PublicationsANALYSING THE LIABILITY OF NON-EXECUTIVE- INDEPENDENT DIRECTORS

October 11, 20210
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Index
  1.  Research Questions
  2. Introduction
  3. Who are non-executive-Independent directors, and what are their duties under The Companies Act, 2013?
  4. Scrutiny of the role and position of independent directors in the recent past
  5. What are the liabilities of non-executive-Independent directors?
  6. Are Independent directors ‘independent’ in nature?
  7. The scope for the future: an opinion and new findings formed through the analysis
  8. Conclusion
Introduction

Our society’s development as a capitalistic society, with businesses and companies playing an enormous role in shaping humanity as a whole led to a need to introduce independence upon the board of companies, which would help in governance. Consequently, governance reform in recent years has increasingly pinned hope as well as a responsibility on non-executive directors[1] (especially independent directors) to enable higher standards of governance.[2] The concept of ‘Independent Directors’ was first introduced in the United States in the 1950s, while in India it was “introduced in the 1998 CII Report which was enthusiastically endorsed by the Kumar Mangalam Birla Committee Report which emphasised that the independent directors have “a key role in the entire mosaic of corporate governance”[3]. Although the idea of independent directors was not explicitly mentioned in the Companies Act, 1956, it was Clause 49 of the listing agreement that mandated all listed companies to include independent directors[4] on their board[5]. The aforementioned was eventually codified in a systematic manner through the Companies Act, 2013, wherein Section 149 and Schedule IV largely discusses the specifics of independent directors, and they are also further governed by SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015.

The increase in corporate and financial frauds in the recent past has resulted in the role of independent directors being under a scanner and has led to an ongoing debate within the financial and legal communities of whether independent directors are really needed? And if yes, then do they fulfill the role they are required to?

This research paper is an attempt to analyze various aspects associated with independent directors through the medium of secondary sources and judgments.

Who are non-executive-Independent directors, and what are their duties under The Companies Act, 2013?

Ideally, there are two types of directors on the board of a company, ‘Executive directors’ and Non-executive directors. Executive directors are often referred to as ‘whole-time directors’ and have to partake in the key day to day decisions of the company, whereas non-executive directors are appointed for their independent judgment and ‘creative contribution’[6] towards the company, since there are not required to participate in the day-to-day functioning. This paper will essentially be focusing on ‘Independent directors’ who come under the ambit of non-executive directors. Section 149(6) of The Companies Act, 2013 begins by stating that an ‘independent director must possess the relevant expertise and experience’ and further lays down the requirements for a director to be considered as ‘independent’ in nature.[7] Section 149(4) lays down the minimum requirement of independent directors in the company “as at least one-third of the total number of directors”[8] while also stating that the “central government may prescribe the minimum number of independent directors in case of any class or classes of public companies”.[9] Independent directors are entrusted with numerous duties and responsibilities which are varied in nature as they range from “bringing an independent judgment to bear on the deliberation of strategy and performance, scrutinizing the performance of the management, safeguarding the interests of the stakeholders, regularly updating their skills to keeping themselves informed about the company and the external environment” to many more as listed in the Schedule IV of The Companies Act, 2013[10]. The remuneration provided to non-executive directors (including independent directors) can be ascertained by the company and maybe in the form of sitting fees be decided on the basis of participation in meetings and/or profits.[11]

Independent directors are often viewed as crucial to the structure of corporate governance because their independent position within the company is expected to bring an unbiased perspective to the Board. They have been previously referred to as “conscience keepers who guide the company towards its right interests” as they are expected to question and scrutinize the company’s practices while safeguarding the interests of the stakeholders of the company.

