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Independent Directors Rules: What are they and how do they help

All you need to know about the Independent Directors Rules.

December 02, 2019 / 07:34 PM IST

Overview on the Independent Directors Rules

The Ministry of Corporate Affairs ("MCA") on October 22, 2019 introduced the Companies (Creation and Maintenance of databank of Independent Directors) Rules, 2019 and the Companies (Appointment and Qualification of Directors) Fifth Amendment Rules, 2019 [collectively hereinafter referred to as "Independent Directors Rules"], both being effective from December 01, 2019.

The MCA has also introduced the Companies (Accounts) Amendment Rules, 2019 [effective from December 01, 2019] which now requires additional disclosure to be made in the Directors’ Report of a company. Accordingly, a company, as part of its Directors’ Report, is now required to provide a statement regarding opinion of the Board with regard to integrity, expertise and experience (including the proficiency) of the independent directors appointed during the year. The expression “proficiency” means the proficiency of the independent director as ascertained from the online proficiency self-assessment test conducted by the institute notified under sub-section (1) of Section 150 of the Companies Act, 2013 i.e. Indian Institute of Corporate Affairs ("IICA").

For the purpose of this Article, we have dealt with only the Independent Directors Rules.

Understanding the Independent Directors Rules

Under the Independent Directors Rules, any person who is willing to be appointed (or is already an) Independent Director, must apply online to the IICA for inclusion of his/her name in the data bank of independent directors, ensure compliances as required and most importantly pass an online proficiency self-assessment test to be conducted by ICAI with at least sixty percent (60 percent) marks in such test.

It is essential to note that any person who wishes to be appointed as an Independent Director (i.e. who is not already an Independent Director) is required to make such online application before his appointment as an Independent Director. Such inclusion of name in the data bank can be done for a period of one year or five years or for lifetime by payment of prescribed fees. The Independent Directors Rules also provides for renewal of such name inclusion in the data base, unless the individual has paid life-time fees for inclusion of his name in the data bank.

The online proficiency self-assessment test is required to be cleared by the individual, conducted by the IICA, within a period of one year from the date of inclusion of his name in the data bank, failing which, his name shall stand removed from the data bank of the IICA.

However, the MCA has granted exemption from the requirement of clearing the said online proficiency self-assessment test in case of individuals who has served for a period of not less than ten years, as on the date of inclusion of his name in the data bank, as a Director or Key Managerial Personnel ("KMP") in a listed company or in an unlisted public company having paid-up share capital of Rupees ten crores or more. It is clarified that for the purpose of calculation of the period of ten years, any period during which an individual was acting as Director or as KMP in two or more companies at the same time shall be counted only once.

The information available in the data bank shall be provided only to companies required to appoint independent director after paying a reasonable fee to the IICA.

The online proficiency self-assessment test is intended to cover companies law, securities law, basic accountancy and such other areas relevant to the functioning of an individual acting as an independent director.

Since the Independent Directors are expected to protect the interests of minority shareholders and act as watchdog for the purpose of ensuring corporate governance, the necessity of the online proficiency self-assessment test will ensure qualified Independent Directors are appointed on the Board of the companies. This move is also expected to distil those Independent Directors or individuals occupying position of Independent Directors just for the namesake or for the purpose of mere compliance. One can expect to have individuals, with diverse skill sets, to serve as Independent Directors of Companies and to infuse some rationale decision making in the conduct of the activities of the Board of Director essentially to uphold highest standards of corporate governance.

How will the rules help?

It can be safely estimated that the need for introduction of the Independent Directors Rules is the result of various corporate governance lapses and fiascos. This is likely to weed out the practice of appointing (distant) relatives and (at times) friends and domestic help as independent directors. This is expected to infuse some sanity in the entire process and the uphold the very objective of having independent directors in the first place. Apparently, similar provisions are prevalent in few other Western countries.

Most of the companies select an individual for appointment as an independent director on the basis of his/her skill and competencies in the sector in which such company operates, market credibility and required experience in such sector. Apart from this, the companies would also have to find an additional attribute (i.e. clearing the online proficiency self-assessment test) in the prospective Independent Director, which may prove to be a steep target. Needless to add, the exemptions provided in the Independent Directors Rules provides for some breather and which can be seen as a ‘ray of hope’ for some. The requirement i.e. online proficiency self-assessment test may be perceived as an additional burden by the Companies as well as the prospective Independent Directors in the entire process and add to that the high clearing benchmark of 60 percent grades in such online proficiency self-assessment test.

Due to recent actions initiated not only against errant promoter-directors, executive directors and KMPs, but also against auditors and, in some cases, independent directors; several prominent independent directors have stepped down or are reluctant to take up directorship. Most of them are now willing to come on board as advisors or consultants. The situation becomes onerous in case of companies under financial stress or subjected to any regulatory/statutory investigations/inquiry where such companies eventually end up on the wrong side of the law especially on the compliances front. This endangers the directors as the default on part of such companies causes the directors to incur disqualification and affects their directorships elsewhere.

Considering the various recent corporate indiscretions, not many may be keen to act as independent directors, especially considering many of the existing ones already stepping down. The situation may prove to be daunting with the requirement of the online proficiency self-assessment test.

Suggestive next steps and conclusion

In addition to the exemptions already enshrined in the Independent Directors Rules, the MCA may perhaps also consider granting exemption to professionals who have completed recognised higher degree courses, such as CA, CS, Advocates, Engineers, MBAs, etc. Apart from such proposed additional exemption criteria, it may also be pertinent to provide for some kind of training programmes as that could make more sense (from the point of practicality) than merely clearing some ‘test’, for which interestingly there is no restriction on the number of attempts for passing the online proficiency self-assessment test.

Although, the intention appears to be clear and at the same time honourable and virtuous to have some kind of ‘test’ for having independent directors, being viewed as guardians of corporate governance, only time will indicate whether this formal ‘test’ proves to be an all-encompassing panacea to address the several corporate governance misadventures or ends up as one more addition to the already bulging rule books.

Authored by: Prem Rajani, managing partner, Rajani Associates; Rajeev Nair, principal associate, Rajani Associates; Rahul Pandey, senior associate, Rajani Associates

The views are personal.

Moneycontrol Contributor
Moneycontrol Contributor
first published: Dec 2, 2019 07:34 pm