By Mukundan Bharathan
Finally, almost 57 years after the Companies Act of 1956, India’s Parliament passed a new Companies Act of 2013, which received the assent of the President on August 29, 2013. The old Companies Act of 1956 had already outlived its tenure by 1978. Previous governments had recognized the need for a major revision of the Companies Act to reflect changing corporate governance norms, but failed to get the legislation enacted. Governments made efforts to replace the old Act with a new one in 1993, 1997 and 2000, but each time the bill did not pass, perhaps because it had a large volume of sections.
Indeed, the 2013 Act is so comprehensive, at 29 chapters with 470 sections, that all of its provisions have yet to be brought into effect and the rules to enforce the statute are still being framed. Thus, like the U.K. Companies Act of 2006, which took three years to fully implement, India’s 2013 Act is taking effect in phases, and it may take many months before it is completely implemented. Despite this, the Ministry of Corporate Affairs (MCA) has notified (brought into effect) large portions of the Act. All of the notified sections of 2013 Act are made effective from April 1, 2014.
New Provisions For Increased Accountability, Transparency And Better Governance Of Companies
The 2013 Act has several new provisions relating to the roles, duties and liabilities of the independent directors. Out of India’s 1.3 million registered companies around 1.1 million are private limited companies and about 5,000 are listed on a stock exchange. Thus, most companies are held by directors who were their founding promoters. Under the new Act promoters/directors cannot serve as independent directors given their inherent self interest in all important company decisions.
For this reason independent directors must be independent of the promoters and management of the company. They cannot be majority shareholders and cannot have any conflict of interest with the Company. Independent Directors are, nevertheless, entitled to compensation. They are eligible to receive sitting fees as well as a percentage of commissions on sales as approved by the board of directors. However, they can no longer be offered Employee Stock Options (ESOP).
An independent director needs to be impartial and must act in the interest of the company, its shareholders, society and the community at large. He or she should be selected for special skills that are considered to be in the interest of the Company, and must play the role of a watchdog/whistle blower and moderate all conflicts within the company.
The role of the independent director is more proactive now and being a whistle blower means not keeping quiet if there is anything suspicious in any of the dealings that come to one’s knowledge. To act as whistle blower, the independent director should have independent communication with the Key Managerial Personnel including CEO, CFO, Company Secretary, Functional Heads such as finance, legal, human resources and supply chain. In fact, internal audit firms and employees should also be encouraged to have an open discussion with the independent directors. Independent directors are expected to raise red flags and ask questions and act diligently. The independent director is no longer a rubber stamp and must cast a dissenting vote to any resolution he or she feels is prejudicial to the interests of all stakeholders.
The role of an independent director is so crucial that the 2013 Act has emphasized that an independent director should be included in key committees for certain types of companies. The company’s committee on Corporate Social Responsibility (CSR) must have one independent director. The Audit Committee must have a majority of independent directors, and half of the Nomination and Remuneration Committee be also be independent directors. The requirement of one independent director on the CSR committee applies only to companies with annual profits of more than ₹50 million or where turnover exceeds ₹10 billion or net worth is over ₹5 billion (at the time of writing the exchange rate was ₹60 to U.S. $1).
Corporate Social Responsibility (CSR) provisions are also applicable to foreign companies. Every foreign company which has a place of business in India and conducts business activities in India and which has a branch office or project office in India, is required to engage in CSR activities as provided under the Act. A company may carry out CSR activities either by itself or through a registered trust, registered society or a company established by its holding, subsidiary or associate company.
The new Act requires at least one-third of the total board members to be independent directors. The one-third requirement under the old Act applied only to listed companies. The new Act applies to public listed companies as well as public companies having a paid up share capital of over ₹1 billion and over ₹2 billion in loans, borrowings and deposits.
