass an ordinary resolution for the appointment of Independent director.
- Issuance of Appointment Letter: According to Schedule IV(IV)(4) to the Companies Act, 2013, the directors will issue the appointment letter to Independent Director. Moreover, it needs to post the terms and conditions of the appointment of Independent Director on its website.
- Obtain Declaration of the Independent Director: As per section 182 (1) read with section 182 (2) of the Companies Act, 2013, the directors need to obtain the declaration of the appointed Director concerning in Form MBP-1 within thirty days of appointment or at the first BM (Board Meeting) in which he participates as an independent director.
- File Form DIR-12: According to Rule 8 read with Rule 18 of the Companies (Appointment and Qualification of Directors) Rules, 2020, and section 170 of the Companies Act, 2013, the company needs to file Form DIR- 12 with the ROC (Registrar of Companies) containing all the details of the appointment of Independent Director within thirty days of his appointment.
- Declaration by the Independent Directors: The Independent Director needs to submit a statement of his independence according to section 149(6) of the Companies Act, 2013 before her appointment. He needs to place such declaration before the 1st Board Meeting in which he participates as an independent director and the subsequent first board meeting in each financial year.
- File MGT- 14: The directors need to file the form MGT- 14 with the ROC, in case a special resolution is passed for re-appointment of Independent Director. Further, they need to file MGT- 14 within thirty days of the date of the annual general meeting.
- Necessary Changes in the Register of Directors: Lastly, the directors need to make necessary entries in the register of key managerial personnel, directors, and shareholders.
Appointment of Independent Director: Things to Consider
The things to consider during the appointment of an Independent Director can be summarised as:
- An independent director cannot work in more than seven listed companies at a time;
- An independent director will neither be retired by rotation nor will be included in ‘Total Number of Directors’ for the computation of rotational directors;
- For becoming an alternate director, the person must be eligible to be appointed as an independent director;
- A small shareholder director can be considered as an independent director in the following situations:
- If he is eligible under section 149 (6) for appointment as an independent director;
- If he submits a declaration of his independence under section 149(7).
- If the directors want to call a Board meeting at shorter notice for transacting some urgent business, then the presence of at least one independent director is compulsory. In case of absence of the independent director, the decision passed shall be circulated to all the directors of the company and later approved by at least one independent director;
- The Nomination committee needs to include three or more non-executive directors out of which one-half will be the independent directors;
- The Audit Committee needs to consist of a minimum of three directors together with independent directors establishing a majority.
- Remuneration Committee needs to include at least three non-executive directors out of which one-half shall be the independent directors;
- Corporate Social Responsibility Committee will also include at least three non-executive directors out of which one must be an independent director;
- All the independent directors of a company need to mandatory hold at least one joint meeting in a year, without the presence of Members and Non-Independent directors.
Independent Directors: Remuneration
An independent director may receive remuneration through sitting fees and is qualified to any stock option as well. The sitting fees means the fees for attending the Board Meetings, which is a maximum of Rs 1,00,000 per meeting. Further, the remuneration of an Independent Director is regulated by the provisions of section 197 (5) of the Companies Act, 2013.
Independent Directors: Resignation
In India, the provisions concerning the resignation of Independent Directors are as follows:
- An Independent Director can resign from his office by providing notice in writing to the directors of the Company;
- The Board needs to file form DIR -12 with the ROC (Registrar of Companies) within thirty days from the date of receipt of such resignation notice;
- The said independent director also needs to forward a copy of his resignation together with detailed reasons to the ROC within thirty days of his resignation.
Independent Directors: Removal
In India, the removal of an independent director can be summarised as:
- A Company can remove an independent director by passing an ordinary resolution before the expiry of his tenure. However, the said resolution can only be passed after him giving a reasonable opportunity of being heard.;
- The company needs to send a special notice to all the directors, for passing a resolution regarding the removal or appointment of the independent director.
- The company needs to fill the vacancy within 180 days of such removal.
Independent Directors: Intermittent Vacancy
As per the second proviso of Rule 4 of the Companies (Appointment and Qualification of Directors) Rule, 2020, the Board needs to fill the intermittent vacancy in the office of an independent director either within three months from the date of intermittent vacancy or by the next board meeting, whichever is earlier.
Independent Directors: Extent of Liability
The Companies Act, 2013, restricts the liability of an Independent Director only in respect of acts of commission or omission by the company which had happened with his knowledge, connivance or consent or where he had not acted diligently.
After discussing in-depth about the appointment of Independent Director, it is crystal clear that an independent director acts as a bridge between the shareholders and management, also helps in bringing an independent judgement. Further, these directors also encourage the concept of corporate governance by providing accountability, transparency, and disclosures in the working and functioning of the company. Therefore, their assistance is a must for a company in implementing the best practices of corporate governance.