AbstractIndependent Directors of a company have a very importantrole in assuring quality corporate governance in a company. “The landmark legislation regarding independent directors isthe Clause 49 of the listing agreement of the SEBI Guidelines given out in theyear 2005. How ever following various scams that took place in India and inother countries like the Satyam Scam and The Enron Scam due to which the roleof Independent Directors have come under the spotlight once again. Thefollowing paper is about the role of Independent Directors in a company.”IntroductionThere have been en masse resignation of Independent Directors in variouscompanies that underwent various corporate governance scams, it has brought therole of independent directors in the corporate governance of the company underheavy scrutiny. “The Satyam scam is not the only incident wherein the independentdirectors showed lack of responsibility towards the duties that they areexpected to perform, the spate of highly publicized corporate governancescandals such as Enron, WorldCom and including the Walt Disney Company,Hollinger International and Airbus Industries, have resulted in puttingcorporate governance under heavy scrutiny in the public spotlight.
“The concept of independent directors is not new, “it has evolved over the past 20 years,since the concept and position were first introduced. Independent directors areexpected to play an extremely crucial role in ensuring the high quality ofcorporate governance in a company. It is their burden to provide an assuranceto all stakeholders of the company that all the dealings of the company will beundertaken in a responsible manner.
‘In ‘the landmark case onthe point of Independent Directors would be, Lennard’s Carrying Company Ltd v.Asiatic Petroleum Co. Ltd ,”Viscount Haldane, Lord Chancellor, while highlighting the importance ofnon executive directors, had elaborated and specified how the non executivedirectors’ contribution can be instrumental in complementing the executive’scompetence by stating” :”My Lords, a corporation is an abstraction.
It has no mind of itsown any more than it had a body of its own; its active and directing will mustconsequently be sought in the person of somebody who for some purposes may becalled an agent, but who is really the directing mind and will of thecorporation, the very ego and centre of the personality of the corporation.That person may be under the direction of the shareholders in general meeting;that person may be the board of directors itself, or it may be, and in somecompanies it is so, that that person has an authority to co-ordinate with theboard of directors given to him under the articles of association, and isappointed by the general meeting of the company, and can only be removed by thegeneral meeting of the company.”Further the Naresh Chandra Committee while emphasising on thesignificance of the presence of Independent Directors in the composition of theBoard of a company had stated that, “Clearly, a board packed with executivedirectors, or friends of the promoter or of the CEO, can hardly be expected toexercise independent oversight judgement.”Independent “Directors constitute a necessary component of a balanced board structurewhere the in depth knowledge of the executive directors is blended with thewider experience and knowledge of the independent outside directors.
” Independent directors in “particular can provide a perspective tothe discussion based on their experience, technical expertise and wisdom thatmake a great contribution in the area of strategy. In the following article, we will be critically examining the concept ofIndependent Directors, the role they play in the corporate governance of thecompany and their under liability for the companies actions.”AnalysisThe concept of “”independent directors” is not an inherent one in the Indian businessorganisation system but has been borrowed from the corporate governance normsof the U.S. and U.K.The term “independent Directors” became a part of the Indiancorporate lexicon after the publication of the Kumar Mangalam Birla committeereport, formulated by SEBI, to start up reforms in the area of Corporategovernance, which resulted in the introduction of clause 49 in Listingagreements.
“The committee had extensively debated on the issue of independentdirectors and opined that independence be suitably, ‘correctly and pragmatically defined, sothat the definition itself does not become a constraint in the choice ofindependent directors on the board of companies. “The Birla committee defined IndependentDirectors as those “who apart from receiving directors remunerations do nothave any other material pecuniary relationship or transactions with thecompany, its promoters, its management or its subsidiaries, which in the judgementof the board may affect their independence of judgements.”On 21st August 2002,” following the enactment of the Sarbanes–Oxley Act of 2002 in the U.S.,the Ministry of Finance appointed the Naresh Chandra Committee to examinevarious corporate governance issues primarily around auditor – companyrelationship, rotation of auditors and defining Independent directors. Thecommittee came to the conclusion that the definition in contained in clause 49of the Listing Agreement could be made more precise without compromising thespirit of the independent directors.” It recommended that independent directors should not be less than fiftypercent of the board and that nominee directors of lending institutions not beconsidered as independent.” It also provided for training of independent directors and recommendedto exempt them from criminal and civil liabilities.
