Introduction:
Corporate governance is a method or system primarily established by a company to manage the company in a fashion that would benefit all the stakeholders. Over time the importance of good corporate governance has caught on in economics and people have started to see the difference it makes in a company. Due to these revelations, the governments of nations have started to include corporate governance in the codified laws of the nation. The Companies Act, 2013 includes multiple provisions for the regulation of corporate governance in the companies registered under said act.
Good corporate governance includes principles of accountability responsibility and transparency as well as fair practices and regularly updated policies. To enforce these rules, are a set of directors appointed to every company either by the shareholders or other board members. There are two major kinds of directors in each company, executive and non-executive. The executive directors are those directly in the employment of the company who actually run the company from day to day and usually maintain relations with all the other stakeholders. The non-executive directors, on the other hand, don’t necessarily have any stake in the company and aren’t involved in the day to day activities of the firm, but they are involved in the strategic planning and maintaining of the corporate governance of the company.[1]
Independent directors are a type of non-executive directors who are to be compulsorily appointed in certain companies as mentioned in the Companies Act, 2013. These directors have no relation to the company or the executives or the senior management or associates or any of the promoters or any other board members of the company in any way shape or form. Their only transaction with the company is the remuneration they receive for the conduct of their duties towards the maintenance of good corporate governance of the company. Independent Directors have been defined in section 149, sub-section 6 of the Companies act, 2013, and outlined in detail under Schedule IV of the act.
What is Corporate Governance?
All of this change began way back in 1998 with the emergence of the concept of corporate governance but was only made mainstream with the addition of clause 49 in the listing agreement by SEBI in 2009. This clause made it compulsory for companies to comply with certain corporate governance guidelines to be listed on the stock exchange. It brought into function the various codes pertaining to board of directors, audit committees, whistleblower policies and disclosures with respect to related party transactions. But only in 2013 with the introduction of the Companies Act, 2013 did it come into proper code and function of the entire country to be followed by not just companies listed on the stock exchange, but also unlisted companies to safeguard the interests of all stakeholders.[2]
Corporate governance is important to companies for many reasons. The first would be strengthening strategic thinking by brining in unbiased independent directors into the top management. It sets benchmarks for efficiency and ethical practices as it pushes for transparency in the financial management and auditing procedures. All of these features help to manage a healthy balance between management and ownership, which reflects well on the company and in turn, keeps the investors happy.[3]
The core principles of corporate governance include transparency towards the stakeholders, accountability at all levels to achieve the vision and responsibility to maintain efficiency via sustainable development. Following these principles along with fairness, shareholder engagement and good leadership are the duty of the shareholders, directors and other officers of the company. Not following these norms could lead to bad corporate governance on the part of the companies, which reflects badly on the companies to the shareholders and in turn reduces their trust on the company, driving the value down. If the company does not cooperate with auditors, it may lead to wrongful calculation and publication of finances causing unnecessary complications and could even attract legal action. This kind of unreliability occurs due to bad corporate governance which can heavily impact a company’s financial health. [4] The Volkswagen clean diesel scam is a great example of how bad governance can directly lead to major losses.[5]
Who are Independent Directors?
An independent director is defined under sub-section (6) of section149 in The Companies Act, 2013. It is someone other than the managing, whole-time or nominee director. He must know his way around in the field, work with integrity and should possess any other qualifications as may be required by the board members of the company as a prerequisite. He should not be a promoter, nor be related to any promoter or director of said company or any of its associate companies. He should have had no pecuniary relationship with the company or any stakeholders of said company in current or the past two financial years. No relatives of the independent director should have had any pecuniary relations with the company or any of its stakeholders amounting to more 2% of the company’s gross turnover or total income or 50 lakh rupees, whichever is lower in the current or last 2 financial years.
