Abstract of the company that all the

Abstract

Independent Directors of a company have a very important
role in assuring quality corporate governance in a company. “The landmark legislation regarding independent directors is
the Clause 49 of the listing agreement of the SEBI Guidelines given out in the
year 2005. How ever following various scams that took place in India and in
other countries like the Satyam Scam and The Enron Scam due to which the role
of Independent Directors have come under the spotlight once again. The
following paper is about the role of Independent Directors in a company.”

We Will Write a Custom Essay Specifically
For You For Only $13.90/page!


order now

Introduction

There have been en masse resignation of Independent Directors in various
companies that underwent various corporate governance scams, it has brought the
role of independent directors in the corporate governance of the company under
heavy scrutiny. “The Satyam scam is not the only incident wherein the independent
directors showed lack of responsibility towards the duties that they are
expected to perform, the spate of highly publicized corporate governance
scandals such as Enron, WorldCom and including the Walt Disney Company,
Hollinger International and Airbus Industries, have resulted in putting
corporate governance under heavy scrutiny in the public spotlight.”

The concept of independent directors is not new, “it has evolved over the past 20 years,
since the concept and position were first introduced. Independent directors are
expected to play an extremely crucial role in ensuring the high quality of
corporate governance in a company. It is their burden to provide an assurance
to all stakeholders of the company that all the dealings of the company will be
undertaken in a responsible manner.’

In ‘the landmark case on
the point of Independent Directors would be, Lennard’s Carrying Company Ltd v.
Asiatic Petroleum Co. Ltd ,”Viscount Haldane, Lord Chancellor, while highlighting the importance of
non executive directors, had elaborated and specified how the non executive
directors’ contribution can be instrumental in complementing the executive’s
competence by stating” :

“My Lords, a corporation is an abstraction. It has no mind of its
own any more than it had a body of its own; its active and directing will must
consequently be sought in the person of somebody who for some purposes may be
called an agent, but who is really the directing mind and will of the
corporation, the very ego and centre of the personality of the corporation.
That person may be under the direction of the shareholders in general meeting;
that person may be the board of directors itself, or it may be, and in some
companies it is so, that that person has an authority to co-ordinate with the
board of directors given to him under the articles of association, and is
appointed by the general meeting of the company, and can only be removed by the
general meeting of the company.”

Further the Naresh Chandra Committee while emphasising on the
significance of the presence of Independent Directors in the composition of the
Board of a company had stated that, “Clearly, a board packed with executive
directors, or friends of the promoter or of the CEO, can hardly be expected to
exercise independent oversight judgement.”

Independent “Directors constitute a necessary component of a balanced board structure
where the in depth knowledge of the executive directors is blended with the
wider experience and knowledge of the independent outside directors.” Independent directors in “particular can provide a perspective to
the discussion based on their experience, technical expertise and wisdom that
make a great contribution in the area of strategy. 

In the following article, we will be critically examining the concept of
Independent Directors, the role they play in the corporate governance of the
company and their under liability for the companies actions.”

Analysis

The concept of “”independent directors” is not an inherent one in the Indian business
organisation system but has been borrowed from the corporate governance norms
of the U.S. and U.K.

The term “independent Directors” became a part of the Indian
corporate lexicon after the publication of the Kumar Mangalam Birla committee
report, formulated by SEBI, to start up reforms in the area of Corporate
governance, which resulted in the introduction of clause 49 in Listing
agreements.”The committee had extensively debated on the issue of independent
directors and opined that independence be suitably, ‘correctly and pragmatically defined, so
that the definition itself does not become a constraint in the choice of
independent directors on the board of companies. “The Birla committee defined Independent
Directors as those “who apart from receiving directors remunerations do not
have any other material pecuniary relationship or transactions with the
company, its promoters, its management or its subsidiaries, which in the judgement
of the board may affect their independence of judgements.”

On 21st August 2002,” following the enactment of the Sarbanes–Oxley Act of 2002 in the U.S.,
the Ministry of Finance appointed the Naresh Chandra Committee to examine
various corporate governance issues primarily around auditor – company
relationship, rotation of auditors and defining Independent directors. The
committee came to the conclusion that the definition in contained in clause 49
of the Listing Agreement could be made more precise without compromising the
spirit of the independent directors.” It recommended that independent directors should not be less than fifty
percent of the board and that nominee directors of lending institutions not be
considered as independent.” It also provided for training of independent directors and recommended
to exempt them from criminal and civil liabilities.