In 2003, SEBI constituted the Narayana Murthy committee, with the aim to reviewClause 49 of the Listing Agreement, and suggest measures to improve corporategovernance standards. The committee adopted the Chandra Committee definition ofindependent directors, however, without the condition of nine-year term.”It is on the basis of the above recommendations that the definitionindependent director has been formulated under the Indian law. As per clause 49of the Listing Agreement an” ‘independent director’ shall mean a non-executive director of thecompany who:a. apart from receiving director’s remuneration, does not have anymaterial pecuniary relationships or transactions with the company, itspromoters, its directors, its senior management or its holding company, itssubsidiaries and associates which may affect independence of the director;”b. is not related to promoters or persons occupying management positionsat the board level or at one level below the board;c. has not been an executive of the company in the immediately precedingthree financial years;d.
is not a partner or an executive or was not partner or an executiveduring the preceding three years, of any of the following:i) the statutory audit firm or the internal audit firm that isassociated with the company, andii) the legal firms and consulting firms that have a materialassociation with the company.e. is not a material supplier, service provider or customer or a lessoror lessee of the company, which may affect independence of the director; and,f.
is not a substantial shareholder of the company i.e. owning twopercent or more of the block of voting shares.Although the Indian Companies Act, 1956, imposes a legal duty on alldirectors to act in the best interests of the company it has been observed timeand again, that the same is not adequate to give full assurance, that,potential conflicts between the interests of the majority stakeholders andthose of the public, will not impair the board’s decision-making, particularlywhen family-run businesses account for such a large proportion of Indiancompanies. It is in such circumstances that the need for IndependentDirectors arises.Independent Directors counterbalance management weaknesses in a companyand also ensure that the company follows a legal and ethical framework in thereday to day transactions, while strengthening accounting controls.More importantly, the need for appointing independent directors on theboard of a company arises due to the fact that they are the solerepresentatives of the public shareholders and thus have the responsibility ofupholding their interests in the company.
In fact the main rationale behind appointingIndependent Directors in the company’s board is to keep a check on theactivities of the company, as an oversight mechanism.”The Naresh Chandra Committee whileexpressing its views on the role of Independent Directors had stated that, “atthe core of corporate governance is the board of directors.” Furthermore, theSupreme Court in Central Government Vs. Sterling Holiday Resorts (India) Ltd.and Ors.
had also emphasised that the “the Board of directors should bestrengthened by appointing independent directors.” “The “role of IndependentDirectors ranges from policies regarding the long-term survival of the companyto improved internal controls.Managerial oversight is an important function of a board of directors.
Independent members bring in an objective view while evaluating the board andmanagements decisions since they have no personal interests in the company.Independence is particularly crucial in those areas which involve a potentialconflict of interest between managers and shareholders. “Independent directors have a crucial role to play,” especially since the majority ofcompanies in India are family-run businesses, having a strong control overtheir management. In such cases, the presence of a good ratio of IndependentDirectors on the board helps in reducing instances of conflict between themajority and minority shareholders interests and ensures that the rights ofminority shareholders are upheld and protected.”Independent Directors bring wider experience, “expertise and a fresh perspective tothe boardroom and can effectively exercise their best judgment for theexclusive benefit of the Company, since their judgment is not clouded by realor perceived conflicts of interest.
As public information has become more transparent and reliable, investors—especiallyinstitutional investors now clearly prefer companies with better governancestandards, over those whose corporate governance practices may still bedubious. Having independent directors on boards sends a very strong signal toinvestors that the company is well run and governed, and its board is soundenough to ensure that nothing less than the very best international corporategovernance practices are adhered to.” The presence “of independent directors brings diversity to the board.
While executivedirectors bring with them the organizational insight, independent directors, onthe other hand, generally being experts in their respective field, get theirknowledge, expertise and objective mindedness to the table. Together, abalanced board can steer the company on the path of success. The process of the internal control commences right from the developmentof new policies by the Board of directors and includes administrativeregulations, manuals, directives and decision, internal auditing etc. Theindependent directors act as a supervisory body monitoring the internal controlsystem of the company and are responsible for the identification of flaws inthe internal control system and presenting them before the board to findsuitable solutions.” Independent Directors are responsible for identifying and analyzing “all such risks that may Lennard’sCarrying Company Ltd v. Asiatic Petroleum Co.
