Clipped from: https://economictimes.indiatimes.com
Independent directors are appointed for their expertise in particular areas of corporate governance. Their tenure of five years on their company’s Board of Directors prescribes the statutory duty to secure risk management, balanced decision-making, and deterrence of fraud.
The COVID-19 pandemic and the lockdown it triggered have disrupted life and normal living conditions, most notably by their impact on businesses across the globe. This unprecedented upheaval has revised the customary role of an independent director as watchdog of listed and public companies. At a time when financial markets and mutual funds are reeling under unforeseen economic pressure, independent directors will have to ensure that public stake in the company that they represent is protected while the company itself takes measures to ensure seamless continuity.
Independent directors, though non-executive directors, are appointed for their expertise in particular areas of corporate governance. Their tenure of five years on their company’s Board of Directors prescribes the statutory duty to, among other things, secure risk management, balanced decision-making, and deterrence of fraud.
The Ministry of Corporate Affairs has been cognizant of the specialized role of an independent director on the board of a company, and the necessity of maintaining its independence. It has therefore introduced safeguards to protect any exploitation, imposition, or disruption of the functioning of such directors in India.
The formal origin of the regime of independent directors in India can be traced back to the year 2000, under Clause 49 of the SEBI, Listing Obligation and Disclosure Requirements. Subsequently, the Companies Act, 2013 (“Act”) provided statutory recognition to independent directors who are appointed and governed under Section 149 of the Act.
Companies Act, 2013
The Act and the schedule thereunder, which details the roles and duties of independent directors, seeks to protect them from frivolous prosecution by stipulating that allegations against them must be backed by proof of knowledge (attributable to board process), consent, connivance, or the failure to exercise diligence. An independent director discharges his duties on the basis of information presented by the company’s key managerial personnel (“KMP”) and executive directors. Thus, independent directors can raise red flags only on issues that come to their knowledge in the ordinary course of business and via board processes, and they cannot be expected to conduct roving inquiry.
Sadly, recent incidents of alleged financial frauds, such as those that beleaguered IL&FS and PMC Bank, and made headline news with the Nirav Modi-Mehul Choksi saga and the insolvency proceedings of the Amrapali Group and Jaypee Group, have put independent directors under the scanner. Many seasoned independent directors did not foresee these frauds. Hence, nagging questions have arisen with regard to the need for independent directors, their role, and the inherent limitations. Realizing that expectations of independent directors are exceeding the stipulated norms, the Ministry has taken certain corrective measures.
Indian Institute of Corporate Affairs (“IICA”)
In October 2019, the Ministry notified the IICA to maintain an online databank of all existing and eligible independent directors to ensure standardized process and integrity of the independent directors being appointed by companies. This notification introduced a proficiency qualification examination for independent directors, mandating a minimum score of 60% for any individual to qualify for appointment. However, the merits of such a reform are yet to be tested and may be viewed as unwarranted intervention reminiscent of licence-quota raj prevalent pre-liberalization.
Safeguard action by the Ministry
Recently, the Ministry issued a general circular dated March 02, 2020 (“Circular”) clarifying that civil or criminal proceedings should not unnecessarily be initiated against independent directors unless enough evidence exists to the contrary, and, if already initiated, must be reviewed.
The Circular is a welcome step as it seeks to identify and fix accountability of an “officer who is in default” or other specific directors/KMPs who voluntarily take up specific responsibilities in a company. It makes important clarifications in respect of the prosecution framework of independent directors. First, it underscores the distinction between independent directors and other directors/ KMPs; secondly, it focuses on the nature of default while affixing responsibility; thirdly, and most significantly, it shifts the burden of proof from the accused independent directors to the investigating/prosecuting agencies. The circular also calls for greater deliberation at the ministerial level before initiating prosecutions against independent directors.
For the same purpose, agencies too should be sensitized about the role of independent directors who are at a disadvantage if a hidden design is hatched to deceive them. Independent directors do not have the benefit of being privy to information that may be discovered too late. Such asymmetry of information might make a reasonable decision seem inappropriate on hindsight. However, with the benefit of such post facto information, investigators sometimes adopt an attitude of ‘guilty till proven innocent’. Hopefully, the Ministry’s new initiatives have corrected this misguided course.
With great power comes greater responsibility. Thus, in a revised framework of the post-COVID market scenario, independent directors will need to revitalize their role to protect their company from the envisaged economic distress. An additional duty for these governance-guardians of the board is to ensure that their companies put in place adequate guidelines and policies to safeguard the company’s stakeholders. Their vital role in ensuring corporate credibility does not make them liable for any acts of commission or omission that had occurred without their knowledge.
(Dheeraj Nair is Partner, Kumar Kislay is Senior Associate and Vishrutyi Sahni is Associate at J. Sagar Associates.)