Legally independent, factually dependent

The role of independent directors needs to be debated in the light of the Satyam row. The larger issue is whether corporate governance can be codified at all? The fact is that corporate governance can be made ‘legal’ to certain extent; however, the implementation of any rule on governance, in spirit, depends on the willingness of the particular company in safeguarding the interests of its stakeholders.

But the legislature cannot ignore two fundamental aspects of any enactment, namely, the human side and the ground reality of functioning of the corporate world, before drafting a series of sections covering the ‘directors liability’ and their ‘independence’ to an already bulky law.

Independence defined

The latest legal literature defining ‘independence’ is contained in the Companies Bill, 2008, seeking to comprehensively amend the existing Companies Act. Independence is sought to be established by this Bill for a non-executive director, as an individual (i) who does not receive any remuneration, (ii) who is not a relative to any of the board members or a level below that or a material supplier or a substantial shareholder, (iii) who was not an executive of the company in the last three years, and (iv) who is not part of the statutory audit firm or legal firm advising the company.

Listed companies have never had difficulties in finding a person who satisfied the legal requirement of ‘independence’.

The real test is not whether the person satisfies the qualification of independence but whether such person would be in a position to function independently during his/her term on the board The answer may be positive in a few instances of large corporations, but in a good majority of cases the existing system does not work for many reasons.

Directors do not enjoy any substantial right under the Companies Act. For instance, a resigning director needs to inform the Registrar of Companies (RoC), but the filing of such information (Form 32) can be done only by the company.

If the company fails to file the relevant form with the RoC or delays it, then the legal position is that the director who had factually resigned will continue to be a director as per the office of the Registrar and would continue to be legally liable.

The Articles of Association (AoA) of the company offers indemnity for recovering expenses incurred by any director from the company but such rights are in reality difficult for enforcement against the company.

Unlike shareholders’ meeting — wherein both ordinary and special resolutions are passed — the director’s meeting witnesses only voting by simple majority. Thus, if a director would like to dissent, he has to ensure proper recording in the minutes and secure a copy of that to protect his legal position.

But he can use this to absolve himself of any personal liability only after the law suspects him too as a villain and causes sufficient damage to his reputation because of his directorship. Even with regard to petty offence such as cheque-bouncing, a director — who is not involved in the operations of the company — can be hauled up before courts.

Director’s dilemma

In practice, directors, once appointed, face constraints of many kinds. First, the agenda for the board meeting reaches them only a few days before the meeting. Typically, even in a mid-sized company, the transactions that are put through the board for active consideration involve high stakes.

It is difficult for any director to consider in 4-5 board meetings, the entire year’s major transactions in detail, and to thoroughly marshall the facts and ask probing questions, seeking full clarity on the proceedings of the board, which in most companies commence and conclude in less than an hour.

The directors, guided by their own common sense, go through the motions to watch out for any doubtful areas.

In the process many tricky transactions get their nod without being fully and critically analysed.

The other approach is to seek professional support from experts such as auditors, lawyers and bankers. If there are no adverse reactions from such experts, the directors may feel confident, sometimes perhaps unjustifiably so, about the transactions supported by them.

The hefty compensation given to independent directors, either as sitting fees, remuneration or commission in relation to the time spent by them in the company, sooner or later dilutes their independency.

A Business solution

The solution lies more in the business approach to the whole exercise rather than through the legal route. The issue itself needs thorough debate in professional circles and the following could help resolve the conflicts:

Preparing with the help of chambers of commerce and premier professional institutes, a panel of persons of high standing and repute;

Enabling the major stakeholders, such as commercial banks and financial institutions, to appoint independent professional directors to safeguard investors’ interests, rather than the current practice of appointing only nominee directors, who are mere representatives of the lenders;

Ensuring that professional directors get legitimate legal protection, with particular emphasis in distinguishing them from promoter-directors;

Making sure that the board of limited companies clearly earmarks the domain that each director would be responsible for, such as revenue matters, audit committee, compliance with the law, and so on. This is imperative, considering the ever-growing complexity of corporate legal and regulatory requirements in the country. This should also give comfort to the directors that all of them cannot be held uniformly liable for all acts of the company; and

Requiring companies to publish as part of annual accounts the votes cast by the directors, dissenting or otherwise, and reasons for the dissenting views.

Article by K. Ramesh, The author is a practising advocate and a fellow of ICAI