CENTRAL UNIVERSITY OF SOUTH BIHAR

SCHOOL OF LAW & GOVERNANCE

Project Topic

POSITION OF INDEPENDENT DIRECTOR IN INDIA

; an analysis
– Dr. P. K. Das

Submitted by:- ABHISHEK HANSDA

Program:- LLM
En. No.:- CUSB2013131003
 INDEX
SL. NO. TOPIC
01 Preface
02 Introduction
03 History
04 Inter-relation
05 Position on independent director in India
06 Who is independent director
07 Origin of concept of independent director
08 Role of independent director
09 Remuneration to independent director
10 SEBI and independent director
11 Lecuna in the concept of independent director
12 Conclusion
13 Bibliography
Preface
This project deals with the concept and development of independent director in india. Regarding
this it is discussed how the concept of independent director develop in india, its role and working
in corporate governance under company act 2013. This project also discuss about how
independent director is appointed, what are their tenure. It also discuss the role of regulatory
body( i.e SEBI) in respect of independent director.
Introduction
A Company is a separate legal entity but for various functions it needs to act via human agency.1
The two main constituents of a Company are the Shareholders and the Board of Directors. They
comprise of various forms of directors who supervise and regulate the functions of the Company.
They include rotational directors, executive directors, minority shareholders’ directors,
independent directors etc. They are accountable to the body of shareholders in case of any
mishap. Directors usually comprise promoters, majority shareholder and persons who are
personally interested in the company. Unfortunately, this leads to a lack of balance of
responsibility between the Board which is supposed to protect the Shareholders’ interests at all
times. Taking this into account the countries of United States of America and United Kingdom
devised a method to restore this balance by introducing the concept of an ‘Independent Director’.

Independent Director is a non-executive director of board of directors who does not have any
pecuniary relationship with the company except sitting fees. This concept emerge as important
solution for fraudulent activities in the company. They have right to bring judgement in decision
making related to corporate governance. Provision of independent directors is mentioned in stock
exchanges’ listing documents. These provisions are different for different countries. These
independent directors are also in committees like audit, compensation, nomination and
grievances committees, and their role as an independent director to preserve the interest of
shareholder and overall interest of the company as whole.

History

The term ‘Independent Director’ has no clear universal definition throughout the world as they
operate with different levels of power and responsibility in each jurisdiction. But it is safe to
assume the common thread underlying their core functions is to monitor the functions of the
company and provide objective un-biased inputs to the Board of Directors to ensure that the
investors of the company are being protected at all times. In the first half of the 20thCentury the
form of corporate governance prevalent in the US was a managerialist model dominated by
insider directors who were appointed and under the control of the CEO. The concept of
Independent Director emerged through the related model of the ‘monitoring board’ in the 1970s
mostly due to the impact of the shutdown of the railway company Penn Central and the Book by
Eisenberg entitled, “The Structure of the Corporation”. Both these incidents caused the
companies to re-evaluate their stance on the inclusion of outsiders on their board but the

1
A Ramaiya, pg. 2833
essentiality of the boards function to monitor the company by being independent from it had
been understood. This led to partly staffed boards comprising of independent directors.

In India on the other hand under the Companies Act, 1956 the inclusion of the concept of
Independent Directors was made under Cl. 49 of the Act which stated the importance of
Corporate Governance. This concept was at the time followed more in theory than in practice.
After its inclusion under the recent act 2,the role and relevance of independent directors has
widened.3 As of 2016 most of the EU and Asian countries have laid down regulations regarding
the appointment of Independent Directors. Furthermore, the OECD Principles of Corporate
Governance of 2015 has also recommended that independent directors must not be appointed
purely to satisfy the provisions of the law but they must be given responsibilities and power in
the company at par with other directors of the Board.

