It is widely considered that independent directors on the board of a company would improve corporate governance, especially given the responsibility of the board to balance various interests. The reason for such belief stems from the opinion that the directors representing specific interests would be confined to the perspective dictated by those interests, whereas, an independent director could bring an element of objectivity to the decision making process of the board with regards to the general interests of the company and also protect minority shareholders1. The appointment of these independent directors are governed by the relevant sections and schedule of the Companies Act, 2013 ("Act") read with the Companies Appointment and Qualification of Directors)Rules, 2014 ("Rules").
On October 22, 2019, the Ministry of Corporate Affairs ("MCA"), vide notification G.S.R. 804(E) amended the Rules with the Companies (Appointment and Qualification of Directors) Fifth Amendment Rules ("Amended Rules")2. The Amended Rules is a significant amendment especially for independent directors.Through this article we aim to explain the Amended Rules and its applicability.
Who is an independent director?
An independent director in relation to a company, means a director other than a managing director or a whole-time director or a nominee director, who, in the opinion of the board, is a person of integrity and possesses relevant expertise and experience. This individual cannot be a promoter of the company, or any of its affiliate companies, nor be related to any of the promoters or directors of the company or affiliate companies, nor have any sort of pecuniary relationship with that company during the past 3 (three) financial years.
Is it compulsory to have an independent director on your board?
Under the Act, a publicly listed company must have at least one-third of the total number of directors as independent directors3 and that the Central Government may prescribe a minimum number of independent directors for any other classes of public company.Under the Rules, it has been stipulated that the public companies which are not listed to have (i) at least 2 (two) Independent Directors if that public company has a paid-up share capital of Rs. 10,00,00,000/- (Rupees Ten Crores Only) or more, or, (ii) a turnover of Rs. 100,00,00,000/- (Rupees One Hundred Crores Only) or more, or, (iii) outstanding loans or debentures or deposits which in aggregate exceed Rs. 50,00,00,000/- (Rupees Fifty Crores Only)4. A private company and unlisted public companies which do not meet the criteria under the Act or the Rules are not required to appoint independent directors, but may still do so.
The Data Bank
Under Section 150 of the Act, it was envisaged that a data bank for independent directors would be maintained by an institute as notified by the central government. This data bank was to maintain records of all such individuals who are eligible and willing to be appointed as independent directors and would contain details such as their names, addresses and qualifications of these individuals.
Despite the Act being in force from April 01, 2014, it was only on October 22, 2019 that the MCA formulated the Companies (Creation and Maintenance of Databank of Independent Directors) Rules, 2019 ("Databank Rules")5 which comes into force from December 01, 2019, the same date on when the Amended Rules come into force. The central government vide notification dated October 22, 2019 vested upon the Indian Institute of Corporate Affairs at Manesar ("Institute") the responsibility and duty to maintain this databank6. The Institute can share details of the information stored in the databank of a particular individual only with companies who are required to appoint independent directors and are willing to pay the requisite fees as determined by the Institute. It is important to note that the Institute is required to provide the central government names on a daily basis of those individuals who have (i) enrolled in the databank and provide their permanent account number details or passport numbers for foreign independent directors, (ii) had their application for inclusion in the databank rejected along with the grounds for their rejection and date of rejection and (iii) had their names removed from the data bank along with grounds and the dates of such removal.
The Amended Rules
The whole concept of independent directors was to ensure that independent directors act as gatekeepers and protect the general interests of the company, however over time research7 has shown that independent directors have been afraid to voice their dissent at board meetings and might not take an active role at these board meetings, due to fears of not having their terms renewed amongst other reasons. From December 01, 2019, i.e., the date from when the Amended Rules shall come into force, the MCA to ensure that the process to become an independent director becomes more stringent, will ensure that individuals who are eligible and willing to be appointed as independent directors adhere to a new set of compliances.
Under the Amended Rules, if an individual wishes to be appointed as an independent director after December 01, 2019 he/she would have to apply to the Institute to have their name included in the data bank for a period of 1 (one), or 5 (five years) or for their lifetime ("Term"). If an individual has already been appointed as an independent director as on December 01, 2019, a period of 3 (three) months has been granted for applying to the Institute to have their name included in the data bank for the Term decided by them.
Every independent director who has their name already included in the data bank for a Term of their choosing would have to submit a renewal application for a Term of their choosing within 30 (thirty) days of the date of expiry of the period upto which the name of the individual had applied for inclusion in the data bank.
Once an individual has submitted his details to the Institute for the purpose of the databank, the individual would be required to undertake an online proficiency self-assessment test that will be conducted by the Institute within a period of one year from the date of inclusion of the individual's name in the databank. If the individual fails this online test, the individual's name would be removed from the databank of the Institute. The only individuals who are exempt from taking this online test are individuals who on the date of having their name included in the databank have held a position of a director or a key managerial position in a listed public company or in an unlisted
public company having a paid-up share capital of Rs. 10,00,00,000/- (Rupees Ten Crores Only) or more.
If an individual does not meet the experience criteria set out under the Amended Rules, they would be required to obtain a score of at least 60% (sixty percent) to pass the online test. The Amended Rules, however, do grant some leniency by allowing candidates for this online test to take as many attempts as required to pass this online test.
Syllabus for the Exam
Under the Databank Rules, it is mandated that the Institute would conduct this online test, the syllabus for which would be "companies law, securities law, basic accountancy, and such other areas relevant to the functioning of an individual acting as an independent director"8. To help individuals prepare for this online test, the Institute is required to prepare the basic course material for the online test, provide online lessons and even provide individuals an option to take advance tests.
Critics for the online test have argued that given that the role and function of independent directors are varied, a single examination may not cover all attributes that may be required of an independent director whose role could differ from industry to industry.
1 A. Ramaiya, Guide to the Companies Act, Vol.2 2839 (18th ed., 2015)
3 Section 149 (4) of the Companies Act, 2013
4 Rule 4 Companies Appointment and Qualification of Directors) Rules, 2014
8 Section 4 of the Companies (Creation and Maintenance of Databank of Independent Directors) Rules, 2019
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.