Neither the independent director himself nor his relatives should have worked at this company or any of its subsidiaries in any capacity for at least 3 financial years before the year in which he is to be appointed. None of them should have been employed in or under any auditing firm or any company secretary or any legal or consulting firm that had any transaction with any subsidiary comprising of over 10% of its gross turnover of the company or the company itself in which the person is to be appointed an independent director. He and his relatives’ shares combined should not give them more than 2% of the total voting power in the company. None of them should be in an executive position or a director of any non-profit that receives over 25% of their donations from the said company or a subsidiary of that company or any of its promoters or directors or anyone that holds more than 2% voting power in the company.[6]
The independent directors may not have any relation to the company in any way, but that does not mean they can exploit the company or abuse the resources. There is a whole code of conduct for these professionals mentioned in Schedule IV of the Companies Act, 2013, as mentioned under section 149 (8) of the act. This code helps keep the independent directors in check, and if followed diligently, will see the company develop better. There exist some basic guidelines of professional conduct that they need to follow, like upholding ethical standards, devoting sufficient time, not abusing the position at the shareholder’s cost, refraining from any activity that would mean the loss of his independence and the most important, to implement benchmark corporate governance practice.
The procedure for the appointment of an independent director is also elaborated in this schedule. The board picks a qualified candidate, without involving the company management in this decision. The said director should be approved at the subsequent shareholder meeting, where it is clearly declared that said person fulfils all conditions mentioned in the act. The content to be mentioned in the letter of appointment is also mentioned in part IV of this schedule. The terms and conditions of said appointment shall be available for inspection to any member at the registered office during normal business hours and should also be posted to the company’s website.[7]
An independent director may resign or be removed like any other director in the firm as explained under section 168 and 169 of the act. A new independent director should be appointed within 180 days from the date of such resignation or removal, unless the company already has the required number of independent directors as required by the act (1/3rd of the total number of directors must be independent directors) even after said independent director leaves. An Independent director may hold office for 5 consecutive years and can be reappointed to the position based on his performance evaluation conducted by the entire board of directors except himself. No independent director can hold office for more than 2 consecutive terms.[8]
Roles, Functions and Duties of Independent Directors
The independent director is looked upon to carry out many important jobs in the company in which he is appointed. He is supposed to guide the board while forming opinions on issues relating to strategy, performance, risk management, resources etc. They are supposed to help keep the performance of the board and the management in check via monitoring, reporting and evaluation. All financial documents and controls must be maintained with the utmost integrity. They must safeguard and balance the conflicts in the interest of the stakeholders, taking special care of the minority stakeholders who don’t enjoy as much say in the running of the company. They also have a say in the remuneration, appointment and removal of executive directors, key management positions and senior managers. They must also resolve conflicts between management and shareholders keeping the interests of the company first.
Other than the said tasks, independent directors must also live up to certain standards as best they can. They must regularly update their skills and knowledge as may be required for the best interest of the company. They may even seek professional advice or expert opinion at the cost of the company if need be. He must strive to actively attend all the general and board meetings of the company where the interests of the company are discussed. They must keep themselves up to date with detailed knowledge of the field in which the company operates. They must see to it that the board of directors address any concerns about the running of the company during meetings and must push the board to come to a resolution as long as they aren’t obstructing the agenda of that meeting.