In 2003, SEBI constituted the Narayana Murthy committee, with the aim to review
Clause 49 of the Listing Agreement, and suggest measures to improve corporate
governance standards. The committee adopted the Chandra Committee definition of
independent directors, however, without the condition of nine-year term.”

It is on the basis of the above recommendations that the definition
independent director has been formulated under the Indian law. As per clause 49
of the Listing Agreement an” ‘independent director’ shall mean a non-executive director of the
company who:

a. apart from receiving director’s remuneration, does not have any
material pecuniary relationships or transactions with the company, its
promoters, its directors, its senior management or its holding company, its
subsidiaries and associates which may affect independence of the director;”

b. is not related to promoters or persons occupying management positions
at the board level or at one level below the board;

c. has not been an executive of the company in the immediately preceding
three financial years;

d. is not a partner or an executive or was not partner or an executive
during the preceding three years, of any of the following:

i) the statutory audit firm or the internal audit firm that is
associated with the company, and

ii) the legal firms and consulting firms that have a material
association with the company.

e. is not a material supplier, service provider or customer or a lessor
or lessee of the company, which may affect independence of the director; and,

f. is not a substantial shareholder of the company i.e. owning two
percent or more of the block of voting shares.

Although the Indian Companies Act, 1956, imposes a legal duty on all
directors to act in the best interests of the company it has been observed time
and again, that the same is not adequate to give full assurance, that,
potential conflicts between the interests of the majority stakeholders and
those of the public, will not impair the board’s decision-making, particularly
when family-run businesses account for such a large proportion of Indian
companies. It is in such circumstances that the need for Independent
Directors arises.

Independent Directors counterbalance management weaknesses in a company
and also ensure that the company follows a legal and ethical framework in there
day to day transactions, while strengthening accounting controls.

More importantly, the need for appointing independent directors on the
board of a company arises due to the fact that they are the sole
representatives of the public shareholders and thus have the responsibility of
upholding their interests in the company. In fact the main rationale behind appointing
Independent Directors in the company’s board is to keep a check on the
activities of the company, as an oversight mechanism.

“The Naresh Chandra Committee while
expressing its views on the role of Independent Directors had stated that, “at
the core of corporate governance is the board of directors.” Furthermore, the
Supreme Court in Central Government Vs. Sterling Holiday Resorts (India) Ltd.
and Ors. had also emphasised that the “the Board of directors should be
strengthened by appointing independent directors.” ”

The “role of Independent
Directors ranges from policies regarding the long-term survival of the company
to improved internal controls.

Managerial oversight is an important function of a board of directors.
Independent members bring in an objective view while evaluating the board and
managements decisions since they have no personal interests in the company.
Independence is particularly crucial in those areas which involve a potential
conflict of interest between managers and shareholders. ”

Independent directors have a crucial role to play,” especially since the majority of
companies in India are family-run businesses, having a strong control over
their management. In such cases, the presence of a good ratio of Independent
Directors on the board helps in reducing instances of conflict between the
majority and minority shareholders interests and ensures that the rights of
minority shareholders are upheld and protected.”

Independent Directors bring wider experience, “expertise and a fresh perspective to
the boardroom and can effectively exercise their best judgment for the
exclusive benefit of the Company, since their judgment is not clouded by real
or perceived conflicts of interest.

As public information has become more transparent and reliable, investors—especially
institutional investors now clearly prefer companies with better governance
standards, over those whose corporate governance practices may still be
dubious. Having independent directors on boards sends a very strong signal to
investors that the company is well run and governed, and its board is sound
enough to ensure that nothing less than the very best international corporate
governance practices are adhered to.”

 

The presence “of independent directors brings diversity to the board. While executive
directors bring with them the organizational insight, independent directors, on
the other hand, generally being experts in their respective field, get their
knowledge, expertise and objective mindedness to the table. Together, a
balanced board can steer the company on the path of success. 

The process of the internal control commences right from the development
of new policies by the Board of directors and includes administrative
regulations, manuals, directives and decision, internal auditing etc. The
independent directors act as a supervisory body monitoring the internal control
system of the company and are responsible for the identification of flaws in
the internal control system and presenting them before the board to find
suitable solutions.” 