Interrelation between corporate governance and independent

director
The concept of Corporate Governance is presumed to be a relatively new concept though it has
been prevalent since ancient times through various forms of organizations. It has grown
tremendously in the last decade due to which various corporate governance codes have been
recommended and implemented in various jurisdictions.4 This has been done to ensure that there
is transparency, fair play and accountability within the company. Its importance has been
amplified due to the financial scams that have occurred in various countries. It is understood by
the investors that with the implementation of corporate governance codes the level of
responsibility of the Board of Directors to the Investors will increase manifold.

This led to the creation of the concept of ‘Independent Directors’ by way of the Monitoring
Method which advocated the inclusion of independent directors on the Board to balance the
personal interests of the Board and the interests of the investors. The role of an Independent

2
Sec. 149 of the Companies Act, 2013
3
http://www.ey.com/Publication/%24FILE/Corporate_governance_for_changing_regulatory_scenario_and_the_ro
le_of_the_independent_director_EY_FIDS.pdf
4
International Journal of Academic Research in Business and Social Sciences, Vol. 2, No. 4

April 2012, ISSN: 2222-6990

Director varies depending from country to country but the benefits it brings to the corporate
governance of a company cannot be undermined. The benefits include:

• Independent Directors assist in improving the internal accounting structure of a company

leading to long term survival.
• The Financial Statement is an important element of good corporate governance which
helps investors in deciding their choice of investment. The Independent Directors are
expected to ensure that the Report is transparent in nature further adding value to the
operations of the company.
• According to William H, cited in Borowski I (1984), Independent Directors ensure
transparency, accountability, fairness and responsibility towards the stakeholders of the
company and society at large thereby presenting themselves to be the agents of good
corporate governance.

Through this essay the researcher would put forth firstly, the role, appointment and functioning
of Independent Directors in India by way of case studies pre- 2013 Act and Post 2013 Act.
Secondly, the researcher would like to present the functioning of Independent Directors in the
jurisdictions of United Kingdom, United States of America, China and the European Union to
emulate the optimal functioning of Independent Directors in India. Lastly, as part of the ever
evolving concept of good governance, the ‘independence’ of Independent Directors and lacunae
in their practical day-to-day workings would also be discussed and suggestions will be provided
to improve this integral concept.
Position of independent director in India
The concept of Corporate Governance is presumed to be a relatively new concept though it has
been prevalent since ancient times through various forms of organizations. It has grown
tremendously in the last decade due to which various corporate governance codes have been
recommended and implemented in various jurisdictions.5 This has been done to ensure that there
is transparency, fair play and accountability within the company. Its importance has been
amplified due to the financial scams that have occurred in various countries. It is understood by
the investors that with the implementation of corporate governance codes the level of
responsibility of the Board of Directors to the Investors will increase manifold.

This led to the creation of the concept of ‘Independent Directors’ by way of the Monitoring
Method which advocated the inclusion of independent directors on the Board to balance the
personal interests of the Board and the interests of the investors. The role of an Independent
Director varies depending from country to country but the benefits it brings to the corporate
governance of a company cannot be undermined. The benefits include:

• Independent Directors assist in improving the internal accounting structure of a company

leading to long term survival.
• The Financial Statement is an important element of good corporate governance which
helps investors in deciding their choice of investment. The Independent Directors are
expected to ensure that the Report is transparent in nature further adding value to the
operations of the company.
• According to William H, cited in Borowski I (1984), Independent Directors ensure
transparency, accountability, fairness and responsibility towards the stakeholders of the
company and society at large thereby presenting themselves to be the agents of good
corporate governance.

Through this essay the researcher would put forth firstly, the role, appointment and functioning
of Independent Directors in India by way of case studies pre- 2013 Act and Post 2013 Act.
Secondly, the researcher would like to present the functioning of Independent Directors in the
jurisdictions of United Kingdom, United States of America, China and the European Union to
emulate the optimal functioning of Independent Directors in India. Lastly, as part of the ever

5
International Journal of Academic Research in Business and Social Sciences, Vol. 2, No. 4

April 2012, ISSN: 2222-6990

evolving concept of good governance, the ‘independence’ of Independent Directors and lacunae
in their practical day-to-day workings would also be discussed and suggestions will be provided
to improve this integral concept.

