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Independent Directors: Meaning and Functions

The Companies Act, 2013 states that “independent director means an independent director referred to in sub-section (6) of section 149.”[i]

The concept of independent directors has been ever-growing, owing to the evolution of corporate governance in India. Independent directors are directors who apart from receiving director’s remuneration 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 judgement.[ii] The independent directors play a pivotal role and are expected to have neutral judgment for the efficient functioning of a company. Their roles majorly include improving corporate governance and the credibility of a company. Apart from this, they play an active role in risk management as well as in various committees set up by the company. Schedule IV, Code of Independent Directors of the Companies Act, 2013 lays down a strict eligibility criterion for the appointment of independent directors. The code is a guide for professional conduct of independent directors and sets out the roles, duties and functions of independent directors.

Under the Companies Act, 2013, there is a specific obligation that at least one-third of the board of directors should comprise of independent directors. The provision is applicable to the following class of companies:

  • Listed Companies,
  • Public Companies having paid-up share capital of one hundred crore rupees or more; or
  • Public Companies having a turnover of three hundred crore rupees or more;
  • Public Companies which have, in aggregate, outstanding loans or borrowings or debentures or deposits, exceeding two hundred crore rupees.

MCA Rules

The Ministry of Corporate Affairs on 22nd October, 2019 notified new rules which require the independent directors to take up an online proficiency self-assessment test to get into or retain their Board positions. Under the Companies (Appointment and Qualification of Directors) Fifth Amendment Rules, 2019, coming into force in December, persons who are eligible for board membership have to apply to the Indian Institute of Corporate Affairs (“IICA”) before signing up for the job or within three months of the new rules taking effect.

After a candidate has been included in the IICA database, the proficiency test has to be passed within a year. However, the directors or persons in key managerial positions, who have served at least 10 years in listed or unlisted public companies (having paid-up share capital of 10 crores or more) have been exempted under the new rules. The Ministry has entrusted the Indian Institute of Corporate Affairs with the formation and regulation of an online databank for all the requisite information about the independent directors. The directors would be required to secure at least 60% in the test, failing which their names can be removed from the database.  

A Cumbersome Condition?

The amendments have been notified with an aim to increase accountability of companies regarding appointment of independent directors and to ensure that the appointed directors have the requisite skills and qualifications. The Companies Act, 2013 require listed as well as certain large unlisted public companies to have at least one-third of the board to constitute independent directors on their board. The regulations governing the appointment of independent directors majorly focus on the independent nature of the director. However, no specific qualifications and skills have been laid down under the legal framework, except for when an independent director is a part of the audit committee.

The new rules seem like a step towards an attempt to increase the corporate governance at various levels and to maintain certain degree of financial literacy. The minimum requirements for knowledge and skills is definitely commendable, but it has to be ensured that with the increasing requirements, the scope of their power and remuneration are also made worthwhile. Independent directors are usually only independent “on paper” and possess poor powers. The framework regulating the qualifications of independent directors have always remained broad and open-ended, which is why there have been several major corporate scandals time and again. With these amendments, a more transparent and qualified process of appointment is likely to take place.

The tighter norms of qualifications would serve their purpose only if a corresponding corporate governance framework is notified in order to maintain the independence of the directors. Evidently, several clarifications are needed, both in terms of time and requirements. A mere proficiency test would not be enough if the freedom of an independent director is not secured. While it may have an effect on the corporate literacy, it is unlikely to serve the larger purpose.

[i] Section 2 (47), the Companies Act, 2013

[ii] Report of the Kumar Mangalam Birla Committee on Corporate Governance, available at http://www.nfcg.in/UserFiles/kumarmbirla1999.pdf

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