The Hindu Business Line : Will independent directors steer the corporate ship better?

SOME of the proposals in the Companies (Amendment) Bill, 2003 (Amendment Bill) are unrealistic, while some others appear unlikely to serve the purpose for which they are intended. Enormous powers are being conferred on the administration — collection of information from banks, and so on — through new Section 615A. But there is no indication of who will exercise them and in what circumstances. Each of the new provisions will require detailed examination, if it is to be used effectively.

One of the main deficiencies in the Amendment Bill is that thought has not been evidently given to the objects which each provision is expected to fulfil and to the practical aspects of the solution evolved for achieving them.

Appointment of independent directors

One of the hotly debated issues in corporate governance is the appointment of independent directors in public companies to avert disasters such as those of Enron and other giant companies that have come up like an avalanche during the last three years in the US. According to the new Section 252, which is to be substituted for the existing Section 252, every public company having paid-up capital and free reserves of Rs 5 crore or more or a turnover of Rs 50 crore or more shall have a minimum of seven directors, of which, the majority shall be independent directors.

No public company shall have more than 15 directors. And they shall include such number of women directors as may be prescribed, though it may take quite some time for qualified ladies to be available in required numbers. A company with 1,000 or more shareholders and with paid-up capital of Rs 5 crore or more, may have a director elected by `small shareholders' in the manner as may be prescribed.

The provision in the new Section 252 should make it clear whether the representative of small shareholders will be a part of the majority of independent directors or will be included in the directors other than independent directors. The independent directors will obviously be recruited by the existing board of the companies consisting of promoters and others who have acquired a substantial interest in them, either from panels maintained by the Government or from the open market. But there should be no exaggerated expectation of the effectiveness of the new provisions.

The following are some of the qualifications for an independent director and the conditions for his induction in a company:

No whole-time director or managing director of a company shall be `capable' of being appointed as an independent director of that company.

No one who "has any transaction with the company (including its holding or subsidiary company) or its chairman or managing director or whole-time director or secretary or manager or any officer who can be considered as an officer in default in connection with business or profession or in any other capacity" will be eligible for consideration as an independent director.

What the words `in any other capacity' mean or relate to is far from clear. The definition of an `officer who is in default' (and, therefore, of an officer "who can be considered as an officer in default") covers "any person in accordance with whose directions or instructions the board of directors of the company is accustomed to act" and also "any person charged by the board with the responsibility of complying with that provision".

This condition is so vague and so extensive in its scope that it will be very difficult to disqualify any candidate with reference to it. At the same time, promoters of a company may have no serious difficulty in enlisting `relatives' not covered by the definition of the term in Section 6 read with Schedule 1A to the Act, as `all the king's men', despite the seemingly wide scope of the provision in the proposed Section 252A. Name lenders, stooges and henchmen do not, in any case, have to be relatives.

No relative of the chairman or managing director or whole-time director or secretary or manager or "any officer who can be considered as an officer in default" in the company can aspire to a career as an independent director in that company. By the expression "any officer who can be considered as an officer in default", what is meant is apparently any officer whose defaults in the discharge of his duties or responsibilities can be penalised under the law. These observations are equally relevant here.

No one who has held any post in the company can ever hope to become one of its independent directors. The constitutional validity of this prohibition is open to question.

No one who has been an auditor or internal auditor or consultant (including advocate or legal advisor) of the company during any of the three preceding financial years can be a candidate for the post of an independent director.

Neither a former supplier/vendor of goods or services nor even a customer can be considered for appointment as an independent director. The inclusion of a `customer' in the prohibited list appears unfair since the expression has not been defined. Will only regular purchasers or those with long standing relationship as customer be hit by the ban or even a casual one-time purchaser of any products of the company?

No one who holds 2 per cent or more of the securities of the company, having voting rights, can apply for the post. But can he get over the hurdle by transferring his holding to his spouse or any of his children who have attained majority if the objection is only to his continuing to retain 2 per cent of the company's equity capital in his own name? Does he stand a chance if he reduces his holding to 1 per cent or does he have to get rid of all the shares he has held as a condition precedent to his induction as an independent director?

A brief spell of part-time directorship will not stand in the way of his serving the company as an independent director. However, one cannot have an innings as an independent director for more than nine years continuously in the same company.

One who holds any equity shares of the company during his term of office as an independent director "and six months after he ceases to be an independent director" is also mentioned in clause (i) of sub-section (1) of Section 252A. There does not seem to be any sense in the stipulation, since the ban on the entry of any one holding "two per cent or more in the securities of the company having voting rights" implies that there can be no objection to his holding less than 2 per cent shares at the time of his induction into the company or even afterwards.

In any event, what purpose does a restriction on his acquiring shares after his retirement from the company serve? Is it the intention that such acquisition of shares within six months after he has ceased to be a director will be held against him if he seeks the post of an independent director thereafter?

If the Department of Company Affairs (DCA) reviews one of its dormant schemes for a course in corporate lore and laws, it may be able to provide sinecure jobs for a few superannuated civil servants, but the cynical businessmen who have become wise to the ways of corporate business by sheer experience are not likely to take the scheme seriously.

There is also another aspect to the problem. There has been a general belief that a personal stake in a business drives one to give his best to it. If one has nothing to lose in the office he holds, as in Government service, there is no sense of belonging and, therefore, no incentive for good performance. Those who are dedicated to their work or to whom `work is worship' will slog wherever they are posted. The view that the independence of a director can be ensured only if he holds no shares in the company for which he works is yet to be tested.

The object of regulatory law should be to see that working conditions are conducive to honesty and independence but there is no way by which the law can see that one is not exposed to temptations or pressures and ensure that one does not succumb to them.

The proposed provisions are, therefore, all right to start with, subject to suitable clarificatory amendments. But they are nowhere near being foolproof.

(By arrangement with Corporate Law Adviser, New Delhi.)

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