Understanding the Role of Independent Directors in Indian Companies

Posted by Written by Naina Bhardwaj Reading Time: 6 minutes

Independent directors, per India regulations, play a pivotal role in balancing corporate interests and enhancing governance in companies. As per the Companies Act 2013, they offer expertise without being involved in daily operations. Their role spans guidance, risk management, stakeholder protection, and ethical oversight. Qualifications are stringent, ensuring independence. There are limits on directorships, and appointments involve board approval. Liability arises if they breach fiduciary duties.

In the Indian corporate landscape, the role of independent directors is paramount to enhancing corporate credibility and governance standards. Independent directors hold a crucial role in balancing the interests of a company’s management and its owners. They contribute to achieving not just maximum profits but also the well-being of shareholders.

As per Section 2(47) of the Companies Act 2013, independent directors are non-executive directors who contribute to improving corporate governance. They are individuals not directly or indirectly associated with the company’s day-to-day operations.

Put simply, an independent director is like a neutral observer on a company’s board of directors. They’re not involved in the day-to-day operations or part of the company’s top management. Instead, they bring an outsider’s perspective to decision-making.

Read: Appointment and Removal of Independent Directors in India: Alternate Mechanism Notified

Mandatory appointment of independent directors in India

The appointment of independent directors in India is governed by Section 149 of the Companies Act 2013, along with Rules and Regulations. Here’s a breakdown of which companies must or can appoint independent directors:

Public listed companies (mandatory)

  • Requirement: Every public listed company must have at least one-third of the total number of directors as independent directors.
  • Explanation: This is a mandatory requirement, ensuring that public listed companies have a significant presence of independent directors to enhance corporate governance.

Other classes of public companies (prescribed by the federal government)

  • Requirement: The Union government has the authority to prescribe the minimum number of independent directors for other classes or classes of public companies.
  • Explanation: The government can extend the requirement of appointing independent directors to specific categories of public companies beyond the mandatory provision for listed companies.

Public companies with certain criteria (mandatory)

  • Criteria: Public companies meeting the following criteria must have at least two independent directors:
    • Paid-up share capital of INR 100 million or more
    • Turnover of INR 1 billion or more
    • Aggregate outstanding loans, debentures, borrowings, and deposits exceeding INR 500 million
  • Exceptions: However, there are exceptions to these criteria, including:
    • Joint ventures
    • Wholly-owned subsidiaries
    • Dormant companies as defined under the Act

Role and duties of an independent director in corporate governance

Independent directors play a pivotal role in enhancing corporate governance and ensuring ethical practices within a company. Their responsibilities extend to various aspects of guiding and monitoring the company’s operations.

Role of an independent director

  • Guidance and mentorship: Independent directors serve as guides, mentors, and coaches to the company, offering their experience and insights to steer the company in the right direction.
  • Enhancing corporate credibility: They contribute to improving corporate credibility and governance standards by upholding transparency, accountability, and ethical behavior.
  • Watchdog and Risk Management: Independent directors act as watchdogs, ensuring that the company operates within legal and ethical boundaries while also helping manage risks effectively.
  • Active committee involvement: They actively participate in various committees set up by the company, such as audit, nomination, and remuneration committees, contributing to better governance practices.
  • Stakeholder protection: Independent directors safeguard the interests of all stakeholders, especially minority shareholders, by balancing conflicting interests and advocating for fair practices.
  • Strategic decision-making: They provide an independent perspective on key matters such as strategy, performance, risk management, resource allocation, and key appointments.
  • Evaluation and reporting: Independent directors evaluate the performance of the board and management, ensuring that goals and objectives set in board meetings are met and reported.
  • Financial integrity: They monitor the integrity of financial information and ensure effective financial controls and risk management systems are in place.
  • Conflict resolution: In cases of conflicts between management and shareholder interests, independent directors work towards solutions that serve the company’s best interests.
  • Remuneration oversight: They establish appropriate levels of remuneration for executive directors, key managerial personnel, and senior management.

Read: India Allows Independent Directors to Retake Online Self-Assessment Proficiency Test

Duties of an independent director

  • Continual learning: Independent directors should continuously update their skills, knowledge, and familiarity with the company.
  • Active participation: They should attempt to attend general meetings, board meetings, and committee meetings where they are members or chairpersons.
  • Informed decision-making: They must have adequate knowledge about the company and its external operating environment to make informed decisions.
  • Ethical conduct reporting: Reporting unethical behavior, fraud, or violations of the company’s code of conduct or ethics policy is a crucial responsibility.
  • Protecting interests: They should protect the legitimate interests of the company, shareholders, and employees while acting within their authority.
  • Committee involvement: Participating as members or chairpersons of board committees is essential to their role.
  • Confidentiality and vigil mechanism: Independent directors should maintain confidentiality and ensure the company has a functional vigil mechanism to address concerns.