Ltd ,Viscount Haldanethreaten the assets, resources and earning capacity of the company. Their roleis to critically scrutinize the decision making process and ensure that theinvestments, funds, business transactions etc do not result inlosses. “By virtue of their “appointment and the subsequent role played by them in managing theaffairs of the company, the liability of independent directors has been amatter of debate and controversy.A lesser degree of liability for independent directors has beenadvocated by some quarters, citing differences in their roles in comparisonwith those of the executive directors.” While expressing its views on the subject,” the Naresh Chandra committee hadopined that not even the most stringent international tenet of corporategovernance and oversight assumes that an independent directors who interactswith the management for no more than two days every quarter will know of everytechnical infringement committed by the management of the company in its normalcourse of activity.
“The committee “had further observed that at a more practical level, it would be verydifficult to attract high quality independent directors on the board of Indiancompanies if they have to constantly worry about serious criminal liabilitiesunder different acts.This view was reiterated by the Irani committee who had recommended thatthe independent director should not be held liable for contravention of anyprovisions of law that happens without his knowledge or consent or connivance.” The new Companies Amendment Bill 2009, contains a “similar provision which is based on theSupreme Court’s verdict in the case of KK Ahuja v VK Arora where the courthad held that “liability arises from being in charge of and responsibility forthe conduct of business of the company at the relevant time when the offencewas committed and not because on the basis of merely holding designationor office in a company.
” Further in S.K Alagh Vs State of U.P ,the Supreme Court had held that “Indian Penal Code, save and except some provisionsspecifically providing therefore, does not contemplate any vicarious liabilityon the part of a party who is not charged directly for commission of anoffence.””Thus there is a “general consensus among the people that the responsibility of independentdirectors is ideally considered to end with vigilance in the Boardmeetings and that they cannot be held liable for acts outside their knowledge.
However, the 2010 judgement of the Bhopal District Court, sentencing MrKeshub Mahindra, a former non-executive director of Union Carbide, with twoyears of imprisonment, in the Bhopal Gas tragedy case, has given rise to aseries of arguments regarding the scope of independent director’s liability.”Those supporting the “court’s decision are of the view that the ultimate legal responsibilityfor a company’s act lies with its board of directors and when a crime takesplace, it is their collective responsibility to be liable and since neither theCompanies Act, nor any other legislation excludes Independent Directors fromcriminal liability, they are also equally accountable for such acts. ColinGonsalves, founder of the New Delhi-based Human Rights Law Network, is of theview that, “being an independent director does not mean being independent oflaw.
” According to him ‘sleeping’, ‘non-executive’ and ‘independent’ are justpretentious terms to restrict the legal responsibility of a director in thecompany and that, “there are no restrictions in the law to cut down liability.”” On the other hand, many believe that even though, as board members,independent directors have the same legal duties and obligations as executivedirectors, but, because of their limited involvement in the day-to-day runningof the company,” it is undesirable for the law to expose them to personal liability. TheCII has strongly recommended that the law regarding the potential liability ofindependent directors needs to undergo a change, for independent members cannotbe made to undergo the ordeal of a trial for offence of non-compliance with a statutoryprovision unless a prima facie case has been established against them holdingthem liable for the failure on part of the company. “In the absence of such safeguards, many believe that, people will be farmore reluctant and careful in accepting the position of independent directorsin this atmosphere of uncertainty.
CONCLUSIONWhile independent directors” form an essential and powerful component of a company, providingnumerous advantages to the board, however in order to ensure that they areactually able to play an effective role in the corporate governance of thecompany, there is an urgent need to strengthen the institution of independentdirectors. Efforts should be made to properly lay down and codify lawsregarding their responsibilities, duties and rights. Further, in order securethe independence of independent director there is need to break the nexusbetween the independent directors and promoters who sponsor them. Thenomination of independent director by SEBI and government can be a suitablesolution for the same.
Thus it can be clearly concluded that independentdirectors have the potential of becoming effective regulators of the company’sactivities and policies provided sufficient and adequate provisions are madefor their empowerment.”