A COMPARATIVE STUDY ON ROLE OF INDEPENDENT DIRECTOR IN CORPORATE GOVERNANCE IN THE USA, UK AND INDIA

By Garima Bothra

Independent Directors under the Companies Act, 2013 (“Act”) have not been defined. However, the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations 2015 defines an Independent Director as a non-executive director, other than a nominee director of the listed entity.

Appointment of Independent Directors under the Act:

According to S.149(4) of the Act, every listed public company shall have at least 1/3^rd of the total number of Directors as Independent Directors. Any fraction of 1/3^rd of the total number is to be rounded off to one.

The following types of companies shall have a minimum of two Independent Directors:[1]

• Public Companies having paid-up share capital of ten crore rupees or more.
• Public Companies having a turnover of one hundred crore rupees or more.
• Public Companies which have aggregate outstanding loans, debentures and deposits, exceeding fifty crore rupees.

The above-mentioned criteria are notwithstanding cases where a higher number of independent directors are to be appointed owing to the composition of an audit committee.

Eligibility of an Independent Director:

An independent director means a director who in the opinion of the Board of Directors is a person of integrity and possesses relevant expertise and experience. The following persons cannot be an independent director:

• Managing director or whole-time director or a nominee director.

• Any person who is or was a promoter of the company or its holding, subsidiary or associate company.

• Any person who is related to the promoter of the company or its holding, subsidiary or associate company.

• Any person who has or had a pecuniary relationship with the company or its holding, subsidiary or associate company.

• Relatives of the following persons:
• who hold any security or interest in the company or its holding, subsidiary or associate company during the two immediately preceding financial years or during the current financial year.
• who is indebted to the company, its holding, subsidiary or associate company or their promoters, or Directors during the two immediately preceding financial years or during the current financial year.
• who has given a guarantee or provided any security in connection with the indebtedness of any third person to the company, its holding, subsidiary or associate company or their promoters, or Directors of such holding company, during the two immediately preceding financial years or during the current financial year.
• who has any other pecuniary transaction or relationship with the company, its subsidiary, or its holding or associate company.

• Any person who himself or his relatives holds the following positions in the company or its subsidiary, or its holding or associate company in the three financial years immediately preceding the financial year in which he is proposed to be appointed:
• key managerial personnel or is an employee.
• any person who is or was an employee of the proprietor or partner.
• any person who holds together with his relatives, 2 per cent of the total voting power in the company.
• any person who is a chief executive or director of any non-profit organization that receives more than 25 per cent of its receipts.

• Any person who has any qualifications as may be prescribed.

A person also cannot serve as an independent director in more than seven listed entities.

Remuneration of an Independent Director:

According to S.149(9) of the Act, an independent director shall not be entitled to any stock option and may receive remuneration by way of fee provided under sub-section (5) of section 197, reimbursement of expenses for participation in the Board and other meetings and profit related commission as may be approved by the members.

Tenure of an Independent Director:

According to S.149(10) of the Act, an independent director shall hold office for a term of up to five consecutive years on the Board of a company but shall be eligible for reappointment on the passing of a special resolution by the company and disclosure of such appointment in the Board’s report.

However, no independent director shall hold office for more than two consecutive terms, but such an independent director shall be eligible for appointment after the expiration of three years of ceasing to become an independent director.

Role of Independent Directors in India:

The presence of independent directors on a company’s board enhances corporate governance, which is crucial for public companies or those with significant public interest. While directors representing specific interests are often limited by their affiliations, independent directors provide an objective perspective that benefits the company, including minority and smaller shareholders. Independence should be understood not just as freedom from promoter interests, but also as a safeguard for vulnerable stakeholders whose voices might otherwise go unheard. Independent directors act as vigilant overseers of promoters and management on behalf of public shareholders, offering strategic advice to help maximise the firm’s overall value.

Duties of an independent director

Schedule IV of the Companies Act, 2013 lays out the duties of independent directors as follows:

• Undertake appropriate induction and continually refresh and improve their understanding of the company and their own skill set.
• Ask for clear information and get professional advice from outside experts when needed, with the company covering the costs.
• Try to attend general meetings and every meeting of the board. The director should also attend and participate in all meetings held by committees of which they are a member.
• Stay informed about the business and the external environment in which it functions.
• Not to interfere unfairly with the operations of the board or the committees.
• Confirm that any related party transaction is in the best interests of the company and has been properly assessed before authorising it.
• Ensure the presence of an effective mechanism to safeguard whistleblowers from retaliation.
• Report instances of unethical behaviour, fraud, or breaches of the company’s code of conduct.
• Assist in safeguarding the company’s interests, shareholders, and employees within authorized limits.
• Maintain confidentiality and refrain from disclosing sensitive information without board approval or legal requirement.

