The Board of Directors is responsible for overseeing a company’s operations. It is made up of individual directors, and under the Companies Act, 2013, certain companies are required to appoint independent directors to their board.
Unlike the Companies Act, 1956, which did not define the role, the Companies Act, 2013 has brought Independent Directors into focus. The Act now clearly defines the term “Independent Director” and introduces specific guidelines regarding their appointment, roles, duties, and responsibilities.
Independent Director
An Independent Director is a non-executive director who plays a crucial role in enhancing a company’s governance and credibility. An independent director cannot be involved as a managing director, whole-time director, or nominee director of the company.
To maintain impartiality, independent directors must not have any relationships with the company that could impair their judgment. The rules for appointing independent directors are detailed in Section 149 of the Companies Act, 2013, and must be considered in conjunction with Rule 4 and Rule 5 of the Companies (Appointment and Qualification of Directors) Rules, 2014.
Applicability of Appointing an Independent Director
Listed Public Companies:
All listed public companies are required to have at least one-third of their board comprised of independent directors. Any fraction resulting from this calculation must be rounded up to the nearest whole number.
Unlisted Public Companies:
According to Rule 4 of the Companies (Appointment and Qualification of Directors) Rules, 2014, the following categories of unlisted public companies must have a minimum of two independent directors:
- Public companies with a paid-up share capital of Rs. 10 crore or more.
- Public companies with a turnover of Rs. 100 crore or more.
- Public companies with total outstanding loans, debentures, and deposits exceeding Rs. 50 crore.
Key Considerations:
- The figures from the most recent audited financial statements should be used when calculating paid-up capital, turnover, or outstanding loans, debentures, and deposits.
- If a company requires more independent directors to form an audit committee, it must appoint a greater number than the minimum mandated.
- Joint ventures, wholly-owned subsidiaries, and dormant companies are exempt from the requirement to appoint independent directors, even if they meet the above thresholds.
Independent directors must submit a declaration of their independence at the first board meeting they attend as a director, and annually at the first board meeting of each financial year. This declaration must also be submitted if any situation arises that affects their independent status. Additionally, the terms and conditions of their appointment should be publicly available on the company’s website.
Qualifications of an Independent Director
An independent director must have relevant experience, knowledge, or skills in areas such as law, finance, management, marketing, sales, research, administration, technical operations, corporate governance, or other disciplines pertinent to the company’s business.
The director or their relatives must not:
- Owe any debts to the company, its subsidiaries, holding, or associate companies, or their directors or promoters.
- Provide any guarantee or security in connection with third-party indebtedness to the company, its subsidiaries, or holding/associate companies in an amount of Rs. 50 lakhs or more within the last two financial years or the current financial year.
Additionally, the independent director:
- Must not be a promoter of the company or its subsidiaries, holding, or associate companies.
- Should not be related to any directors or promoters within the company or its subsidiaries, holding, or associate companies.
- Should have no financial relationship with the company (except for remuneration as a director or a transaction not exceeding 10% of the company’s total income) in the current or the last two financial years.
- Must not have held, or currently hold, a Key Managerial Personnel (KMP) role or been employed by the company or its subsidiaries, holding, or associate companies during the previous three financial years.
The director or their relatives must not have:
- Been an employee, proprietor, or partner during the last three financial years with any firms providing auditing, legal, cost auditing, or secretarial services to the company or its subsidiaries.
- Held more than 2% of the company’s total voting power along with their relatives.
- Been the CEO or director of a non-profit organization that receives 25% or more of its revenue from the company, its promoters, directors, subsidiaries, holding, or associate companies, or holds more than 2% of the company’s voting power.
Role of an Independent Director
An Independent Director plays a critical role in guiding and mentoring the company, helping to enhance corporate credibility and governance. They act as a watchdog, helping manage risk, and ensuring that governance standards are maintained. Independent directors are necessary for fulfilling several key responsibilities, including:
- Countering pressures from ownership: Helping the company resist undue influence from owners.
- Succession planning: Playing a key role in guiding leadership transitions.
- Independent judgment: Providing an impartial perspective on key matters such as strategy, performance, risk management, resources, key appointments, and standards of conduct.
- Objective evaluation: Offering an unbiased assessment when evaluating the performance of the board and management.
- Monitoring and scrutiny: Overseeing management’s progress on agreed goals and objectives during board meetings.
- Protecting stakeholder interests: Ensuring the interests of all stakeholders, particularly minority shareholders, are safeguarded.
- Balancing stakeholder interests: Navigating conflicting interests among stakeholders to achieve balanced outcomes.
- Ensuring financial integrity: Verifying the accuracy of financial information and ensuring that financial controls and risk management systems are in place.
- Resolving conflicts: Mediating between management and shareholders when conflicts arise, aiming to find solutions in the company’s best interest.
- Setting remuneration: Determining appropriate compensation for executive directors, key managerial personnel, and senior management.