Scrutiny of the role and position of independent directors in the recent past

The rise in corporate scandals over the past few decades has put the importance and the contributory role of independent directors under scrutiny, they have been viewed as an ‘unnecessary burden on the corporation and often referred to as ‘fair-weather friends’ of companies who stay committed within good times but desert the company at the first sign of impending disasters’[12] and are often blamed for just enjoying the perks of their position without effectively performing their duties, numerous instances from the last few corporate frauds/failures are proof of this, Mr. Anil Umesh Haldipur the independent director of Gitanjali Gems resigned after the PNB fraud, Vikram Mehta the independent director of Jet Airways also quit. While Independent directors often cite ‘lack of time’ as the reason for alienation, it is evident that they do so because of the unfortunate position of the company.[13] Therefore, this leads to questioning their role within a company as one of their essential duties is ‘monitor the performance of the management and ‘maintain the interests of the stakeholders’ which was clearly neglected by them in case a governance issue occurs. However, the question that arises is whether they are to be blamed for any of these acts and what is the extent of their liability in such cases?

Liability of non-executive-Independent directors

The Companies Act, 2013 provides what could be considered as a ‘safe harbour provision’ to Independent directors under section 149(12) which restricts the liability of independent directors “only in respect of acts of omission or commission by a company which had occurred with his knowledge, attributable through board processes, and with his consent or connivance or where he had not acted diligently.”[14] However, considering the recent events and judgements by courts it remains crucial to understand and judge whether Section 149(12) remains to be the ‘safe harbour’ provision it was expected to be.

Since the Companies Act, 2103 does not answer the implication of vicarious liabilities upon independent directors, we will attempt to analyse the same through the medium of judgments.

The principle of vicarious liability originates from the Latin term ‘Qui Facit per Alium Facit’ which means that “he who acts through another, acts through himself”[15], through legal perspective, it is essentially “the holding of a person or entity responsible for damages or harm caused by someone else”[16], it has often been questioned whether independent directors should be held vicariously liable or should they be excused from the repercussions of the acts of the company and its other agents due to their ‘independent nature’. In the 2018 case of C.S. Raju v. SEBI the Apex court held that “Non-Executive Directors are, therefore, persons who are not involved in the day-to-day affairs of the running of the company and are not in charge of and not responsible for the conduct of the business of the company.”[17]Further a similar nexus was established in the recent case of Har Sarup Bhasin v Origo Commodities India Private Limited, the issue in question was whether the petitioner (being an independent director) would infer any vicarious liability under Section 138 r/w Section 141 of the Negotiable Instruments Act, 1881 for the ‘failure of making arrangements in the bank for honouring issued cheques’. Herein, the petitioner argued that considering that he was an Independent Director (not being a promoter or key managerial personnel) under Section 149(2), he shall only be held liable for any acts of omission or commission by the company which had occurred with his knowledge, as provided in Section 149(12), however in this case the respondent had not disclosed any circumstances to the petitioner, therefore no liability could be attributed against him. The Delhi High Court after referring to other judgments ruled that “the petitioner being an Independent and Non-Executive Director, in the absence of any specific role attributed to against the petitioner for his active participation in the day to day affairs of the company and of taking all decisions of the company, where the petitioner was not a signatory to the cheques in question, vicarious liability cannot be fastened on the petitioner in the absence of any specific role attributed to him.”[18]  And then again in the case of Sunita Palta v M/s Kit Marketing Private Limited court held a similar opinion that to legally hold a person liable under Section 141 he shall be “in charge of and responsible to the company for the conduct of the business of the company, at the relevant time the offence was committed  Every person connected with the company shall not fall within the ambit of the provision.”.[19]In the aforementioned cases, courts relied on the assertion laid down in the case of Pooja Ravinder Devidasani v. State of Maharashtra & Anr. wherein the Supreme Court said that “Non-executive Director is no doubt a custodian of the governance of the Company but does not involve in the day-to-day affairs of the running of its business and only monitors the executive activity. To fasten vicarious liability under Section 141 of the Act on a person, at the material time that person shall have been at the helm of affairs of the company, one who actively looks after the day-to-day activities of the company and particularly responsible for the conduct of its business.”[20]

This analysis of cases shows that the courts have maintained a similar trend through the years of choosing to not hold the independent directors vicariously liable as in the aforementioned cases it was proven that since the independent directors were not responsible for the day-to-day working of the company and were also not aware of the commission of the crime, they shall not be held liable for an act done without their knowledge, as provided under Section 149(12).[21]