They must also pay attention to the transactions conducted by the company and make sure none of them is made for any reason other than the benefit of the company. Contingency plans must be created, with the attempt to ensure security for the interests of all the parties involved in the business. They must protect the legitimate interests of the company, shareholders and employees by reporting any unethical behaviour, fraud, or any other violation of the company’s code of conduct etc. The last but most important basic duty of an independent director is to maintain confidentiality, breaking the confidentiality agreement could be punishable by law.[9]
They must also hold at least one meeting per year just amongst the independent directors to review the performance of non-independent directors, the board as a whole and the chairperson of the company. In this meeting, they must also assess the flow of information among the managers and directors. They must keep this flow as efficient as possible for the company to effectively complete its goals.[10]
Case Laws
The Chairman, Sebi vs Shriram Mutual Fund & Anr: The Supreme court declared that corporate governance has been included in the regulations, and hence must be adhered to with sincerity. A violation of said rules will call for the imposition of penalty regardless of intention.[11]
Rustom Cavasjee Cooper v. Union of India: The court observed that the merits of political theories or economic policies are not for the court to adjudicate, but if a policy has been enacted, the judiciary shall enforce it. Thus, the policy on corporate governance, added to the Companies Act, 2013 and the Securities Exchange Board of India (SEBI) regulations for whatever reason, will have to be followed religiously by any company registering under either of the regulations.[12]
BALCO Employees Union vs. Union of India (UOI) and Ors: When the government chooses to run an industry by forming a company, the said company must be run in accordance with the Companies Act.[13] That being said, the honourable Securities Appellate Tribunal held Vas Infrastructures Ltd. Liable for failing to set up an audit committee as per clause 49 II-A of the Listing Agreement.[14]
Conclusion
Corporate governance is an important step towards achieving the standard of ethical practices that would reduce the number of financial frauds in the country. Independent directors are a crucial part of this step, being the drivers of corporate governance out in the practical environment. It depends on them to make sure the company functions with integrity and they must blow the whistle in case of malfunction. This a method which changes the system from within the company to make sure no wrong is committed, unlike the usual methods where wrongful acts are punished when the culprit is caught. These are fairly new regulations and seem adequately fair as not many large companies have any issue in complying with said function because they are always willing to add qualified professionals to their staff to increase productivity, efficiency and hence profits.[15]
References:
- Bahl, Shagun. Corporate Governance under the Companies Act, 2013. 10 October 2017. <https://blog.ipleaders.in/corporate-governance-companies-act-2013/#:~:text=%E2%80%9CCorporate%20Governance%20is%20the%20application,sustainable%20development%20of%20all%20stakeholders.%E2%80%9D>.
- BALCO Employees Union vs. Union of India (UOI) and Ors. No. AIR 2002 SC 350. Supreme Court of India. 10 December 2001.
- Chen, James. Corporate Governance Definition. n.d. 12 April 2020. <https://www.investopedia.com/terms/c/corporategovernance.asp>.
- Corporate Governance. n.d. CFI Education Inc. 25 September 2020. <https://corporatefinanceinstitute.com/resources/knowledge/other/corporate-governance/>.
- Corporate Governance. 2016. 25 September 2020. <https://www.bcasonline.org/Referencer2015-16/Other%20Laws/Company%20Law/corporate_governance.htm>.
- Rustom Cavasjee Cooper v. Union of India. No. AIR 1970 SC 564 ; 1970 SCR (3) 530. Supreme Court of India. 10 February 1970.
- Saiju, Krishnadas. Concept of Independent Directors In India With Relevance To Increasing Corporate Governance Mechanis. n.d. 25 September 2020. <http://www.legalserviceindia.com/legal/article-581-concept-of-independent-directors-in-india-with-relevance-to-increasing-corporate-governance-mechanisms.html>.
- Schedule IV Code for Independent Directors. n.d. 25 September 2020. <https://www.mca.gov.in/SearchableActs/Schedule4.htm>.
- The Chairman, Sebi vs Shriram Mutual Fund & Anr . No. AIR 2006 SC 2287. Supreme Court of India. 23 May 2006.
- The Companies Act, 2013. 2013. 25 September 2020. <https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf>.
- Vas Educomp Private Limited v. SEBI. No. Appeal No. 43 of 2018 ; MANU/SB/0096/2018. Securities Appellate Tribunal, Mumbai. 15 May 2019. <http://sat.gov.in/english/pdf/E2019_JO201843.PDF>.
[1] (Chen)
[2] (Bahl)
[3] (Bahl)
[4] (Corporate Governance)
[5] (Chen)
[6] (The Companies Act, 2013)
[7] (Schedule IV Code for Independent Directors)
[8] (Corporate Governance)
[9] (Corporate Governance)
[10] (Schedule IV Code for Independent Directors)
[11] (The Chairman, Sebi vs Shriram Mutual Fund & Anr )
[12] (Rustom Cavasjee Cooper v. Union of India)
[13] (BALCO Employees Union vs. Union of India (UOI) and Ors)
[14] (Vas Educomp Private Limited v. SEBI)
[15] (Saiju)
0 Comments