Independent Directors: A shield for minority shareholders

A litmus test of independence

The structure of corporate governance rests on the board of directors. The efficiency and effectiveness of the board is in turn facilitated by Independent Directors (IDs). The more independent the board is, the better the objectivity, transparency and accountability of the company.

However, the “independence” of the Independent Directors(IDs) has time and again been questioned. The ongoing Tata - Mistry - Wadia fiasco has brought down the curtains on one of the ugliest publicly fought boardroom wars in the corporate history.

The intention behind inclusion of IDs in Board of Directors is to enhance corporate credibility, corporate governance standards, act as a watchdog, and mitigate company risks.

In the case of Shailesh Chawla & Anr. V. Vinod Kumar Mahajan (2020), National Company Law Appellate Tribunal (NCLAT) made a sardonic observation that independent directors are not equivalent to ‘sleeping directors’ either under the companies act or under the Insolvency and Bankruptcy Code (IBC).

IDs contribute objectivity to the board while managing the interests of other stakeholders, especially of the minority shareholders.

There have been manifold instances of corporate mismanagement where IDs have either resigned or failed to blow the whistle. With their appointment, remuneration and removal being in the hands of majority shareholders, IDs seldom recognise, let alone ‘represent’ the interests of minority shareholders and risk being stripped off their designation and perks.

It is pertinent to note that even the Hon’ble SC while pronouncing the Tata - Mistry verdict on March 26 2021 has observed that the minority shareholders or their representatives do not automatically get the right to a seat on a private company’s board. Thus, upholding Tata Group’s decision to oust Cyrus Mistry from the board.

These issues were infact considered by the SEBI appointed Kumar Mangalam Birla Committee on Corporate Governance, 2002. The committee while making a conscious distinction between independent directors and non executive directors, laid down that apart from receiving director’s remuneration shall not have any pecuniary relationship with the company, its promoters, management or its subsidiaries. Lest, it would affect the independence of their judgment.

They pragmatically put forth the litmus test of independence to be based on material pecuniary interests. In order to further strengthen the regulatory framework around the functioning of IDs, SEBI in its March 1 2021 consultation paper has recommended the introduction of a system of “dual approval” through a single voting process (two-tier system). It requires approval by majority shareholders and majority of minority shareholders for the appointment, re-appointment or removal of IDs.

This proposal is a step in the right direction in increasing the transparency, objectivity and accountability in corporate governance, provided it is is implemented unlike the Birla Committee litmus test that has been overlooked.

IDs were internationally adopted as a concept to tackle the corporate governance problem of manager-shareholder agency, whereas in India we find it to be a majority-minority shareholder issue.

In its quest to make independent directors further suited for their role on the Board, the corporate affairs ministry conceptualised an online test for independent directors, making the test mandatory and including sections of company law, securities law, basic accounting and corporate governance.

In a rather obvious reaction, considerable opposition has been observed for such a test, with the prime argument against it being that it ignores the experience an individual possesses, thus completely disregarding part of the requirement for appointing an independent director.

The flaw in this argument is that corporations are working with the assumption that experience leads to individuals being more independent in their decision making, which is difficult to believe as corporate mismanagement has occurred in our country at the highest levels and with the most experienced of individuals.

Such a test to ensure knowledge as even though it might not be testing a potential director in all spheres that are taken into account while selecting an individual, it fulfills part of the criteria, thus ensuring at least one condition is fulfilled.

Corporations can select individuals with more experience, but they must prove their knowledge of the field in some form. In an ideal situation, the test would only be a part of the selection process, with companies taking into account other factors in addition to the knowledge of a potential independent director.

A practical compromise would be to have industry-specific tests, so as to make sure that the potential candidate is not being deprived of his position because his knowledge lies in a niche area in which the company functions.

While it is true that the framework of independent directors has its own shortcomings, one must also acknowledge that ‘independence’ is a highly subjective matter. It is impossible for regulatory bodies to ensure that each and every decision made by an independent director is free from influence from other Board members.

A regulator 's role is to be limited to checks and balances. Corporate upheavals are necessary evils for promotion of business innovation.

Corporate alignments and realignments shouldn't be of concern for the regulators, unless it has the potential to negatively impact the economy as a whole. This approach is reflected in the observation of SC in this Tata Mistry case where it distinguished between minority shareholders and small shareholders, declaring Mistry’s Pallonji Group as minority shareholder.

Hon’ble SC interpreted that the Companies Act only provides for protection of rights of small shareholders. This is the whole premise on the basis of which the issue of minority rights representation has been addressed in the judgment.

On a generic note, the court could assume the role of mediators in such issues, nudging the parties into a settlement which is likely to be lasting than a verdict.

It is also imperative to note that even with reinforced protections and privileges, regulatory bodies and government should not expect independent directors to be the solution for all ailments in the corporate sector.

But the dual check of selection criteria under section 149, Companies Act, 2013, and knowledge assessment under the self-assessment test goes a long way in providing independence and objectivity when it comes to selecting IDs.

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