However in a 2017 case involving Jaiprakash Associates, the Apex court put a restraining on the independent directors of the company from transferring any of their personal assets, in case of any violation of the said order the directors were to be held liable for criminal prosecution and contempt of court”[22] Similarly in the Punjab National Bank fraud case, NCLT held the plea of MCA to freeze the assets of the independent directors of the companies of Nirav Modi and Mehul Chowksi, however, they did receive temporary relief from the Supreme Court.[23]

The contrast in the opinion of the court(s) leads to a feeling of ambivalence among the Independent directors across the country, and the people belonging to the fraternity have displayed conflicting opinions about the same, Kiran Mazumdar Shaw the chairperson of Biocon said that “it is unfair to place the entire onus on independent directors who are only privy to the information shared with them by the management. Instead of penalising independent directors, the management and promoters should be penalised.”[24] and Arun Nanda the non-executive director of Mahindra said that “while Independent directors are expected to provide governance, they shall also be protected”[25] while Deepak Parekh the chairman of HDFC bank was of the opinion that it is the job of independent directors to monitor the operations of the company and thus in case of any governance issues it is not fair for them to simply alienate the company and they must bear the consequences.[26]

Therefore, a dilemma remains among the minds of independent directors, about whether Section 149(12) of The Companies Act, 2013 provides immunity to them or not.

However, a recent attempt was made by The MCA to address this dilemma, in a circular released in March 2020, it was clarified that Section 149(12) is a ‘non-obstante’ clause under which the Independent or non-executive directors can only be held liable for in respect of the acts mentioned (under section 149(12)), though, no criminal or civil proceedings must be brought upon them for acts commissioned without their knowledge,[27] and neither shall they be held liable for ineffectiveness or defaults committed in lieu of any ‘routine administrative matters which are outside their purview.’[28]

Are Independent directors ‘independent’ in nature?

The shareholding pattern in India is principally concentrated in nature wherein maximum shareholding is held by domestic and family groups, while Independent directors are expected to be ‘watchdogs’ to shareholders but due to the concentrated nature of companies they tend to get influenced by the needs of the controlling managers and or promoters of the company since they do not want to risk getting removed from their position and losing the perks that come with it.[29] If not all then a few Independent directors no longer act independently to monitor the management of the company and due to the ‘concentrated’ shareholding they tend to work for the benefit of only the dominant shareholders of the company and the primary reason independent directors tend to be inclined towards working for the interests of the majority shareholders is because of the power vested in the majority stakeholders to appoint or remove the independent directors through a special resolution.[30]

The scope for the future: an opinion and new findings formed through the analysis

With the rise in the role businesses and companies play in shaping societies the need for corporate governance has increased and thus resulting in a need for independent directors, their expertise, and judgement. However what is the need of the hour is to protect the independence and rights of the directors, as “financial frauds such as those that beleaguered IL&FS and PMC Bank, and made headline news with the Nirav Modi-Mehul Choksi fraud and the insolvency proceedings of the Amrapali Group and Jaypee Group”[31] have led to questions with regards to the need, role, rights and limitations of the independent directors, making the independent directors feel a constant sense of threat and discouraging them from performing their jobs efficiently and effectively. While the circular released by MCA was a positive step, what is required is the need for its fair implementation, since unfairly holding independent directors liable for commission of acts they are not responsible for will essentially defeat the purpose of their existence. It is crucial to observe that as cited by the court in the judgement of Chintalapati Srinivasa Raju v. Securities and Exchange Board of India‘non-executive-independent directors are not involved in the day-to-day functioning of companies, they are not in charge of and not responsible for the conduct of the business of the company.’[32]so, they also have no alternative to finding the commission of certain suspicious wrongdoings, and at times their opinion and decisions are not even taken into consideration by the board making it almost impossible to effectively govern the company.  However, an effective mechanism must be set up to judge whether the director is in default or was aware of the default or not so his/her liability can be ascertained accordingly, as often it is even possible that an independent director could be the one to be held responsible for a misdeed. Further, the majority stakeholders shall not be vested with complete rights to control the appointment, removal, remuneration etc. of the independent directors, as vesting them with so much control over independent directors essentially takes away their independence.