Liabilities of an independent director

As per Section 149 (12) of the Companies Act, 2013, an independent director will be liable only in respect of such acts or omissions which had occurred with their knowledge, including those attributable to board processes, or which occurred with the director’s consent or connivance or because the director did not act diligently. Similar protective measures for offences committed by companies are also outlined in other statutes. Section 29 of the Payment of Bonus Act, states that

“Notwithstanding anything contained in sub-section (1), where an offence under this Act has been committed by a company and it is proved that the offence has been committed with the consent or connivance of, or is attributable to any neglect on the part of, any director, manager, secretary or other officer of the company, such director, manager, secretary or other officer shall also be deemed to be guilty of that offence and shall be liable to be proceeded against and punished accordingly.”

The SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 address compliance requirements for companies. In the case of Zylog Systems Ltd.,[2] two independent directors, Mr. S. Rajagopal and Mr. V.K. Ramani, highlighted non-payment of dividends during a board meeting and insisted on rectification. Despite their efforts, when the company did not comply, they resigned. SEBI concluded that since these directors had no role in daily management and acted diligently, no action was warranted against them.

In the case of Sunita Palita and Others v. M/s Panchami Stone Quarry,[3] an independent director who was not overseeing or responsible for the company’s operations at the pertinent time will not be held liable under those provisions. It would be unjust to hold directors accountable who had no involvement with the issuance of a cheque.

In March 2020, the Ministry of Corporate Affairs issued a circular clarifying that Section 149(12) of the Companies Act, 2013 is a non-obstante clause. It emphasised that independent directors and non-executive directors should not face civil or criminal proceedings under the Act unless the conditions specified in Section 149(12) are satisfied and there is sufficient evidence against them.[4]

Role and Duties of Independent Directors in the United States:

In the United States, the Sarbanes-Oxley Act of 2002 significantly changed the way corporate governance and financial practice oversight are conducted. This safeguard was put in place in reaction to major accounting and corporate scandals, like the ones that involved Tyco International, WorldCom, and Enron. This Act requires strict measures to reduce accounting fraud and boost business transparency. It requires public businesses to have a majority of independent directors and to have only independent members on the audit, nomination, and remuneration committees. Furthermore, the makeup of committees and the independence of directors are governed by listing rules unique to the NASDAQ and the New York Stock Exchange (NYSE). [5]

The role of independent directors in corporate governance in the United States is critical for

ensuring oversight, transparency, and the protection of shareholders’ interests. Independent directors are expected to bring impartial judgment to board decisions, free from conflicts of interest that might affect the company’s executives or major shareholders. Here are some key aspects of their role:

1. Oversight and Monitoring: Independent directors are essential in overseeing management’s performance, ensuring that executive actions align with the company’s best interests. They help mitigate risks and monitor compliance with legal and ethical standards.[6]
2. Financial Reporting and Audits: They play a crucial role in reviewing and approving financial statements, ensuring the integrity of financial reporting. This includes working with external auditors to verify that the company’s financial disclosures are accurate and transparent.[7]
3. Conflict Resolution: Independent directors are vital in managing conflicts of interest, especially in transactions involving major shareholders or executives. They help ensure that such transactions are fair and in the best interest of all shareholders. This is particularly important in controlled companies where major shareholders might exert significant influence​.[8]
4. Strategic Guidance: They provide independent oversight on strategic decisions, including mergers, acquisitions, and major investments. Their unbiased perspective helps ensure that these decisions are made to benefit the company and its shareholders in the long term​.
5. Risk Management: Independent directors help set the company’s risk appetite and oversee the management of major risks. This includes reviewing the company’s risk management processes and ensuring that risks are adequately identified and managed.
6. Executive Compensation: They are involved in determining executive compensation, ensuring that it is aligned with the company’s performance and shareholder interests. This helps in attracting and retaining competent executives while discouraging excessive risk-taking​.[9]

Role and Duties of Independent Directors in the United Kingdom:

Businesses that are listed on the London Stock Exchange follow the UK Corporate Governance Code, which mandates that non-executive directors who are regarded as independent should make up at least half of the board of directors (apart from the chair). In the UK, independence is not being subject to business or other relationships that could seriously interfere with the ability to make independent decisions.

