The concept of independent directors can be traced back to the countries like the US, and the UK during the 1950s, even before their appointment was made mandatory on the Board of publicly held entities to ensure corporate governance. The concept emerged as a voluntary mechanism based on the belief that a board with some level of independence will introduce objectivity in decision making, add to the diversity and advisory capabilities of the board and hence improve the company’s performance. What commenced as a voluntary movement in the 1950s took on a mandatory form following the various corporate governance scandals that occurred at the turn of the century and consequently resulted in the enactment of stringent legislations in the US and the UK.
The year 1991 saw a major wave of economic reforms in India and economic liberalization ushered in a new era in Indian corporate governance. In 1992, securities markets regulator Securities Exchange Board of India (“SEBI”) was established, which began the securities market reforms that also gradually led to corporate governance reforms. Curiously, the concept of independent directors was first introduced through voluntary code for “Desirable Corporate Governance,” issued by the Confederation of Indian Industry (‘CII’), which was voluntarily adopted by a few companies.
Thereafter, a committee was constituted by SEBI, chaired by Mr. Kumar Mangalam Birla (“Birla Committee”). The Committee submitted a report to SEBI “to promote and raise the standard of Corporate Governance in respect of listed companies.” Based on the recommendations of Birla Committee, in the year 2000, SEBI inserted Clause 49 into the Equity Listing Agreement; prescribing corporate governance norms that were applicable to all listed companies of a certain size. India’s corporate governance norms therefore came to be governed through a clause in the listing agreement popularly referred to as “Clause 49.” Although, several concepts introduced by CII and Birla Committee were indeed those that have already started taking shape in countries such as the U.S. and the U.K.
Thereafter, in the wake of governance scandals across the globe and with a view to further improving the standards of Corporate Governance in India, SEBI decided to strengthen Indian corporate governance norms. SEBI constituted a Committee under the Chairmanship of Mr. N. R. Narayana Murthy (“Murthy Committee”) to examine Clause 49 and recommend the changes to the existing regime. Following the recommendations of the Murthy Committee in 2004, detailed corporate governance norms were introduced into Indian corporate regulations only in the year 2006.
The Satyam case clearly demonstrated the corporate governance failures, even where the level of promoter shareholding was relatively low. Following the outbreak of the Satyam scandal, hundreds of independent directors resigned from several listed companies which provoked uproar in corporate circles. Instead of implementing stringent regulation, the Government chose to adopt a more careful approach. However, the new Companies Bill was still pending with the Parliament. In November 2009, the Task Force constituted by CII made recommendations to modify corporate governance norms in India. Shortly thereafter, the Institute of Company Secretaries of India (“ICSI”) too provided its own set of recommendations for altering corporate governance regulations. Based on these and other proposals received, the Ministry of Corporate Affairs, Government of India published the Corporate Governance Voluntary Guidelines, 2009 which provided a set of best practices for public companies to follow.
The role and ambit of an Independent director has evolved over time in India and has been formalized in the law and through introduction of specific clauses, namely clear definition of Independent Director, procedure of formal appointment on the Board, mandatory appointment on statutory Committees; Audit, Nomination & Remuneration and CSR, number of directorship/membership on the Board or Committees respectively, formal Code of Conduct, training, formal evaluation of performance, remuneration, provision of information in a timely manner, access to company management for information and so on. However, the concept is still evolving in line with changing business dynamics and economic environment.
From the time the report was issued by the Expert Committee on revision of Company Law under the Chairmanship of Dr. J.J. Irani in 2004, the new Companies Act, which was original introduced in 2009, got finally passed in the year 2013. The Companies Act, 1956 did not envisage the concept of independent directors and so there was neither any definition nor mention of the words ‘independent directors ‘. The Companies Act, 2013 (“the Act”) does not only define the term ‘independent directors’, but also provides their duties and responsibilities. Section 149 requires certain type of companies to have minimum number of independent directors on their Board of Directors and provides the meaning of an independent director. The section also directs that an independent director is also required to abide by provisions specified in Schedule IV “Code for Independent Directors”. The Companies (Appointment and Qualification of Directors) Rules, 2014, also provides for number and qualification of independent director and also creation and maintenance of databank of persons offering to become independent directors.