Conclusion

In conclusion, based on the above-cited research, it is established the purpose of introducing independent directors upon the board was crucial for the purpose of corporate governance and was also beneficial for the development of the company in itself, since the duties and roles such as monitoring of management, safeguarding the interests of the stakeholder allotted to independent directors make them an indispensable resource for the company. However, there is a need for independent directors to feel protected and not be held liable for acts that do not come under the purview of their responsibilities, moreover if independent directors are treated just as other directors and managers it will not differentiate them from their colleagues and will entirely defeat the purpose of their existence.

The government must do their best in protecting the interests of the independent directors, however also establishing a middle ground through which while protecting their interests there should also be regular checks on how diligently and effectively, they are performing the tasks allotted to them.

REFERENCES

Table of Authorities

Cases

  1. S. Raju v. SEBI MANU/SC/0598/2018
  2. Chintalapati Srinivasa Raju v. Securities and Exchange Board of India (2018) 7 SCC 443
  3. Har Sarup Bhasin v Origo Commodities India Private Limited MANU/DE/0529/2020
  4. Kanarath Payattiyath Balrajh v. Raja Arora 2017 SCC OnLine Del 7418: (2017) 2 DLT (Cri) 695
  5. Pooja Ravinder Devidasani v. State of Maharashtra & Anr MANU/SC/117/2014
  6. Sunita Palta v M/s Kit Marketing Private Limited MANU/DE/0715/2020

Circulars

  1. Securities and Exchange Board of India, SEBI/CFD/DIL/CG/1/2004/12/10, October 29, 2004
  2. Ministry of Corporate Affairs, General Circular Number 1/2020, January 16,2020

Statutes

  1. The Companies Act, 2013

Secondary Sources

Blogs

  1. Bhatia S and others, “Independent Directorship at IL&FS: Put on Notice” (India Legal April 14, 2019)
  2. Rudrakanthwar N, “Independent Director: A Crown of Thorns, TaxGuru
  3. Varottil U, “MCA Clarifies on Legal Actions against Outside Directors, IndiaCorpLaw
  4. Verma B and Jain S, “Independent Directors: Role, Responsibilities, Effectiveness” (SCC Blog July 15, 2019)

Books

Komal Garg, Concise Commentary on Company Law (1st edn, Wolters Kluwer 2020)

Journal Articles

  1. Arindam M, “THE INDEPENDENT DIRECTOR: HAS IT BEEN INDIANISED ENOUGH?” (2013) 6 NUJS Law Review
  2. Balasubramanian N and Satwalekar DM, “Corporate Governance: An Emerging Scenario” [2010] National Stock Exchange of India, Ltd
  3. Varottil U, “Evolution and Effectiveness of Independent Directors in Indian Corporate Governance” (UC Hastings Scholarship Repository2010)

News Articles

  1. Nair D, Kislay K and Sahni V, “Independent Directors, the Governance-Guardians of the Board, Need to Revitalise Their Role”The Economic Times (July 11, 2020)

Reports

  1. Cadbury Report, The Committee on the Financial Aspects of Corporate Governance and Gee and Co. Ltd.
  2. Management and Board Governance, Ministry of Corporate Affairs

Miscellaneous Websites

  1. “Qui Facet per Alium Facit per Se” (Oxford Reference)
  2. Anonymous, “Vicarious Liability – Definition, Meaning, Examples, and Cases” (Legal Dictionary)

[1]This paper will essentially be focusing on “Independent Directors’ which come under ‘Non-executive directors’

[2]Varottil U, “Evolution and Effectiveness of Independent Directors in Indian Corporate Governance” (UC Hastings Scholarship Repository2010) <https://repository.uchastings.edu/hastings_business_law_journal/vol6/iss2/1/> accessed September 30, 2020

[3]Arindam M, “THE INDEPENDENT DIRECTOR: HAS IT BEEN INDIANISED ENOUGH?” (2013) 6 NUJS Law Review <http://docs.manupatra.in/newsline/articles/Upload/51D72E8E-0E3D-436C-8816-07816F8789EC.pdf> accessed October 3, 2020

[4]Clause 49 mandate for half the board to comprise of Independent Directors

[5]Securities and Exchange Board of India, SEBI/CFD/DIL/CG/1/2004/12/10, October 29, 2004, <https://www.sebi.gov.in/legal/circulars/oct-2004/corporate-governance-in-listed-companies-clause-49-of-the-listing-agreement_13153.html>

[6]Cadbury Report, (The Committee on the Financial Aspects of Corporate Governance and Gee and Co Ltd) rep <https://ecgi.global/sites/default/files//codes/documents/cadbury.pdf> accessed September 30, 2020

[7] The Companies Act, 2013 Section 149(6)

[8]The Companies Act, 2013 Section 149(4)

[9]Id.