Independent Directors are responsible for identifying and analyzing “all such risks that may Lennard’s
Carrying Company Ltd v. Asiatic Petroleum Co. Ltd ,Viscount Haldane
threaten the assets, resources and earning capacity of the company. Their role
is to critically scrutinize the decision making process and ensure that the
investments, funds, business transactions  etc do not result in
losses. ”

By virtue of their “appointment and the subsequent role played by them in managing the
affairs of the company, the liability of independent directors has been a
matter of debate and controversy.

A lesser degree of liability for independent directors has been
advocated by some quarters, citing differences in their roles in comparison
with those of the executive directors.” 

While expressing its views on the subject,” the Naresh Chandra committee had
opined that not even the most stringent international tenet of corporate
governance and oversight assumes that an independent directors who interacts
with the management for no more than two days every quarter will know of every
technical infringement committed by the management of the company in its normal
course of activity.”

The committee “had further observed that at a more practical level, it would be very
difficult to attract high quality independent directors on the board of Indian
companies if they have to constantly worry about serious criminal liabilities
under different acts.

This view was reiterated by the Irani committee who had recommended that
the independent director should not be held liable for contravention of any
provisions of law that happens without his knowledge or consent or connivance.”  

The new Companies Amendment Bill 2009, contains a “similar provision which is based on the
Supreme Court’s verdict in the case of KK Ahuja v VK Arora where the court
had held that “liability arises from being in charge of and responsibility for
the conduct of business of the company at the relevant time when the offence
was committed and not because on the basis of merely holding designation
or office in a company.” Further in S.K Alagh Vs State of U.P ,
the Supreme Court had held that “Indian Penal Code, save and except some provisions
specifically providing therefore, does not contemplate any vicarious liability
on the part of a party who is not charged directly for commission of an
offence.””

Thus there is a “general consensus among the people that the responsibility of independent
directors is ideally considered to end with vigilance in the Board
meetings and that they cannot be held liable for acts outside their knowledge.

However, the 2010 judgement of the Bhopal District Court, sentencing Mr
Keshub Mahindra, a former non-executive director of Union Carbide, with two
years of imprisonment, in the Bhopal Gas tragedy case, has given rise to a
series of arguments regarding the scope of independent director’s liability.”

Those supporting the “court’s decision are of the view that the ultimate legal responsibility
for a company’s act lies with its board of directors and when a crime takes
place, it is their collective responsibility to be liable and since neither the
Companies Act, nor any other legislation excludes Independent Directors from
criminal liability, they are also equally accountable for such acts. Colin
Gonsalves, founder of the New Delhi-based Human Rights Law Network, is of the
view that, “being an independent director does not mean being independent of
law.” According to him ‘sleeping’, ‘non-executive’ and ‘independent’ are just
pretentious terms to restrict the legal responsibility of a director in the
company and that, “there are no restrictions in the law to cut down liability.”” 

On the other hand, many believe that even though, as board members,
independent directors have the same legal duties and obligations as executive
directors, but, because of their limited involvement in the day-to-day running
of the company,” it is undesirable for the law to expose them to personal liability. The
CII has strongly recommended that the law regarding the potential liability of
independent directors needs to undergo a change, for independent members cannot
be made to undergo the ordeal of a trial for offence of non-compliance with a statutory
provision unless a prima facie case has been established against them holding
them liable for the failure on part of the company. ”

In the absence of such safeguards, many believe that, people will be far
more reluctant and careful in accepting the position of independent directors
in this atmosphere of uncertainty. 

CONCLUSION

While independent directors” form an essential and powerful component of a company, providing
numerous advantages to the board, however in order to ensure that they are
actually able to play an effective role in the corporate governance of the
company, there is an urgent need to strengthen the institution of independent
directors. Efforts should be made to properly lay down and codify laws
regarding their responsibilities, duties and rights. Further, in order secure
the independence of independent director there is need to break the nexus
between the independent directors and promoters who sponsor them. The
nomination of independent director by SEBI and government can be a suitable
solution for the same.  Thus it can be clearly concluded that independent
directors have the potential of becoming effective regulators of the company’s
activities and policies provided sufficient and adequate provisions are made
for their empowerment.”