More liability on the cards for independent directors

More liability on the cards for independent directors

The Supreme Court decision last month that ended the four-year boardroom feud in the Tata-Mistry saga exposes the vulnerabilities of independent directors when they do not agree with promoters.

While the 26 March verdict is seen as a win for the Tata Group, which ousted Cyrus Mistry as chairman in October 2016, it has put the spotlight on the failure of Indian laws to uphold corporate governance principles. It also demonstrates how the independence of independent directors is at stake. Tata Sons not only ousted Mistry, who had complained of management and corporate governance failures, but also fired Nusli Wadia, the group’s most vocal independent director, for siding with him.

The case has underscored the urgent need to change the way independent directors are appointed, removed, and remunerated. The Securities and Exchange Board of India (SEBI) recently proposed a number of changes to this effect. But what will eventually materialise from these proposals depends on the public consultation process.

The proposed changes are a “bold step”, says Umakanth Varottil, an associate professor in the Faculty of Law at the National University of Singapore. “Only a handful of other jurisdictions have gone this far in moderating the influence of promoters in the appointment and removal process of independent directors.”

There is a lot missing from SEBI’s proposals, says Ranjeev Dubey, though the founder of N South Advocates acknowledges it to be a “brave attempt” and “a great start”. Among the various proposals, SEBI has suggested a “dual approval” process in the appointment or removal of independent directors, which should include a majority of minority investors. Now, 51% shareholder approval is required without any sign-off from minority shareholders. Dubey says this is not enough. “If you want true independence, you have to totally divest promoters of any say in the matter,” he says. Instead, the appointment and removal of independent directors should be undertaken by a committee of independent directors or minority shareholders.

SEBI has tried bridging the gap by proposing greater checks and balances in the appointment of independent directors by key management and employees of promoter group companies. It has also proposed that nomination and remuneration committees should evaluate the skills, knowledge, and experience of potential candidates. To prevent situations where an independent director is fired for disagreeing with major shareholders or promoters, SEBI recommends that resignation letters be published.

SEBI’s radical proposal to ensure that independent directors have skin in the game by offering them stock options as part of their remuneration package received a mixed response. The Companies Act, 2013, does not permit giving independent directors stock options. They are instead paid sitting fees and profit-linked commissions.

Stock options are a common feature in Singapore, Europe and the US. These are especially good for startups and distressed companies as the only currency they might have is equity, says independent director Anjali Bansal, who was speaking at a panel discussion on SEBI’s proposed changes for independent directors, organised by The Associated Chambers of Commerce and Industry of India. Independent directors with skin in the game would not create misalignment, she said.

However, some fear that once stock options were granted, independent directors would focus on the short-term prosperity of a company, not on long-term goals. Dubey highlights the conflict of interest if independent directors were given stock options or their remuneration pegged to profits. Promoters could try to induce them to vote for certain resolutions, he says. Instead, their fees should be based on the size of the business, not its growth, he adds.

“Remuneration should be sufficient to justify the role and risk independent directors take and they should be paid even if they oppose the company,” Dubey says. In effect, they would have two jobs: to protect the minority shareholders and drive governance, risk and compliance.”

The role of independent directors has come under scrutiny due to corporate scandals. The 2009 Satyam Computer Services accounting scandal underscored the need for more effective independent directors. Yet eight years later, similar concerns arose after IL&FS Financial Services defaulted.

“In several situations, most particularly the IL&FS case, the government has launched proceedings against all past independent directors without application of mind,” says senior advocate Shyam Divan.

The potential risk of accepting a position as an independent director thus appears high, with possible prosecution and regulatory action even when not involved in day-to-day operations, he points out.

“Independent directors should be given complete immunity from legal proceedings as long as they complain of any governance, risk or compliance issues,” says Dubey.

The Business Law Digest is written by Freny Patel.