Qualifications and eligibility criteria for independent directors

The provisions governing who can serve as an independent director are outlined in Section 149(6) of the Companies Act 2013. Here’s a breakdown of the qualifications and eligibility criteria for individuals to be appointed as independent directors:

  • Integrity and expertise: An independent director must be a person of integrity and possess relevant expertise and experience, as determined by the board of directors.
  • Not a promoter: The individual should not be a promoter of the company, any of its subsidiaries, or any of its holding or associate companies.
  • No relationship with promoters or directors: The person should not have any direct or indirect relationship with the promoters of the company or the directors in the company. This includes directors of its holdings, subsidiaries, or associate companies.
  • No pecuniary relationship: The individual should not have or have had any pecuniary relationship with the company, its holdings, subsidiaries, or associate companies during the previous two financial years. However, this pecuniary relationship should not include remuneration as a director or transactions that do not exceed 10 percent of their total income.
  • No relative with a pecuniary relationship: None of the individual’s relatives should have or have had any relationship with the company, its holdings, subsidiaries, or associate companies that is of a pecuniary or transactional nature.
  • Restrictions on relatives: During the current or the two immediately preceding financial years, none of the individual’s relatives should:
    • Hold any security or interest in the company exceeding INR 5 million, or two percent of the paid-up capital
    • Be indebted to the company
    • Provide a guarantee or security for the indebtedness of a third party
  • No managerial position or employment: The individual or any of their relatives should not have held any managerial position of importance or been employed in the company, its holdings, subsidiaries, or associate companies during the three immediately preceding financial years.
  • Restrictions on employment in specific firms: During the three immediately preceding financial years, the individual or any of their relatives should not have been an employee, proprietor, or partner in firms engaged in specific roles, including:
    • Auditors of the company
    • Company secretaries of the company
    • Cost auditors of the company, its holdings, subsidiaries, or associate companies
    • Legal firms conducting transactions on behalf of the company, its holdings, subsidiaries, or associate companies, amounting to 10 percent or more of gross turnover
  • Restrictions on voting power: The individual should not hold two percent or more voting power in the company, along with their relatives.
  • Head of receiving non-profit organization (NPO): The individual should not be the head of a NPO that receives 25 percent or more of its receipts from the company, its holdings, subsidiaries, or associate companies.
  • Prescribed Qualifications: The individual should have any additional qualifications as may be prescribed by relevant authorities.

These stringent criteria ensure that independent directors are truly independent and free from any conflict of interest that could compromise their ability to provide impartial guidance and oversight within the company.

Is there a limit on independent directorships?

Section 165 of the Companies Act 2013 sets a cap on the number of directorships a person can hold, which is 20 companies, including alternate directorships. This limit also considers directorships in private companies like holdings and subsidiaries when calculating the total.

For public companies, the maximum number of directorships a person can have is 10. However, the Companies Act 2013 doesn’t specify a specific limit for the number of companies where a person can serve as an independent director.

Appointment and term

The appointment of an independent director requires board approval. They can serve for up to five consecutive years. Reappointment for another five years necessitates a special resolution in a general meeting.

Remuneration of independent directors

Independent directors cannot receive stock options but may be compensated through sitting fees, reimbursement of meeting-related expenses, and profit-related commissions approved by the members.

Declaration of independence: annual declaration under Section 149(7)

Independent directors must declare their independence status at their first board meeting, the first meeting in each financial year, and whenever any circumstances arise that may affect their independence.

Vacancies and liability

If a vacancy arises, it must be filled within three months. Independent directors are liable for acts of omission or commission with their knowledge, consent, or connivance.

Resignation procedures for independent directors

Resigning independent directors must give written notice to the company. The company must conduct a board meeting within seven days to accept the resignation, followed by filing Form DIR-12 with the Registrar of Companies.

Removal of independent directors

The board can recommend the removal of an independent director to the members. If a special notice is received from members, the removal process involves providing an opportunity to the director and conducting a general meeting.

Liability of independent directors in corporate misconduct

An independent director may face liability for the company’s misconduct or unlawful actions if they are proven to have knowledge of or involvement in such activities. However, their responsibility involves acting in good faith and displaying due care and diligence, and potential liability arises from breaching their fiduciary obligations.

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