Independent Directors (IDs) have a rather crucial role to play in corporate governance and protecting shareholder interests. In India, the Companies Act of 2013 and the Securities and Exchange Board of India (SEBI) provide an exhaustive legal framework for the appointment and governance of IDs in companies. However, questions regarding the adequacy of these laws intrigue many, especially at the juncture when an independent director switches to another role in the company or sits for a few consecutive terms. This article delves into the independent legal requirements with respect to IDs, limits on their reappointment, and the contribution of proxy advisory firms in swaying governance decisions.
Independent Directors in Perspective and the Legal Underpinnings
By the definition provided in Section 149(6) of the Companies Act, 2013, an Independent Director is a non-executive director who has not been an employee of the company and is not having any material pecuniary relationship with the promoters or group of the company. To be classified as an ID, persons must possess the threats of several indicators that guarantee that they remain free from any probable conflict of interest. This requires a comprehensive set of eligibility criteria for listed companies and for unlisted companies.
For listed companies, SEBI applies higher standards, as set out under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. These regulations call for additional disclosures and governance practices concerning an ID’s independence and tenure, among other aspects. Nonetheless, despite the rigorous checks, questions seem to continue around the governance considerations that prevail when IDs are to be reappointed or undergo a change in their status in the company.
Restrictions in Appointment and Reappointment of Independent Directors
Some of the prominent legal provisions for ID regard the restriction on consecutive terms. As per Section 149(11) of the Companies Act, an independent director can be on the board for two consecutive terms, after which his/her reappointment as ID shall be mandatory after an interval of three years-that is, a cooling-off period of three years. This cooling-off period makes sense so that, if the company has given him employment for a long period of time, such long affiliation will not jeopardize his objectivity and independence with respect to the company.
With respect to reappointments of IDs in the same capacity, however, this cooling-off period does not apply. If he/she is appointed in a different capacity within the company, such as non-independent non-executive director (NINED), there are no similar constraints. This allows companies greater room for managing their boards under the flexibility that this provision creates and less rigidly on the cooling-off period for IDs.
Transition of Independent Director to an Executive Role
The other major consideration is the appointment of IDs as executive directors, especially in the listed companies. This was addressed in SEBI Regulation 25(11) of the SEBI LODR. Such regulation prohibits the appointment of an ID who has resigned from such position as an executive or whole-time director, in the company or its subsidiaries or any company in the promoter group for at least one year. The rationale for this clause is to prevent any possibility of conflict of interest arising from too early an assumption of a senior executive position from an independent director.
This is done to avert scenarios where an ID would turn biased making the decision simply because of the prospect of promotion into an executive position. With the introduction of this cooling-off period, SEBI attempts to ward off such imputation of motives on the governance structure of the board.
The Role of Proxy Advisory Firms in Governance
Historically, proxy advisory firms have gained enormous importance in the functioning of corporate governance over the last few years, especially towards listed companies. These firms provide voting recommendations to institutional investors to assist them in matters such as the reappointment of directors or election of new board members. While their recommendations are valuable, proxy advisory firms have been known to hold views that are often inconsistinct with governance standards, much above those laid down by the law.
For instance, most proxy advisory firms take a tough line on the reappointment of long-term directors. They argue that after directors have served for 10 years or more, they may lose their independence from the company due to the concern of conflicts of interest. Therefore, proxy advisory firms habitually advocate a cooling-off period for directors after 10 years of service regardless of their legal eligibility for reappointment. These advisories greatly influence the voting by shareholders as institutional investors mostly follow the advice given by proxy firms.
Interestingly, western governance standards may be readily adopted by proxy advisory firms, while seldom do they reflect the conditions in the Indian marketplace. In cases where the tech sector has been able to witness governance programs where an overly independent board takes charge, the recommendation of reappointment of long-then-serving IDs may invite hindrance, to an extent where the company may start lacking independent oversight.
Governance Issues and the Necessity of an Independence Check
The parameters regarding corporate governance stipulate a long-standing argument regarding whether a director loses his independence when he goes from an ID position to a non-ID post. Some proponents argue that such continued engagement with the company may impair a director’s independence; however, we should bear in mind that once appointed as an ID, a director is subjected to very well-defined processes of investigation regarding their independence. If indeed they move into a non-ID role, there is no onus in law for an immediate presumption of the compromise of his independence, especially since their duties as a continuing director remain intact under Section 166 of the Companies Act.
This provision elaborates that all directors, including non-IDs, should act in the best interest of the company and stakeholders. Subsequently, even after being an ID, the director’s duty to exercise independent judgment and act in good faith cannot waive off.
Conclusion: Controlling the Complexities of Independent Director Appointment
Although a relatively comprehensive legal framework exists for the appointment and reappointment of independent directors, a maze of nuances exists that companies will have to navigate, especially with reference to proxy advisory firm influences and governance issues concerning long-serving directors. Although the law is permissive, listed companies must consider the guidelines of the proxy advisory firms so as not to land in governance challenges that may affect shareholder approval.
In order to minimize any discord, the company should justify the reappointment of an independent director or the transfer to a different responsibility very clearly. Sufficient justification and the indication of how the director helped the company would significantly reduce the basis on which proxy advisory firms would recommend voting against such a resolution. Transparent and proactive governance practices are a means to strengthen the governance of the company so that the board can operate effectively and in the interest of the shareholders.