[10] The Companies Act, 2013 Schedule IV

[11]Management and Board Governance, Ministry of Corporate Affairs http://www.mca.gov.in/Ministry/reportonexpertcommitte/chapter4.html

[12]Balasubramanian N and Satwalekar DM, “Corporate Governance: An Emerging Scenario” [2010] National Stock Exchange of India, Ltd. <https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1855226> accessed September 30, 2020.

[13] Rudrakanthwar N, “Independent Director : A Crown of Thorns” <https://taxguru.in/company-law/independent-director-crown-thorns.html> accessed September 31, 2020.

[14]The Companies Act, 2013 Section 149(12)

[15]“Qui Facet per Alium Facit per Se” (Oxford Reference) <https://www.oxfordreference.com/view/10.1093/oi/authority.20110803100000562> accessed October 5, 2020.

[16]Anonymous, “Vicarious Liability – Definition, Meaning, Examples, and Cases” (Legal DictionaryOctober 29, 2018) <https://legaldictionary.net/vicarious-liability/> accessed October 5, 2020

[17]MANU/SC/0598/2018

[18] MANU/DE/0529/2020

[19] MANU/DE/0715/2020

[20] MANU/SC/117/2014

[21]The courts cited similar reasons for not holding Independent directors liable in multiple other judgements such as Kanarath Payattiyath Balrajh v. Raja Arora 2017 SCC OnLine Del 7418 : (2017) 2 DLT (Cri) 695

[22]Verma B and Jain S, “Independent Directors: Role, Responsibilities, Effectiveness” (SCC BlogJuly 15, 2019) <https://www.scconline.com/blog/post/2019/07/12/independent-directors-role-responsibilities-effectiveness/> accessed September 30, 2020

[23]NCLT- National Company Law Tribunal

   MCA- Ministry of Corporate Affairs

[24]-Vijayaraghavan, K. and Philip, L., 2021. Independent directors in a fix after SC order on asset transfer in Jaiprakash Associates case. [online] The Economic Times. Available at: <https://economictimes.indiatimes.com/news/company/corporate-trends/independent-directors-in-a-fix-after-sc-order-on-asset-transfer-in-jaiprakash-associates-case/articleshow/61841159.cms?from=mdr> [Accessed 11 July 2021].

[25]Komal Garg, Concise Commentary on Company Law (1st edn, Wolters Kluwer 2020) 135.

[26]Ibid

[27]Ministry of Corporate Affairs, General Circullar Number 1/2020, January 16,2020 https://www.mca.gov.in/Ministry/pdf/Circular_03032020.pdf

[28] Varottil U, “MCA Clarifies on Legal Actions against Outside Directors” <https://indiacorplaw.in/2020/03/mca-clarifies-on-legal-actions-against-outside-directors.html> accessed October 1, 2020

[29]Balasubramanian, Satwalekar (n 9).

[30] The Companies Act, 2013, Section 169(1)

[31]Nair D, Kislay K and Sahni V, “Independent Directors, the Governance-Guardians of the Board, Need to Revitalise Their Role ”The Economic Times (July 11, 2020) <https://economictimes.indiatimes.com/small-biz/legal/independent-directors-the-governance-guardians-of-the-board-need-to-revitalise-their-role/articleshow/76904950.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst> accessed October 1, 2020

[32](2018) 7 SCC 443

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AUTHOR DETAILS
https://i0.wp.com/www.legalmaxim.in/wp-content/uploads/2021/10/IMG_20210723_204136.jpg?resize=160%2C160&ssl=1

Author: Ankita Singh

Designation:  4th Year Law Student

University: O.P Jindal Global University, Jindal Global Law School

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