The Act enumerates various responsibilities on the independent directors and the key ones are:
An independent director while not fully involved in day-to-day operations of the company, however, the duties and tasks are perhaps similar to normal directors as:
Fair remuneration to the Independent Director has always been a favourite point of discussion among the governance professionals and also an analysis criterion affecting the corporate governance, led by the independent directors. Most will align with the fact that the independent directors need to be provided sufficient incentives to carry out their functions effectively. Compensation of independent directors is the most measurable of incentives in monetary terms. It is necessary to appropriately remunerate the independent directors so that they can conduct their job in a responsive and accountable manner. At the same time, there is a risk of over-compensating directors that may cause them to lose their independence. However, limiting compensation will make it more difficult for companies to attract qualified people when the pool is already shrinking due to increased liabilities they could face. The monetary compensation should not be so high that the independent director begins to rely heavily on the board position. It is critical that the line is drawn very carefully.
Independent directors are currently remunerated in two ways:
Independent director may receive remuneration by way of fee provided under sub-section (5) of section 197, reimbursement of expenses for participation in the Board and other meetings and profit related commission subject to resolution of the shareholders duly passed at a general meeting. However, the Company is not mandatorily obligated to pay the compensation to the Independent Directors.
Further, sub-section (9) of section 197 provides that any director including independent director draws or receives, directly or indirectly, by way of remuneration any such sums in excess of the limit prescribed or without approval required, under the section 197, he/she shall refund such sums to the company, within two years or such lesser period as may be allowed by the company, and until such sum is refunded, hold it in trust for the company. As per sub-section (10), the company shall not waive the recovery of any sum refundable to it under sub-section (9) unless approved by the company by special resolution within two years from the date the sum becomes refundable.
This is to be noted that the basis of existing compensation to the Independent Directors is “net-profit’ only and he/she cannot receive the remuneration above the prescribed limit. In order to broaden the criteria of monetary compensation to the independent directors, the certain amendments have been made in the relevant provisions affecting the monetary compensation to the independent Directors, by passing the Companies (Amendment) Act, 2020.
The Amendment Act, 2020 brought certain changes impacting remuneration payable to independent directors. As per existing provisions of section 197 (3) of the Companies Act, 2013, only executive Directors are entitled to remuneration in case of no-profit or inadequate profit. Since the Non-executive Directors including Independent Directors devote their time, not only on monitoring but also on strategic matters of the Company, hence, as per amendment, the independent directors are now eligible for remuneration in the event of noprofit or inadequate profit. If a company fails to make profits or makes inadequate profits in a financial year, any nonexecutive director of such company, including an independent director, shall be paid remuneration in accordance with Schedule V of the Act.
1. Section 149: the proviso to the sub-section (9) of section 149 of the Act, has been amended and new proviso as follows:
“Provided that if a company has no profits or its profits are inadequate, an independent director may receive remuneration, exclusive of any fees payable under sub-section (5) of section 197, in accordance with the provisions of Schedule V.”
2. Section 197: Further, in sub-section (3) of section 197 of the principal Act, after the words “whole-time director or manager,”, the words “or any other non-executive director, including an independent director” have been inserted and whole para as follows:
“Notwithstanding anything contained in sub-sections (1) and (2) of section 197, but subject to the provisions of Schedule V, if, in any financial year, a company has no profits or its profits are inadequate, the company shall not pay to its directors, including any managing or whole-time director or manager or any other non-executive director, including an independent director, by way of remuneration any sum exclusive of any fees payable to directors under sub¬section (5) hereunder except in accordance with the provisions of Schedule V.”
The role, responsibility, accountability and compensation of an independent director has evolved considerably over the last decade and is still in the area of flux. The entire fulcrum of Independent Directors is based on the need to strengthen the corporate governance in an organization; they do not participate in day-to-day activities of the Company, but they render their valuable time in planning, policy making, strategy and more importantly monitoring of corporate governance norms.
This is a welcome move and one step ahead of setting some minimum compensation to independent directors, as mentioned in the Uday Kotak Committee report on Corporate Governance, 2017, by providing compensation in the event of no profit or inadequate profit. The abovementioned amendments are a step in the right direction but an ongoing process to make the provisions related to independent directors more fair, transparent and keeping with the changing macro-economic.
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