The Hindu Business Line : Independent directors and vicarious liability

Independent directors are invited to sit on the board purely for their special skills and expertise in particular fields and they represent the conscience of the investing public. As long as they show due diligence, the law should exempt them from all types of liabilities for the actions of the board or the managing director they may not be aware of. In the absence of such safeguards, no worthwhile talent can be expected to join a company's board in the capacity of an independent director.

CORPORATE India's boardroom is in a state of flux. All of a sudden, its composition and character are set for a tremendous change. Most Indian companies are used to being run by families, from generation to generation. The general impression is of a corporate structure that lacks transparency and board decisions that are subjective, and taken by those in control.

All this is set to change. The Securities and Exchange Board of India (SEBI) has revised the norms for corporate governance.

Clause 49 of the Listing Agreement has been amended with prospective effect from January 1, 2006.

From then, it will be obligatory for listed companies to have independent directors on their boards, apart from those elected by shareholders. The revised Clause 49 stipulates that at least half the board should be of independent directors.

The Department of Economic Affairs in the Ministry of Finance, and the Ministry of Company Law have broadly accepted this viewpoint of SEBI.

There are more than 9,000 listed companies in India with paid-up capital running into thousands of crores of rupees.

All these companies have to comply with the new Listing Agreement norm on independent directors before December 31, 2005, or face severe penalties.

Irani Committee recommendations

The Expert Committee made up of 13 members and six special invitees under the chairmanship of Dr J. J. Irani, that considered the question in great detail, is firmly of the view that the presence of independent directors will improve corporate governance.

While specialist directors would be confined to the perspective of their area(s) of interest, independent members would be able to bring an element of objectivity to the board process in the general interest of the company and to the benefit of minority and smaller shareholders.

The Committee felt that about a third of the total number of directors of a board should be independent.

The independent director's role will be non-executive and he will have no material or pecuniary interest in the company or its associates.

The company may appoint as independent directors persons of integrity, possessing relevant expertise and experience and also satisfying the criteria for independence.

These members will ensure due diligence by the board and review legal compliance reports. They can also record their dissent in the minutes whenever they disagree with board decisions.

The problem

There is an abundance of talent waiting to be harnessed in India. A company can tap the bank of talented individuals such as scientists, engineers, lawyers, professors and a host of academics and experts to sit on its board as an independent director.

There are, however, two problems to be tackled before the proposal to have independent directors can be successfully implemented.

The first problem is not insurmountable. Independent directors will get remuneration like others on the board. Sitting fee may not be a decisive factor in accepting or rejecting a company's invitation to be an independent director.

However, resourceful companies are known to pay commissions and a share of profits even to non-executive independent directors and these amounts may be substantial.

The payment of such commission can compromise the independence of such directors. This, however, is a matter for the Department of Company Affairs to tackle.

Liability

The more intractable problem for the independent director arises from the concept of vicarious liability.

The company and the board are responsible for all the consequences of actions taken by the officers of the company.

The law does not make a distinction between directors who are in charge of the day-to-day affairs of the company and non-executive members attending only the board meetings once in three months. It does look unreasonable to make such non-executive directors liable for the actions and decisions of the company they may not be aware of.

Directors are of different kinds — additional, alternate, casual and nominee. Welfare legislation and tax laws have imposed multitudinous responsibilities and liabilities on directors.

Financial institutions appoint nominee directors to represent their interests. The IFCI and the IDBI have elaborate instructions for their nominees on company boards.

The statutes of the IDBI and the IFCI provide an element of protection to their nominee directors against legal prosecution or other proceedings under certain circumstances. Such protection is not available to non-executive independent directors.

It is significant that the Irani Committee specifically recommended that nominee directors appointed by any institution or in pursuance of any agreement or by the government should not be deemed to be independent members.

It took the view that such nominees represented specific interest and could not, therefore, be rightly termed as independent.

The Committee also recommended that the non-executive/independent director should not be held liable for contravention of any provisions of law that happens without his knowledge or consent or connivance.

There have been cases where respected non-executive independent directors have been dragged to the criminal court for the failure of the principal officer of the company to deduct tax at source. Happily, courts have frowned at these practices and quashed such prosecutions.

A recent bugbear relates to the cheque bouncing offence. Here again, in a recent ruling, the Supreme Court came to the aid of the independent directors, holding that they cannot be hauled up to criminal courts for acts of commission and omission by the managing director.

Independent directors are invited to sit on the board purely on account of their special skills and expertise in particular fields and they represent the conscience of the investing public and also take care of public interest.

As long as they show due diligence, the law should exempt them from all types of liabilities for the actions of the board or the managing director they may not be aware of.

In the absence of such safeguards, no worthwhile talent can be expected to join a company's board in the capacity of an independent director.

This issue brooks no delay. There is sufficient case law on the subject. The Government must wake up and issue guidelines concerning the legal liability of independent directors.

That is the only way to attract talented, honest and experienced individuals to act as independent directors on the boards of companies.

(The author is a former Chief Commissioner of Income-Tax.)

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