Changing role and liabilities of independent and non-executive directors – boon or bane?
January 2016 | EXPERT BRIEFING | BOARDROOM INTELLIGENCE
Company law is the gamut of laws dealing with the incorporation, workings and winding up of a company. In India, the law relating to companies was governed by the Companies Act, 1956, which has been amended over 25 times since its enactment due to numerous lacunas, and its ineffectiveness, as the provisions had become redundant in today’s modern world and changing global business trends. Thus, owing to its shortcomings, the old act was replaced by the Companies Act, 2013. The 2013 Act sets to overhaul the provisions relating to independent directors entirely by conferring greater power and responsibility in the governance of a company.
Independent directors are essentially the custodians of good corporate governance. Though not required to be involved in the day-to-day running of companies, they are expected to monitor the actions of the executives and safeguard the interests of stakeholders. While there were no express provisions dealing with independent directors or non-executive directors under the 1956 Act, the 2013 Act has introduced new concepts and guidelines relating to professional conduct, functions and duties of independent directors.
The new regime has vested directors with broad powers under Section 179 and certain specific powers under Section 180 which ought to be exercised only with the consent of the company through a special resolution. The duties of directors have been dealt with in Section 166 of the 2013 Act, which provides that directors are expected to act in accordance with the articles of the company and in good faith to promote the objects of the company, exercise reasonable care and independent judgment and not have conflicting interests with that of the company. Several other restrictions have also been built into the 2013 Act to ensure that there is no financial nexus between an independent director and the company. For instance, the 2013 Act prohibits independent directors from receiving stock options of the company. There are also limitations to remuneration be paid to independent directors.
Independent directors have to also abide by a ‘Code for Independent Directors’ prescribed under the 2013 Act that sets out guidelines of professional conduct and roles, functions and duties of independent directors. The key functions under the code include: (i) helping to bring independent judgment to the board; (ii) scrutinising the performance of management in meeting agreed goals; (iii) safeguarding the interests of all stakeholders, particularly minority shareholders; (iv) balancing the conflicting interest of stakeholders; (v) striving to attend all board and committee meetings and to participate actively and constructively; (vi) where they have concerns about the running of the company or a proposed action, ensuring that those issues are addressed by the board and, to the extent the same are unresolved, insisting that such concerns are recorded in the minutes of board meetings; and (vii) report concerns about unethical behaviour, fraud or violations of the code of conduct or ethics policy of the company. The 2013 Act also mandates the compulsory presence of independent directors in the Corporate Social Responsibility Committee, Nomination and Remuneration Committee and Audit Committee of companies. The 2013 Act stipulates that, and any act done in contravention to duties of directors enshrined thereunder is punishable with a fine of not less than Rs. 1 Lakh, which may extend up to Rs.5 Lakhs.
Considering the nature of duties foisted on them, independent and non-executive directors have to be watchful and mindful of the liabilities that they are exposed to on account of being fiduciaries. Such liabilities could be either civil or criminal in nature, which may also include claims made either by the company or the shareholders for breaches of their duties as directors.
With a view to safeguarding independent directors or a non-executive director from the negative ramifications arising out of the non-independent directors’ activities, the 2013 Act explicitly provides for mitigations under section 149(12) that they can be implicated only for offences committed with their knowledge, attributable through board processes, connivance or negligence.
‘Knowledge’ would encompass both actual and constructive knowledge. Actual knowledge would refer to something the director in fact knew. Constructive knowledge, on the other hand, would refer to something the director ‘ought to know’, which would impose an obligation on the director to conduct an enquiry.
‘Attribution through board processes’ would essentially be the next step after the director has knowledge of the matter and takes it to the board. The director would be deemed to have knowledge of all matters discussed at a board meeting.
‘Consent or connivance’ would imply that the director would have acted in consultation, consonance and in collusion with others.
‘Not acted diligently’ is linked to the amount of care, skill and diligence that the director has taken and whether all actions taken by him are in adherence to the minimum standards required to be complied by such a director.
The above has also been validated by the Supreme Court in the matter of Pooja Ravinder Devedasani vs. the State of Maharashtra, where it has been held that, “although a non-executive director is no doubt a custodian of the governance of the company and does not usually involve in the day-to-day affairs of the running of its business, if it is proved that at the time the specific decision was taken, the director has been at the helm of affairs of the company, he may be made liable, but simply because a person is a director of a company, does not make him liable for all the actions involved with the company”.
Relying on the above, the District Court at Delhi has in Deepinder Singh Bedi vs. M/s L & T Finance Ltd, observed that, “time and again, it has been asserted by this Court that only those persons who were in charge of and responsible for the conduct of the business of the company at the time would be held liable”.
The 2013 Act makes a considerable effort to bring the role of independent director in line with changing needs. The primary objective behind the 2013 Act’s provisions on independent directors is to ensure accountability, transparency and efficiency in the working of the directors. Having said that, independent and non-executive directors would have to act cautiously and with due care in discharging their roles and duties effectively, so as to avoid any potential liability in the process.
Rajesh Begur is the managing partner of ARA LAW. He can be contacted on +91 22 6619 9800 or by email: firstname.lastname@example.org.
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