WHO CAN BE INDEPENDENT DIRECTORS?

Section 149(6) provides for Independent Directors in relation of a company which when defined
states any director other than a managing director or a whole time director or a nominee director-

a) Who in the opinion of board, is a person of integrity and possesses relevant expertise and
experience.

In case of Government company, instead of Board, the Ministry or Department of the Central
Government which is administrative in charge of the company.

b) i) who is or was not a promoter of the company or its holding, subsidiary or associate
company.

ii) Who is not related to promoters or directors in the company, its holding, subsidiary or
associate company.

c) Who has or had no pecuniary relationship with the company, its holding, subsidiary or
associate company, or their promoters, or directors, during the two immediately preceding
financial years or during the current financial year. In government companies, the criteria are not
required to be followed.

d) none of whose relatives has or had pecuniary relationship or transaction with the company, its
holding, subsidiary or associate company ,or their promoters, or directors, amounting to two
percent or more of its gross turnover or total income or fifty lakh rupees or such higher amount
as may be prescribed, whichever is lower, during the current financial year.

e) Who, neither himself nor any of his relatives-

i) Holds or has held the position of key managerial personnel or is or has been employee of
the company or its holding, subsidiary or associate company in any the three financial years
immediately preceding year in which he is proposed to be appointed

ii) Is or has been an employee or proprietor or a partner in any of the three financial years
immediately preceding the financial year in which he is proposed to be appointed

iii) Hold together with his relative 2% or more of the total voting power of the company
 iv) is a chief executive or director of any NPO that receives 25% or more of its receipt from
the company, any of its promoters, director or its holding subsidiary or associate company or that
holds 2% or more of the total voting right of the Company

f) Who posses such other qualifications as may be prescribed.6

ORIGIN OF ‘INDEPENDENT DIRECTORS’

The concept of independent directors can be traced to the developed economies of the West with
the United Kingdom and the U.S.A sharing credit for its evolution during 1950s, even before
legislation mandated the induction of independent directors to ensure that the only work of the
corporate entities were not only with the profit motive but also providing insight into other
values, ethical social and moral which ultimately gave rise to the concept of Good Corporate
Governance.

In India, the concept of independent directors was first introduced through voluntary guidelines
issued by the Confederation of Indian Industry (‘CII’). The Report suggested that any listed
company with a turnover of Rs. 100 crores and above should have professionally competent,
independent, non-executive directors, who should constitute at least 30 per cent of the board if
the chairman of the company is a non-executive director or at least 50 per cent of the board if the
chairman and managing director is the same person. This CII recommendation was later on
incorporated in SEBI’s Kumar Mangalam Birla Committee Report. The Kumar Mangalam Birla
Committee Report recommendation led SEBI to include clause 49 in the Listing Agreement in
the year 2000.7

6
DR. G.K.KAPOOR & DR. SANJAY DHAMIJA, COMPANY LAW PG NO. 339-340( 21T ED,2018)
7
SEBI, REPORT OF THE KUMAR MANGALAM BIRLA COMMITTEE ON CORPORATE GOVERNANCE, 1999: (2000) 2 COMP LJ
23 (JOURNAL).
ROLE OF INDEPENDENT DIRECTORS
1. Help in bringing an independent judgment to bear on the Board’s Deliberations especially
on issues of strategy, performance, risk management, resources, key appointments and
standard of conduct.
2. Bring an objective view in the evaluation of the performance of board and management
3. Scrutinize the performance of management in meeting agreed goals and objectives and
monitor the reporting of performance
4. Satisfy themselves on the integrity of financial information and that financial controls and
the systems of risk management are robust and defensible
5. Safeguard the interests of stakeholders, particularly the minority shareholder.
6. Balance the conflicting interest of stakeholders.

