Education

Independent directors: More questions than answers

Updated on: May 12, 2013

Should an indepedent director be held responsible if he/ she did not smell a rat?

Globally, an independent director (ID) is expected to serve as a strategic advisor to management, and as a watchdog to protect the interest of the minority shareholders. However, in India, most IDs view their role principally as that of strategic advisors to the promoters. Relatively, most IDs do not perceive their role to be that of a watchdog.

Taking on the watchdog responsibility would mean that an ID gives up all his occupation and runs a full-time office to fulfil those duties. Such an onerous responsibility cannot be fulfilled by attending four to six meetings in a year. On the other hand, minority shareholders, other stakeholders, and regulators want them to act as watch dogs. Clearly there is an expectation gap.

Schedule IV Code for Independent Directors of the Companies Bill requires an ID to safeguard the interest of all stakeholders, particularly minority shareholders. It is a strange irony that IDs appointed by promoters have to protect the interest of the perceived adversaries of the promoters — the minority shareholders.

Independent directors argue that they do not have voting power and should not be seen as a panacea for wrongdoings. All that he/ she can practically do is to resign when his/ her efforts to correct the wrongdoings are unsuccessful. Despite the general perception of the public that IDs should act as watchdogs, it appears that — given the actual functioning of the Boards, the supremacy of the promoters, and the few Board/ audit committee meetings (assume average of six in a year) — the watchdog function is not exhaustively performed. Besides IDs may very well be kept in the dark — such as when a promoter pays a bribe to win a contract, it may not be escalated to the Board. Very often, the ID has to rely on the management, internal and external auditors, valuation experts and others for information. Should the ID be held responsible if he did not smell a rat?

The Ministry of Corporate Affairs’s general circular, dated March 25, 2011, requires the registrars of companies to exercise due care while including a non-Executive Director (ED) as an “officer in default”. It specifically states that an ID of a listed entity would not be held liable for any act that occurred without his knowledge or where he acted diligently in the Board process. While there is some kind of immunity — for example, in the case of a bounced cheque where the ID can plead that it was done without his knowledge — certain events have sent confusing signals. The

Nimesh Kampani and AMRI hospital fire event in Kolkata, where IDs were imprisoned, suggest that there may be no immunity to IDs, even when they were not the cause of the problem. Besides the Company law, there are several other legislations in India that may cause havoc in the lives of IDs.

Clause 149(12) of the Companies Bill clarifies that IDs and other non-EDs shall be liable only in respect of such acts of omission or commission by a company that had occurred with his knowledge, attributable through Board processes, and with the consent or connivance, or where he had not acted diligently. From this, it appears that the clause seeks to provide immunity to IDs from civil or criminal action in certain cases.

However clause 166(2) of the Bill seems to be a contradiction. It states that the whole Board is required to act in good faith in order to promote the objects of the company for the benefit of its members, and in the best interest of the company, its employees and shareholders, the community, and for the protection of the environment.

Post Satyam, IDs have realised that their role is no longer going to be ceremonial. For IDs of global companies, the risk of non-compliance increases significantly due to onerous global legislations such as the US Foreign Corrupt Practices Act and the UK Bribery Act.

Independent directors are becoming more vigilant, and taking a direct interest in reviewing the fraud risk management framework put in place by their organisations to mitigate the risk of fraud. Nonetheless, there are a number of questions dogging their minds. What are the stakeholders’ and regulators’ expectations? How can he/ she fulfil those expectations in the absence of any effective powers? How does he/ she redress the wrongdoing? How much trust should be placed on the information presented to him/ her? How much reliance should be placed on experts, such as lawyers, auditors or valuers? What is the extent of due diligence he should carry out? What is the time he/ she should provide to each company where he is an ID? What should be his remuneration? What is he ultimately liable for?

The Companies Bill, despite its good intention to ensure good corporate governance, does not provide concrete answers to the above questions. Moreover, lack of clarity in these areas will only scare away good talent from taking up the position of an indepdent director.

The author is Partner in a member firm of Ernst & Young Global

Published on March 10, 2018

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