Independent directors have onerous responsibilities stipulated in the Companies Act, the Securities and Exchange Board of India regulations, and the common law. They are expected to play strategic, advisory and overseeing roles through the boardroom processes and add value to the growth and prospects of a company while remaining conscious of the tenets of good governance.
The omnibus Schedule IV of the Companies Act, 2013, requires independent directors to be objective, fair, knowledgeable, considerate, diligent, transparent and independent in judgement. Failure in any manner may invite civil and criminal liability. Independent directors are now even being held accountable for the lackadaisical approach of companies towards larger climate change concerns.
In India, the role of independent directors has come under public and judicial scrutiny in cases related to Enron, Satyam Computer, IL&FS, Dewan Housing Finance and HDIL and have also led to reforms in the law.
The Companies Act, which for the first time recognised the concept of an independent director, provides that independent directors shall be held liable not only for such omissions or commissions by a company that occurred with their knowledge and with their consent or connivance but also when they did not act in a bona fide or diligent manner or could have prevented them.
Onus On Them
Schedule IV accordingly outlines the roles, duties and responsibilities of independent directors. Similar provisions are contained in Section 27 (2) of the SEBI Act and regulation 25 (5) of the SEBI (LODR) Regulations, 2015.
The courts have since tested the liability of independent directors in various cases of corporate malfeasance, fraud or lapses. Independent directors thus have no immunity from being prosecuted or subjected to other legal proceedings. The onus is on them to prove that they acted in a bona fide manner and diligently and in the manner required.
It is indeed frightening, but not unreasonable, to see the significant role they have in ensuring good governance in companies with a large number of stakeholders with varying and often conflicting interests. Independent directors have been empowered legally and otherwise to be able to play that role effectively.
They need to be cognisant of their role and shareholder expectations and accordingly tune their mindset and approach.
The position of an independent director is not part-time or pastime one or a post-retirement luxury. It requires professionalism just as any other profession, whether it is chartered accountancy, company secretary, legal or engineering.
Their role, responsibility and liability remain the same whether or not they are remunerated adequately. Being an expert in a field or a person of eminence is good but not enough. They cannot rely only on the knowledge, experience or skill sets of other directors.
At the same time, they need not be experts or knowledgeable in all aspects before or during their tenure as independent directors. All they need is the basic idea of the type of skills they require and they can build on them.
For instance, they may not be chartered accountants to understand financial statements, but they should be aware of critical information such as related-party transactions, cooked profit, changes in accounting policies, and fair value measurements.
They should develop an understanding of audit reports and know how to look for gaps in audit reports and notes to the accounts or greenwashing in a director’s report.
Due Diligence
Ensuring that the appointment of auditors is fair and transparent and knowing the process followed for the purpose simply needs an appreciation of its criticality and developing a probing approach.
Before accepting appointments as independent directors, they should get a good idea about the company, its promoters and directors, its ecosystem, and its risk profile. They should get at least a preliminary understanding of the industry or sector, the competition, the technology used, and the organisation’s structure and culture. These can be obtained from the company itself, in publicly available information or through their own contacts.
The sources of information include documents filed with the Registrar of Companies, SEBI, the stock exchanges, publicly available annual reports, auditor’s reports, industry and market analyst reports, and civil or criminal cases from the newspapers.
Acceptance merely on the basis of familiarity with the promoters, the lure of the position, the sitting fee or the general reputation of the company should be avoided. Carrying out a reasonable level of due diligence before acceptance will enable independent directors to have a clear perspective of their role consistent with the requirements of the Companies Act and SEBI regulations.
Independent directors need to spend an average of 200 to 300 hours per company on preparation for meetings, participation in meetings, and follow-ups after meetings. Board meeting agendas often run up to 1,000 pages and are not structured to focus on important matters like strategy, sustainability, risk, and regulatory noncompliance.
Developing an understanding of the agenda papers requires considerable pre-meeting diligence and mining of these papers to find critical issues and relevant information to enable meaningful participation in discussions and reaching an objective and fair judgment.
Undertaking due diligence before a meeting is important, but that in itself is not enough. Developing a reasoned point of view and the soft skills for articulating them with the ability to patiently listen to the views of others will help in gaining respect and acceptability across board members.
A clear understanding of the subject matter and its associated issues will also help in expressing a reasoned dissent when needed and recording that in the minutes of the meeting. No board member will appreciate the views of someone who talks only to attract attention.
When an independent director is also the chairman of the board, there is the additional responsibility of conducting the meeting effectively by ensuring the quality of the agenda, the discussions are orderly and focussed, and making full use of the expertise of individual board members.
With the advent of shareholder and media activism, the Companies Act allowing class action suits, increasing oversight by regulators and action by enforcement agencies, the position of independent directors has become highly vulnerable to civil and criminal liability.
It has become necessary for them to act in a bona fide and diligent manner while playing their roles and performing their duties and responsibilities as laid down in the law. Such an approach will enable them to play the role expected of them effectively.
Ashok Haldia is a Chartered Accountant. Views are personal, and do not represent the stand of this publication.
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