REMUNERATION TO THE INDEPENDENT DIRECTORS

As per the Companies Act 2013, “remuneration” means any money or its equivalent is given or
passed to any person for services rendered by him and includes perquisites as defined under the
Income-Tax Act, 1961

Independent Directors devote their valuable time to addressing the strategic issues in the course
of the Board and Committee meetings and use their expertise while guiding the management of
the Company from time to time. Independent directors, who are truly independent, can be an
effective barricade against corporate frauds. However, active oversight and prudent judgment
may suffer when remuneration comes into the picture, as it is an important factor which needs
consideration. The extent of remunerating Independent Directors determines their retention and
motivation to discharge their duties without cloudy judgments.

The remuneration of an Independent Director is restricted to the following emoluments:8

1. Sitting Fee: Sitting fee to an Independent Director may be paid for attending meetings of
the Board or committees thereof, such sum as may be decided by the Board of directors
of and shall not exceed INR 1, 00,000 per meeting of the Board or committee thereof.
The sitting fee to be paid to Independent Directors shall not be less than the sitting fee
payable to other directors.

8
PAVAN KUMAR VIJAY WHY QUESTION BEING RAISED ON INDEPENDENCE OF THE INDEPENDENT DIRECTOR?(
SEPTEMBER 27 2018, 6.45 PM)https://www.businesstoday.in
2. Commission: The Act allows a company to pay remuneration to its Independent
Directors either by way of a monthly payment or a specified percentage of the net profits
of the company or a combination of both. Further, it states that where the company has
either a managing director or whole-time director or manager, then a maximum of 1% of
its net profits can be paid as remuneration to its Independent Directors. In case there is no
managing director or whole-time director or manager, then a maximum of 3% of net
profit can be paid. Thus, the basis of payment to the Independent Directors is the net
profit of the Company. The Company is however not obligated to remunerate its
Independent Directors. Hence the Company may pay profit related commission to the
Independent Directors with prior approval of the members. Given this, the commission
should be profit-linked only and not revenue based. The Act does not eliminate profit-
related commission which could create a conflict of interest since the commission is
linked to the company’s performance.
3. Consulting Fee: The remuneration of Independent Directors has been restricted to sitting
fees, reimbursement of expenses for participation in the board and other meetings, and
profit-related commission. Therefore, it can be noted that Consulting Fee is not allowed
to be paid to Independent Directors.
4. ESOP: The Act and SEBI (Listing Obligations and Disclosure Requirements)
Regulations 2015 prohibit the issuance of stock options to Independent Directors, in a bid
to address the concern that it might be causing a conflict of interest and will affect their
independence. An alternative option could have been to place restrictions either on the
total amount of issue of stock options or put a time limit on exercising stock options,
rather than having a complete prohibition.
5. Sweat Equity: The Company may opt to remunerate its Independent Director by way of
issuing sweat equity shares. However, such issuance shall be in accordance with the
procedure prescribed under the Act. The total percentage of voting power of such
independent director together with his relatives shall not exceed more than two percent.
6. Refund of excess remuneration paid: If the Independent Director draws or receives,
directly or indirectly, by way of fee/remuneration any such sums in excess of the limit as
prescribed or without the prior sanction, where it is required, such remuneration shall be
refunded to the Company within two years or such lesser period as may be allowed by the
company and until such sum is refunded, hold it in a trust for the Company. The
Company shall not waive the recovery of any sum refundable to it unless approved by the
Company by special resolution within two years from the date the sum becomes
refundable.
SEBI AND INDEPENDENT DIRECTORS
The Securities Exchange Board of India have issued guidelines under clause 49 of the SEBI
(listing obligations and disclosure requirements) 2015 for the appointment of the independent
directors and the code of conduct they should follow in a company. As per SEBI the term
Independent directors refers to the non-executive director of a company who does not have any
material pecuniary relationship or transaction with the company, with its promoter, directors or
its senior managers. However Independent directors must not be related to the promoters or
persons occupying management positions at the board level or one level below the board or have
been the executive of the company in preceding three financial years.

