Promoting governance by regulation of directors

By Shardul Thacker, Mulla & Mulla & Craigie Blunt & Caroe

Companies are expected to adopt preeminent corporate governance practices to increase the confidence of investors and stakeholders. Scrutiny of the books of account conducted by auditors rotated periodically would add further value in strengthening governance.

Shardul Thacker Partner Mulla & Mulla & Craigie Blunt & Caroe
Shardul Thacker
Mulla & Mulla & Craigie Blunt & Caroe

Corporate governance structure in India is governed by clause 49 of the listing agreement entered between a company and the recognized stock exchanges where the securities of the company are listed. Section 21 of the Securities Contracts (Regulation) Act (SCRA), 1956, gives statutory power to clause 49 of the listing agreement by providing that where the securities of a company are listed in any of the recognized stock exchanges, the company must comply with the conditions of the listing agreement entered with the stock exchanges.

Further, section 23E of SCRA provides that if the company fails to comply with the listing conditions or breaches a listing agreement, it will be liable for a penalty not exceeding ₹250 million (US$4.5 million).

The Securities and Exchange Board of India (SEBI) has formed a committee to examine auditors’ qualifications to the balance sheets of all listed companies and will seek clarification from a company’s management to ascertain whether any accounting standards have been violated. SEBI also proposes to make electronic voting mandatory for corporate resolutions to ensure greater shareholder participation and improve the governance of listed companies.

Office or place of profit

Section 314 of the Companies Act, 1956, indirectly promotes corporate governance by regulating the appointment of a director or any person, firm or body corporate related to a director to “an office or place of profit”. The underlying object of the section is to ensure that those who occupy a fiduciary position in the company do not use the position for their own advantage, directly or indirectly, except with the prior permission of the shareholders or central government in certain cases.

In ordinary parlance, an office or place of profit means any position which brings to the person holding it some pecuniary gain or advantage or benefit – the amount is immaterial. The section carves out an exception and does not apply to a managing director or manager, or to a banker or trustee for a debenture holder.

The Companies Bill, 2011, which is to replace the Companies Act, includes office or place of profit provisions in clause 188, which deals with related-party transactions. The clause defines the term “office or place of profit” and has gone further to define “arm’s length transactions” as well.

Independent directors

To further strengthen the governance structure, the bill statutorily requires that all listed public companies appoint independent directors, and increases the role of independent directors. The audit committee must have a minimum of three directors, with independent directors forming the majority. A nominee director appointed by any financial institution, or in pursuance of any agreement, or appointed by any government to represent its shareholding, will not be deemed to be an independent director.

The bill provides that independent directors must abide by a code of conduct. They can hold office for a maximum of two consecutive terms, each of five successive years. Independent directors are eligible for reappointment in the same company after a cooling-off period of three years.

At least one independent director must be present at a board meeting. If an independent director is not present, the decisions taken in the meeting will not be effective unless they are ratified subsequently by at least one independent director.

Independent directors promote confidence in a company among the investment community, particularly minority shareholders and also other stakeholders. The main role of an independent director is to bring independent judgment to the board’s deliberations especially on issues of strategy, performance, risk management, resources, key appointments and standards of conduct.

The most important duty of an independent director is to ensure that adequate deliberations are held before approving related-party transactions and assure that such transactions are in the best interest of the company.

Independent directors can be held liable if they disclose confidential information such as commercial secrets, technologies, advertising and sales promotion plans or unpublished price-sensitive information. This information can disclosed with the express approval of the board of the company or if required by law.

Unlike the current Companies Act, the bill sets out the specific role and responsibilities of an independent director. The bill attempts to remove the ambiguity with regard to the role of independent directors and provide a straitjacket clause in relation to the role and responsibilities of the directors. This will help companies in implementing the best corporate governance practices.

Shardul Thacker is a partner at Mulla & Mulla & Craigie Blunt & Caroe in Mumbai.


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