While the term used may not be the same, the role of ‘Non-Executive Directors’ (“NEDs”) is more or less the same as independent directors in India. According to the Cadbury Code of Corporate Governance in the UK, the NEDs bring an independent judgement to bear on issues of strategy, performance, resources, key appointments and standards of conduct.[10] Unlike the Indian Company law, the UK Corporate Governance Code 2018 requires half of the board excluding the chair to be NEDs. The UK Code also requires the chair of the Board of Directors also to be independent.[11]

The case of NIAL v Eversheds[12] highlights critical aspects of the role and responsibilities of independent directors (Non-Executive Directors or NEDs) in corporate governance in the UK. Taking the case as reference, the role of Non-Executive Directors in the United Kingdom are:

1. Oversight of Management: Independent directors are expected to provide oversight over the actions and decisions of executive management. This involves scrutinizing management proposals and decisions to ensure they are in the best interest of the company and its shareholders.
2. Active Participation and Due Diligence: NEDs must actively participate in board and committee meetings, thoroughly reviewing all materials and advice provided. This includes legal contracts, meeting papers, and external advice.
3. Collective Responsibility and Communication: Effective communication among board members is crucial. Independent directors should ensure that there is a clear and transparent flow of information.
4. Understanding and Exercising Independent Judgment: NEDs should bring an independent perspective to board discussions, challenging management when necessary and ensuring decisions are made objectively.
5. Role in Committees: Independent directors often serve on various committees, such as audit, remuneration, and nomination committees. Their role in these committees is to provide additional oversight and ensure specialized issues are handled correctly.
6. Accountability and Liability: NEDs can be held accountable for failures in governance. They must carry out their duties with due care, skill, and diligence to avoid personal liability.

Conclusion:

While the regulatory frameworks and specific requirements vary across these jurisdictions, the core responsibilities of independent directors remain similar. They are expected to act in the best interest of the company and its shareholders, provide unbiased oversight of management, and ensure the integrity of financial and strategic decisions. The independence of these directors is fundamental to their role, allowing them to bring an impartial perspective to board discussions and decisions.

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[1] Companies (Appointment and Qualification of Directors) Rules, 2014, rule 4.

[2] In Re: Zylog Systems Limited and Ors. (14.06.2021 – SEBI / SAT) : MANU/SB/1831/2021

[3] Sunita Palita and Ors. vs. Panchami Stone Quarry (01.08.2022 – SC) : MANU/SC/0944/2022

[4] General Circular No. 1/2020, Ministry of Corporate Affairs, Government of India available at: https://www.mca.gov.in/Ministry/pdf/Circular_03032020.pdf

[5] ‘The essential role and responsibilities of independent directors in corporate governance’ (Director’s Institute, 7 June 2024) <https://www.directors-institute.com/post/the-essential-role-and-responsibilities-of-independent-directors-in-corporate-governance> accessed 14 June 2024.

[6] Evaluating The and others, ‘Evaluating the Role of Independent Directors’ 1.

[7] Hebrew Univer- and others, ‘INDEPENDENT DIRECTORS AND CONTROLLING SHAREHOLDERS Lucian A. Bebchuk and Assaf Hamdani.

[8] ‘Principles of Corporate Governance’ (Harvard Law School Forum on Corporate Governance, 8 September 2016) <https://corpgov.law.harvard.edu/2016/09/08/principles-of-corporate-governance/> accessed 14 June 2024.

[9]. Principles of Corporate Governance’ (Harvard Law School Forum on Corporate Governance, 8 September 2016) <https://corpgov.law.harvard.edu/2016/09/08/principles-of-corporate-governance/> accessed 14 June 2024.

[10] Cadbury Committee, ‘Report of the Committee on the Financial Aspects of Corporate Governance’ (Gee and Co. Ltd, 1992).

[11].Financial Reporting Council, The UK Corporate Governance Code (July 2018) Principle 9 https://www.frc.org.uk/getattachment/3b1aa6d2-4a1d-49b0-b456-d192aa32c740/2018-UK-Corporate-Governance-Code-FINAL.PDF accessed 14 June 2024

[12] Newcastle International Airport Ltd v Eversheds LLP [2014] 1 WLR 30735