Submitted By:

Akash Gupta

Paper XII
Corporate Law
Are Independent Directors Truly Independent?

The term "Independent Directors" was introduced after the publication

of the Kumar Mangalam Birla committee report which resulted into
introduction of clause 49 in listing agreements. The committee
mentioned that 'independent directors' are those directors who apart
from receiving directors remuneration do not have any material
pecuniary relationship or transaction with the company, its
management or its subsidiaries which in the judgment of the Board
may affect their independence of judgment. Clause 49 also prescribes
that Audit Committee should comprise of majority of independent
directors.

With the integration of the Indian economy into the world economy,
there is consensus among the corporate leaders that the corporate
governance in India should conform to international norms. Barring a
few exceptions, in India the appointment of independent or non-
executive directors has become a matter of mere legal compliance.
Most of the companies still function in the same old fashion and the
non-executive directors has hardly any say in the management of a
company. In most of the companies, hardly any relevant information is
passed on to the directors and the meetings of the Board discuss minor
and routine matters. The Board meetings are normally held once in
three months and that too for 2 to 3 hours only. It is obvious that
promoters would prefer to appoint their cronies and faithful persons on
their board to have minimum interference of the outside directors.

Who is an Independent Director?

All listed companies in India need to comply with the Listing

Agreement which mandates that the number of independent directors
should be at least one-third of the strength of the Board where
Chairman is a non-executive director or one half where Chairman is an
executive director. The concept of independent directors was first
brought to India by the 1999 Kumar Mangalam Birla committee on
corporate governance. Three years later the Naresh Chandra
committee gave governance more thought. Finally, in 2004 the
Narayanmurthy committee affected changes to clause 49 of the listing
agreement. As it stands today, the existing company law has no
mention of independent directors. It's SEBI who defines an
independent director as a person who:

• Has no material pecuniary transactions with the company or its

associates.
• Has no relationship with the promoters or senior management.
• Has not been an executive with the company in the preceding 3
years.
• Neither is, nor has been for the past three years, a partner with
an audit firm, legal firm or consulting firm to the company.
• Is not a material supplier or lessee to company.
• Does not own more than 2% of the company’s shares.
• Is over 21 years of age.

One third of a listed company's directors are required to be

independent. The erstwhile Company's (Amendment) Bill 2003 had
stated that a majority of the minimum seven directors of public
companies having share capital in excess of Rs. 5 crore should be
independent. The key difference between a non-executive and non-
executive independent director is that the latter is forbidden to have
any pecuniary relationship with the company apart from receiving a
sitting fee which at the time of writing that clause was Rs. 5000/- and
has since been raised to Rs. 20,000/-.

Why have Independent Directors on the Board?

There are several distinct benefits that an independent board of

directors can bring to a company, ranging from long-term survival to
improved internal controls. Independent directors in the board can:

• Counterbalance management weaknesses in a company.

• Ensure legal and ethical behavior at the company, while
strengthening accounting controls.
• Extend the “reach” of a company through contacts, expertise, and
access to debt and equity capital.
• Be a source of well-conceived, binding, long-term decisions for a
company.
• Help a company survive, grow and prosper over time through
improved succession planning through membership in the
nomination committee etc.

Independent directors are therefore also seen as a check on the

management of companies, as an oversight mechanism, apart from
the value addition that they bring to board deliberations. This is to
ensure that action for wrongdoing by the majority stake holders, who
control the management by holding a majority of their own shares, is
not hampered. A director's fulfillment of fiduciary responsibilities
requires more than the mere absence of bad faith or fraud.
Representation of the financial interests of others imposes on a
director an affirmative responsibility to protect those interests and to
oversee with a critical eye.

The shareholders, especially the minority shareholders, look to

independent directors providing transparency in respect of the
disclosures in the working of the company as well as providing balance
towards resolving conflict areas. In evaluating the board’s or
management decisions in respect of employees, creditors and other
suppliers of major service providers, independent directors have a
significant role in protecting the stakeholders interests. One of the
mandatory requirements of audit committee is to look into the reasons
for default in payments to deposit holders, debentures, non-payment
of declared dividend and creditors. Further they are required to review
the functioning of the “Whistle Blower mechanism” and related party
transactions. These, essentially, safeguard the interests of the
stakeholders.

Can Independent Directors really direct the Company?

The recent Satyam Fiasco has brought this question to many people’s
minds. This event has raised questions about the integrity of the
boards of many companies in India, even the blue chip ones. It has put
light on the system of independent directors in India, and how the
Indian concept is impractical. The following points highlight the gaps:

• In India, independent directors are handpicked by the promoter

himself, who then puts the name to the nominations committee,
which the nomination committee of the independent directors then
generally approves. If a company truly needs independent directors,
they have to be nominated by the SEBI which is a regulatory
 authority. If they have a right to regulate, then surely they have a
right to even suggest the appointment of certain directors. So, in
the case of listed companies, SEBI must have the right to nominate
independent directors, and if such legislation is brought in, a lot of
people good competent independent people will apply to SEBI and
ask for nominations. There are a lot of people who are prepared to
work as independent directors and are truly independent because
then they'll be accountable to SEBI, and not to the promoter.

• On the contrary it can be argued that the authority may not be

given to an outside party to place a director on a company. There
may be some merit in having an approved list which means that the
SEBI could perhaps decided that there are certain qualifications
which directors need. They could screen them for positive negative
attributes and have a panel to say that these are independent
directors that can be on listed companies and let management
select or the nomination committee select who they want.

• Then there's the question of how long an independent director can

remain independent. Doesn't familiarity breed dependence? There
are several instances where independent directors have served for
several decades. But that's because currently the law doesn't lay
down a limit. All directors are appointed for a term of three years
and when the term expires, they can offer themselves for
reappointment. The pending company bill seeks to change that by
limiting independent directors to a maximum of three terms or nine
years, after which they can stay on board but can no longer be
defined independent. Narayana Murthy, when he was on the
committee of corporate governance, said that independent directors
should not function on a board for more than nine years.

Hence, it can be said that the notion of independent directors is

actually beneficial for a company, but only in concept. The system with
which independent directors are appointed and regulated is the major
gap that has been put to a harsh test because of the Satyam case. If
the system can be improved in its core and its objective can be
expanded, there will be a far lower chance of another embarrassment
like Satyam ever happening again.