Is an independent director indeed independent?

In March 2021, a 3 Judge Bench of Supreme Court, led by Chief Justice of India, finally settled one of the most infamous corporate disputes of India which began nearly 5 years ago after a fallout between the Indian corporate giant Tata and Cyrus Mistry. However, on the 25th of April 2021, the Shapoorji Pallonji Group moved the Hon’ble Supreme Court with a review petition against its March 26 verdict. It set aside the NCLAT order of reinstating Mistry as the executive chairman.

One of the key issues that has finally caught the attention is whether an independent director is indeed independent. This issue arose when Tata Group of Companies called Extraordinary General Meetings (EGM) for the removal of Nusli Wadia and Cyrus Mistry from their Board of Directors.

This was followed by Independent Directors of IHCL and Tata Chemicals extending their support to Mistry for standing up for minority interests. This led to an extensive debate on the true independence of independent directors and the say of promotors in their removal.

One may think that the person finally appointed as an Independent Director is truly independent. But the law fails to make adequate provisions to safeguard his independence post-appointment.

The process of removal of an Independent Director had been kept the same as in the case of an ordinary director. Section 169 of the Act provides that a director can be removed by way of an ordinary resolution that can be passed with a simple majority (at least 50%). The effect of this provision is that the removal of an Independent Director remains in the hands of the promoters who hold a majority stake in the company.

The position regarding an independent director serving his second term has since been changed for better after a recent amendment in section 169 of the Act. The provision, as it stands now, requires a special resolution (super-majority of 75%) to be passed for the removal of an independent director who is serving his second term.

An independent director should be given an opportunity to be heard before a resolution is passed against him. This amendment provides a certain safeguard to an independent director re-appointed for a second time. It can be considered as a step towards ensuring better corporate governance and independence of independent directors.

However, the absence of any provision which requires the removal of an independent director to be based on sufficient and reasonable grounds makes these provisions a bit redundant. The removal process effectively still remains a number game, notwithstanding that such number has been increased to 75% in the case of re-appointed independent director.

The recent Tata-Mistry-Wadia fiasco has highlighted loopholes in the law surrounding independent directors. Though, the Companies Act, as a legislation, does well to ensure the appointment of an impartial person as an independent director, it fails in ensuring that such impartiality remains even after the appointment by not providing a separate regulatory mechanism for the removal of independent director.

SEBI’s recent consultation paper for regulatory provisions related to Independent Directors has proposed making the process of appointment and resignation of Independent Directors more transparent. This shall secure the approval and interests of minority shareholders thus engaging them in governance decisions that shall affect them. This paper has also proposed for remuneration of independent directors through long duration stock options replacing the current practice of profit linked commission-based remuneration.

What might be construed a significant proposal is disclosure of full resignation letter to stock exchanges. Although this might not be a big move but it could be construed as an indication of SEBI’s willingness to step in.

The lead ought to be taken by the legislature to level the potholes on the road of independence of independent directors. This can be done, firstly, by enabling the minority shareholders to have a complete say in the appointment of a certain number of independent directors.

There should be no interference of the majority shareholders, especially the promoters either in their appointment or their removal. Other directors should be appointed in a proportionate manner.

Further, the removal of an independent directors shall be precluded by showing sufficient and reasonable grounds. The special resolution required for the removal of a re-appointed independent director ought to be made universal, irrespective of the term that such independent director is serving.

The Companies Act places a colossal responsibility on the shoulders of Independent Directors. It, however, fails to provide sufficient safeguards for them to ensure that such responsibilities are discharged in the manner envisaged by the Code. The change in the law must come to secure the independence of independent directors, and sooner the better.

(The writer is an Odisha-based lawyer and honorary member of Advisory Council of Harvard Business Review.)