Conduct of an Independent Director
Independent Directors must follow a code of conduct and act with professionalism and integrity. By adhering to these principles, they inspire trust among investors, including minority shareholders, and regulators. The Companies Act outlines the following guidelines for their professional conduct:
- Uphold ethics and integrity: Maintain high ethical standards and integrity.
- Constructive and objective approach: Actively and objectively participate in decision-making.
- Use powers responsibly: Exercise powers in the best interest of the company and its stakeholders.
- Devote time and attention: Allocate sufficient time to their duties for well-informed decision-making.
- Maintain independence: Ensure that their judgment remains independent, and report any circumstances that may affect this independence to the board.
- Avoid conflicts of interest: Refrain from any actions that could result in personal gain at the expense of the company.
- Support corporate governance: Assist the company in implementing effective governance practices.
Duties of an Independent Director
Independent Directors have specific duties that they must fulfill diligently, including:
- Ongoing learning: Undertake induction programs and continually update their knowledge of the company and its operations.
- Attend meetings: Make every effort to attend general meetings of the company, as well as board meetings and committee meetings in which they are members.
- Stay informed: Be well-acquainted with the company’s operations and the external environment in which it operates.
- Report misconduct: Report any unethical behavior, fraud, or violations of the company’s code of conduct.
- Protect legitimate interests: Act within their authority to protect the legitimate interests of the company, shareholders, and employees.
- Avoid obstruction: Do not unfairly interfere with the functioning of the company or any board committee.
- Maintain confidentiality: Keep confidential information such as trade secrets, business strategies, and price-sensitive information private unless otherwise approved by the board or required by law.
- Support whistleblowers: Ensure that the company has an effective whistleblower mechanism in place and that those using it are not adversely affected.
These roles, conduct standards, and duties are essential for ensuring that independent directors contribute meaningfully to a company’s governance and long-term success.
Additional Provisions Regarding Independent Directors Under the Companies Act, 2013
Certain companies are required to establish a Corporate Social Responsibility (CSR) Committee to develop and oversee their CSR policy. This committee must have a minimum of three directors, one of whom should be an independent director. However, for companies not obligated to appoint an independent director, the CSR committee can be composed of at least two directors.
The appointment of independent directors must be conducted independently from the company’s management. Independent directors can be selected from a database, which contains the names, qualifications, and addresses of eligible and willing individuals. This database is managed by a body, institution, or association recognized by the Central Government.
The approval of the independent director’s appointment must be done at a general meeting of the company. An explanatory statement must accompany the notice for the general meeting, providing justification for selecting the proposed individual as an independent director.
Each independent director must submit a declaration of independence under the following circumstances:
- Upon attending the first board meeting as a director.
- At the first meeting of the board in each financial year.
- When any situation arises that may affect their independent status.
The term of an independent director is limited to a maximum of five years per term, with a maximum of two consecutive terms. After completing two terms, re-appointment requires the approval of a special resolution by the company.
Any vacancy in the position of an independent director must be filled either at the next board meeting or within three months from the vacancy, whichever is later.
An individual may serve as an independent director in no more than seven listed companies simultaneously.
Independent directors are not subject to rotation and are excluded from the calculation of the total number of directors for the purpose of determining rotational directors.
A small shareholder director can also be considered an independent director if they:
- Meet the eligibility criteria outlined in Section 149(6) of the Companies Act.
- Provide a declaration affirming their independent status, as per Section 149(7).
If a board meeting is called at short notice to address urgent business, the presence of at least one independent director is required. If no independent director is present, the decisions made must be circulated to all directors and later approved by at least one independent director.
FAQ’s
What qualifications are necessary to become an independent director?
An independent director should possess relevant experience, skills, and knowledge in areas such as law, finance, management, or corporate governance. They must also meet the independence criteria set out in the Companies Act.
Are independent directors required to attend board meetings?
Yes, independent directors are expected to actively participate in board meetings and committees, contributing their independent judgment on various matters.
What happens if an independent director loses their independence?
If an independent director finds themselves in a situation that compromises their independence, they must promptly inform the board.
Can an independent director be involved in any company’s management?
No, independent directors should remain non-executive and not engage in the day-to-day management of the company to maintain their objectivity and independence.
What is the process for appointing an independent director?
The appointment of an independent director must be approved by the shareholders at a general meeting. An explanatory statement justifying the choice of the candidate should be included in the meeting notice.
Is there a limit on how many independent directors a person can serve as across different companies?
Yes, an individual can serve as an independent director on a maximum of seven listed companies at any given time.
Can a small shareholder director be classified as an independent director?
Yes, if the small shareholder director meets the eligibility criteria for independent directors and provides a declaration affirming their independence.
What should an independent director do if they encounter unethical behavior in the company?
Independent directors have a responsibility to report any unethical behavior, actual or suspected fraud, or violations of the company’s code of conduct or ethics policy.
