Moneycontrol PRO
you are here: HomeNewsOpinion

Companies Act does not provide for ‘permanent’ directors on boards

SEBI’s proposal is that all directors should be subject to the majority shareholders’ will. But they already are since the same majority can remove any such ‘permanent’ director at any time

February 24, 2023 / 04:58 PM IST
SEBI states that the present legal framework permits some directors to be ‘permanent’ on the board.

SEBI states that the present legal framework permits some directors to be ‘permanent’ on the board.

Amongst the many fairly radical recommendations proposed by the Securities and Exchange Board of India (SEBI) in its recent Consultation paper, one relates to the so-called permanency of certain directors on the board of companies. SEBI states that the present legal framework permits some directors to be ‘permanent’ on the board. The implication thereby is that they are not accountable to the shareholders as other directors are. While all directors are meant to be equal, these directors, to borrow from Orwell, are more equal than the others. This special status could arise in several ways.

One is by way of a special provision in the Articles of Association giving them this status. This is typically done by providing a clause that certain directors shall be lifetime directors and/or not capable of being removed. Another way is by the so-called ‘entrenchment’ route whereby such directors can be removed only if an exceedingly high majority of shareholders demand it. Then there is a provision in the Companies Act, 2013, itself that permit a certain proportion of directors as not liable to retire by rotation. Thus, while the other directors offer themselves before the shareholders in alternate years for reappointment, the ‘non-retiring’ directors permanently stay put. SEBI now proposes that no director should have ‘permanent’ status and all should be subject to retirement and reappointment by shareholders at least once in five years.

Supremacy Of The Act

Before we discuss the merits of this proposal, at the outset, it needs to be emphasised that there is no such thing as a permanent director in law. Sure, the articles may have such a provision. But, except perhaps in the case of ‘entrenched’ directors as discussed later, each and every director can be removed by a majority of the shareholders. Hence, effectively, there is a provision already existing in law albeit in a mirror form. SEBI’s proposal is that all directors should be subject to the majority shareholders’ will. But they already are since the same majority can remove any such ‘permanent’ director at any time.

Also, the concern that the articles may contain certain provisions that enable permanency is perhaps exaggerated. Sure, the articles are binding on the company as also the shareholders. But that said, the statute has supremacy over the articles. Section 6 of the Act specifically states that the provisions of the statute would have effect over anything contained in the articles or in any agreement or in any resolution (whether of the board or of the shareholders), etc.

Also, typically, as the consultation paper also notes, such permanent/non-retiring directors are from the promoter group. However, the law does not give any special status to them. A simple majority of shareholders can appoint or remove any director. If the promoters have a majority of shareholding (whether on their own or along with friendly other shareholders), then even if their representatives are required to retire, their reappointment would sail through smoothly. Thus, there is no new accountability that such directors would be subject to, as the consultation paper claims.

The reality also is that it is easier for a person to continue on the board than be removed. Removal of directors would require a concerted effort by a group of shareholders to initiate the removal process and also persuade other shareholders to actively vote for such removal. But even the reappointment is subject to the same difficulty. If the person is a promoter representative, the promoters would vote with their big block of holding to get such a director reappointed. And as in case of removal, the dissenting shareholders would have to garner support from such a number of shareholders as would counter the holding of the promoters and their supporters.

Entrenchment Of Directors

Notably, though, section 5 of the Act permits, the articles to have provisions for ‘entrenchment’ whereby the articles can be amended only if certain conditions are met with. The condition could include approval by a majority, more than even the 75 percent otherwise required. If there exists such a clause in the articles, and if it provides for such a high majority, it could enable a company to have a provision for the permanency of certain directors which can be modified only if a very high percentage of shareholders agree to it.

However, there are certain concerns here too due to ambiguous drafting. This provision was brought into effect from April 1, 2014. Would the clause in articles ‘entrenching’ certain directors as permanent have to be inserted on or after such date or would it apply to already existing clauses? Would such clauses need shareholders' prior approval by way of a special resolution? But whatever the answers to this legal quagmire are, the new SEBI proposals could be effective in neutralising even such entrenchment provisions. The reason is that the fair interpretation would be that, between the Act and the SEBI Regulations, the stricter provision will apply. So even if the Act permits entrenchment, if SEBI Regulations make special requirements for approval, then the latter would apply.

Await The Fine Print

SEBI proposes that these provisions effectively come into effect from April 1, 2024. If, as of that date, there are any directors who have not offered themselves for reappointment in the preceding five years, they would have to do so in the next general meeting after such date. After this date, all directors will have to ensure that their tenure is renewed at least once every five years. These are the broad proposals. SEBI has not released the fine print and hence the actual wording of the amendment may throw up more details and actual implications.

On a general note, one point needs to be emphasised – and that is the increasing divergence between the provisions relating to corporate governance under the Act and under the SEBI Regulations. The area of corporate governance is simultaneously governed by the Companies Act and the SEBI Regulations. The Act governs all companies while the SEBI Regulations govern listed companies. Thus, listed companies have a dual set of provisions to comply with, which creates complications particularly when they provide for different requirements on the same aspect.

There have been amendments to the Act from time to time to bring the provisions in alignment with SEBI Regulations. But SEBI, being more swift-footed by its very constitution as also being closer to the markets, makes regular improvements to its Regulations thereby increasing the gap further. These fresh proposals will add to the already existing differences, making the job of the compliance officer difficult.  The positive side is that the provisions keep getting updated to cure defects as also to keep them in tune with current requirements and international developments.

To summarise, these proposals are welcome but they are not as path-breaking as some of the remaining proposals.

Jayant Thakur is a chartered accountant. Views are personal, and do not represent the stand of this publication.

Jayant Thakur is a chartered accountant.
first published: Feb 24, 2023 04:58 pm