Independent directors are not mere appendages of promoters

The law requires certain companies to appoint independent directors to ensure the board’s independence and objectivity, instil good corporate governance practices, uphold financial integrity and ethical standards, and protect the interests of all stakeholders, particularly minority shareholders.

With the regulatory agencies increasingly tightening the noose around independent directors for their complacency, the question arises if they are independent or whether they have been reduced to mere appendages of the promoters.

According to the guidance note for independent directors  released by The Institute of Company Secretaries of India, one of the challenges to the institution of independent directors is the ownership character of the Indian corporate sector where most companies are predominantly owned and controlled by promoters. In many cases, the independent directors are from a known group and this familiarity with the promoters may impact their independence, which is why some of them have found themselves on the wrong side of the law.

As per Section 149 (4) of the Companies Act (2013) at least one-third of the directors of every listed company should be independent directors. Unlisted public companies shall appoint at least two independent directors if the paid-up share capital exceeds Rs 10 crore; if the turnover exceeds Rs 100 crore; and if the aggregate of all outstanding loans, debentures and deposits exceeds Rs 50 crore.

Schedule IV of the Act lists nine standards that independent directors are expected to adhere to; these include: upholding ethical practices of integrity and probity; acting objectively and constructively; not allowing extraneous considerations while concurring or dissenting from the collective judgment of the board in its decision making; assisting the company in implementing best corporate governance practices; refraining from any action that would lead to their loss of independence, among others.

The independent directors are also required to help in bringing an independent judgment to bear on the board’s deliberations; satisfy themselves on the integrity of financial information and that financial controls and the systems of risk management are robust; balance conflicting interests of shareholders; report concerns about unethical behaviour or frauds; protect the legitimate interests of the company, shareholders and its employees and not disclose unpublished price sensitive information. 

The government and the market regulator, the Securities and Exchange Board of India (Sebi) have, of late, been coming down heavily on defaulting independent directors to ensure their accountability.

Recently, the centre directed the scam-ridden IL&FS and two of its entities to recover Rs 150 crore including managerial remuneration and commissions from its ex-directors. This, after a recasting of accounts showed that the company had incurred losses to the tune of Rs 9,600 crore for the financial years 2013 to 2018, while the now superseded board had wrongly estimated a profit of Rs 1,869 crore for the same period.

The independent directors who faced action included some of the big names from the industry, including the former chairmen of Maruti Suzuki and LIC.

In the case of Leel Electrical Limited, Sebi in its final order imposed a fine of Rs 10 lakh each on two independent directors for failing to fulfil their statutory duties as members of the audit committee.

Sebi had imposed a penalty of Rs 10 lakh on an independent director who
was also an audit committee member of Southern Ispat and Energy Limited for failing to monitor the end use of funds received from the issue of global depository receipts (GDR).

In the case of Fortis Healthcare Limited, which was accused of routing funds to other entities owned by the promoter, all the independent directors who were members of the audit committee were penalised not only for failing to discharge their duties but also for ‘aiding and abetting the scheme of fraud perpetuated by the then management through their consistent inaction and mechanical approval of financial statements’.

The fact that such penal actions have become increasingly common reflects the failure of many independent directors to maintain their independence.

To break the trend of ‘grandfather directors’, the Centre had ruled that companies had to replace independent directors who had completed 10 years on the board as of March 2024. To ensure board effectiveness, the Ministry of Corporate Affairs mandated the Indian Institute of Corporate Affairs (IICA) to conduct an online proficiency test and maintain a database of individuals eligible to be appointed as independent directors.

Sadly, certain companies have found ways to continue the old ties with retiring independent directors, thereby compromising the integrity of the board. A study by the Institutional Investor Advisory Services (IiAS) shows that independent directors who have completed 10 years in an entity join the boards of another company of the same group or are replaced by their family members. Some independent directors have been replaced by former employees.

While policing the corporate sector could be counter-productive, the government and regulatory authorities will have no option but to wield the stick when companies resist measures to ensure good corporate governance aimed at protecting the interest of all stakeholders, and India’s economy in general.

It is also high time independent directors realised that though they are non-executive directors they shall be held liable for such acts of omission and commission that have occurred with their knowledge, consent, or connivance, or where they have not acted diligently.

Good corporate governance will prove beneficial to the companies themselves as it will foster a culture of integrity, transparency, and accountability. This will naturally translate to increased public confidence and consequently consolidate the bottom line. A company can afford to ignore the gold standards of corporate governance at its own peril and when it does, the directors, particularly independent directors must raise the red flag and put the ship back on the right course.

(The writer is a certified independent director)