BENEFITS OF KEEPING INDEPENDENT DIRECTORS

The Potential Benefits of an Independent Director are well known. Independent Directors are
usually leaders with few reasons to be beholden to the CEO. Boards dominated by independent
directors are better able to oversee the CEO and protect the interest of other shareholders and the
stakeholders. Increasing their number can foster better board performance by enhancing
company’s access to external resources and conclusions. A larger number of Independent
directors also allow a board to ensure that its members are not overburdened with over sight
responsibilities to the detriment of strategic counselling. A fully independent board enables a
company to reap these benefits without enlarging its board, thereby avoiding the potential
disadvantage of a large board.
LACUNA IN THE FIELD OF THE INDEPENDENT DIRECTORS
In reference of THE SATYAM FRAUD- Some of the lacuna which limits the working of the
independent directors is that most of them are reluctant to disturb the collegiality and
conviviality of the collective decision making. The biggest example of this lacuna lies in the
example in the Satyam Scandal.

The Satyam episode has brought out the failure of the present corporate governance structure.
The present corporate governance structure hinges on the independent directors, who are
supposed to bring objectivity to the oversight function of the board and improve its effectiveness.
Stakeholders place high expectation on them.

An individual independent director cannot play an effective role in isolation. Even if a particular
independent director is highly committed, she can only ‘watch’ wrong doing and at best initiate a
discussion, but alone she cannot stop a decision even if it is detrimental to the interest of
shareholders or other stakeholders. Neither can she blow the whistle outside the board room (e.g.
to regulators) because board proceedings are considered confidential.9

The only way independent directors can stop wrong decisions is by acting collectively. Even
then they can seldom be expected to stop ‘management fraud’ since turning independent
directors into policemen in the board room will have excessive detrimental effects on the
independence of directors, the freedom of enterprise of the managers and the costs of
governance.

Independent directors may not be in a position to stop management fraud perpetrated at the
highest level, but with high level of commitment and due diligence they should be able to
identify signals. The independent directors on the board included Vinod K Dham (famously
known as 'father of Pentium’ and an ex-Intel employee), M Rammohan Rao (Dean of Indian
School of Business), U S Raju (former director of IIT Delhi), TR Prasad (former union cabinet
secretary), M Srinivasan (retired professor from many US universities) and Krishna Palepu
(Professor at the Harvard Business School).10

The company in its corporate governance report for 2007 did not name Palepu as independent
director, perhaps because he received Rs 87 lakh from the company towards consultancy fees.
Each individual director received around Rs 13 lakh for the year 2007 for say 100 hours of work
(a survey in US reveals that independent directors in large companies devote 50-100 hours per
annum to carry out board responsibilities).11 Keeping in view the compensation levels in India,
the compensation should be considered good. In Satyam it can be said that the independent
directors showed lack of commitment.
9
supra note 3
10
Ibid
11
Ibid
Conclusion
However at the end it can be said that the objectives of corporate governance can be effectively
met without the inclusion of Independent directors in the larger scheme of things. With the
growth of business there is a rise in expectation that the Indian companies would abide by the
Indian standards of corporate governance.

Clause 49 should come as a reminder to the directors that they are the fiduciaries of the
shareholders and not that of the management. This fiduciary relationship strives for affirmative
action on the part of the Independent directors.

Clause 49 of the listing agreement makes the entire exercise of independent directors limited to
legally-defined numbers. All companies follow the norm.
But unless independent directors give their independent views at board meetings, it will not serve
any purpose in having them.
Though on paper, shareholders decide whether a particular person should be appointed as a
director or not, usually, all resolutions get passed in the AGM. Since not much information is
available about most independent directors, minority shareholders also cannot take an
independent view. In such a case, the view of proxy firms or some independent rating agency
would prove to be useful to all the minority shareholders in the country.
BIBLOGRAPHY

Books-

Company law by D.r. G.K Kapoor & D.R Sanjay Dhamija

Websites-

1. www.jstore.org

2. www.sebi.gov.in

3. www.bseindia.com

4. http://www.investopedia.com/articles/analyst/03/111903.asp#ixzz4Vaszrn4c