The 1956 Act did not fasten any liability on independent directors as does the new Act. Only the managing director was held responsible as he was in charge of and responsible for the day to day affairs of the Company at the time of the commission of an offence. Under the new Act, liability has also been extended to independent directors even though they have no day to day operational responsibilities. While courts were often lenient in applying liability to the actions of independent directors, they were held responsible for a default or the commission of an offence if they had the knowledge or if the offence was committed under their direction or control. To avoid liability, an independent director must now prove that he had no knowledge of the offence that was being committed, that he had raised red flags at time, and had asked relevant questions about the particular transaction that was ostensibly detrimental to the interests of stakeholders. An independent director will not be held liable if he or she can demonstrate that he or she acted diligently and cast a dissenting vote against the particular apparently irregular act.
Many companies in India provide for long terms for their independent directors. In the case of Reliance Industries Limited, one of the independent directors was on the board for over 30 years. Mahindra and Mahindra, another well-known company in India, had its independent director on the board for over 31 years. So is the case with another multi-national company, Colgate Palmolive, which has had the same independent directors since 1983. Infosys co-founder Mr. Narayan Murthy had suggested that independent directors serve for no more than three terms of three years each. Now under the new Act the term of the independent director has been capped at two consecutive terms of five years each and then a cooling off period of three years, at the end of which that independent director could serve again.
The issue that corporations now face is getting good quality independent directors especially when their term is limited followed by a cooling off period. Some people are optimistic that many good people will come forward to fill the pool to be created by the Central Government from where companies can choose their independent directors.
Interplay Between The Companies Act 2013 And The Amended Equity Listing Agreement Of The Securities And Exchange Board Of India SEBI)
In addition to Sections 166, 134(5), 149 and Schedule IV of the new Act which set forth the qualifications of independent directors, Clause 49 of the Equity Listing Agreement of the Securities and Exchange Board of India (as amended in April 2013) sets out the code of conduct and the role, responsibilities and functions applicable to them. Independent directors are expected to use their skill and independence in implementing the best corporate governance for the company and in the interest of all stakeholders.
Some of the key provisions of both the new Act and their interplay with SEBI’s amended Clause 49 of the Equity Listing Agreement are highlighted below:
1. SEBI: Two-thirds of the members of a company’s Audit Committee and the Chairman shall be independent directors.
COMPANIES ACT, 2013: The Audit Committee must have majority Independent Directors
2. SEBI: An independent director who has already served on a company’s board for five years can serve only one more term of five years.
COMPANIES ACT, 2013: an independent director may serve up to two terms of five years each.
3. SEBI: Companies to disseminate Independent Director’s resignation letter to Stock Exchanges & on company website
COMPANIES ACT, 2013: Independent Directors must disclose reason for resignation to the Registrar
4. SEBI: A person shall not serve as independent director on more than ten listed company boards
COMPANIES ACT, 2013: A person shall not serve as director on more than then public company boards
5. SEBI: Every listed company must have a Risk Management Committee
COMPANIES ACT, 2013: Every company shall have a Risk Management Policy
Pecuniary And Criminal Penalties
There are other important requirements imposed by the 2013 Act. Each year independent directors must hold at least one meeting to review the performance of non-independent directors. Conversely, the Board must evaluate the independent directors.
The penalty for noncompliance of any provision applicable to independent directors may include a fine from ₹50,000 to ₹500,000 and up to ten years imprisonment. With current fast track courts, the National Company Law Tribunal and the teeth given to the Serious Fraud Investigating Office, directors guilty of having violated some of these provisions may find themselves being sent to jail sooner than under the slower judicial and tribunal procedures of the past
There are many good independent directors presently serving on several Boards. However, an apparent scarcity of reputable and well-qualified candidates with the necessary talent and impeccable integrity essential for the job may make it difficult to fill in the positions of independent directors in other companies which are now required by the new Act to appoint them. Nevertheless, the new Act is a long-needed step to ensure more accountability, transparency and better governance of companies.
Mukundan Bharathan is the Senior Legal Counsel at GlaxoSmithKline Pharmaceuticals Limited, India and the views expressed herein are solely those of the author. Mukundan can be reached at Advocatemukundan@gmail.com