Empowering independent directors

Written by K Mohandas | Updated: Nov 30 2013, 10:22am hrs
The institution of independent directors is an integral part of good corporate governance. The Companies Act 2013 gives statutory recognition to independent directors by making it obligatory for all companies of a certain level to appoint them. Section 149 of the Act stipulates the requirements for a person to be named an independent director apart from his/her remuneration and tenure. Schedule IV of the Act contains the Codea set of comprehensive guidelinesto be followed by them. Section 149 (12), on liabilities, makes a refreshing change by stipulating that an independent director shall be held liable, only in respect of such acts of omission or commission by a company which had occurred with his/her knowledge, attributable through company board (board, hereafter) processes, and with his/her consent or connivance or where he/she had not acted diligently. The key feature of this provision is that it is a direct statement on how liability can arise. The act of omission or commission should have occurred with his/her knowledge and consent or connivance or lack of diligence.

The legislative thinking in the past was different. Most laws enacted in the last 200 years have a section on offences by companies, as per which every person who was in charge , and was responsible to the company for the conduct of its business, shall be deemed guilty of the offence, and shall be liable to be proceeded against and punished. To avoid liability, such person has to prove that the offence was committed without his/her knowledge or that he/she exercised all due diligence to prevent the commission of such offence. Further, where an offence has been committed by a company and it is proved that it has been committed with the consent or connivance of, or is attributable to any gross negligence on the part of any director or officer of the company, that person shall also be deemed to be guilty. Section 24 of the Securities Contracts (Regulation) Act, Section 278B of the Income Tax Act, Section 140 of the Customs Act, Section 16 of the Environment (Protection) Act, Section 70 of the Prevention of Money Laundering Act, Section 39 of the Foreign Contribution Regulation Act and Section 32 of the Industrial Disputes Act are all on these lines.

There is a world of difference between the concept of liability of independent directors in the earlier Acts and that in the Companies Act 2013. Plainly, the old laws held the director prima facie guilty; and if he/she is innocent, he/she has to prove that the alleged offence was committed without his/her knowledge or that he/she exercised all diligence to prevent the offence. The Companies Act 2013 provides that an independent director can be held liable only if he/she had knowledge of the matter and also consented or connived or showed lack of diligence. The burden of proof has thus been shifted on to the investigator. While there was no specific provision in the 1956 Act, the government of India had been advising the Registrars of Companies to avoid harassing innocent directors with criminal prosecution. The master circular dated July 29, 2011, directs the field officers not to take action against independent directors and governments or financial institutions nominee directors unless they had knowledge of the matter through the board process and it had their consent or connivance or they did not act diligently. But it is apparent from the circular itself that the field officers were not fully tuned in. The legislative intent, evident from the 2013 law, has to be appreciated by all those responsible for the implementation of the law.

When alleged offences arise out of actions taken in good faith, section 463 of the Act, corresponding to section 633 of the 1956 Act can be invoked in deserving cases. This section provides that even if one is liable in respect of negligence, default, breach of duty, misfeasance or breach of trust, but has acted honestly and reasonably, the court may relieve him/her, either wholly or partly, of his/her liability. There have been several court judgments in the matter, and generally, innocent directors have been exonerated. But the agony of the processes is a punishment in itself. Of course, the laws other than company law, have not changed and there is no protection from legal action until the director proves his/her innocence or non-involvement in any particular case. Perhaps the government could give administrative guidelines to all concerned departments about legislative intention as demonstrated in the most recent legislation; it could also emerge as a point for judicial interpretation when cases go to the courts.

How liabilities arise

For an independent director to be implicated in an offence, the legal requirements are his/her knowledge of the matter and his/her consent or connivance or lack of diligence. Knowledge comes through the Board process. It would be totally inconceivable that a director would want to protect himself/herself by not knowing. An independent director is expected to be a true professional who would not shirk responsibility. Getting to know about something is the opportunity for intervention; and while providing all support for the companys activities, the independent director has to intervene wherever necessary in the interest of truth, public interest and legal compliance. Often, the director may have to seek information that was deliberately or inadvertently not placed before the Board. The Board is heavily dependent on institutional arrangements like internal audit, external audit, legal counsel for information and control. While being a friend, philosopher and guide for the company, the independent director should always remind himself/herself (and others) that he/she is a statutory functionary, with a role defined by law and has an obligation to function judiciously.

The consent of an individual director is evidenced by the unanimous collective approval of a decision by the board. Consent is implied even when the approval is through silence. The only evidence for not having given consent is a recorded statement of dissent. No prudent company director would give his/her consent for any activity that may constitute an offence under the law. The presumption is not that the managements of companies all have criminal intent; on the other hand, there would often be temptations to circumvent the law in the interest of the business activity, especially because the regulatory systems can be slow, cumbersome and irrational. It should be possible for the board to discuss and arrive at proper agreed decisions based on inputs and advice given by the independent directors. If there is no agreement, the directors may agree to disagree. Lack of consent of the director is expressed through his/her dissent, and this dissent has to be properly recorded in the minutes of the meeting. Such dissent will protect a director in the investigation of any alleged offence.

Connivance is much beyond consent; it is a conscious decision to support and to associate oneself with a criminal activity. Connivance of the director in an illegal act can render him liable for prosecution and penalties. Obviously, one would be suffering the consequences of ones own action.

Diligence is the degree of care required in a given situation. Assiduity and attention are critical; indolence and carelessness can be criminal. A director becomes culpable if he/she had the knowledge, but did not act diligently. Diligence demands that a director reads and understands all material placed before him/her and becomes an active participant in the boards deliberations. While a director may not be an expert in all areas of management, it is necessary that he/she widen the horizons of his/her knowledge and apply enlightened common sense in all matters.

Weak areas in the Act

While the importance of the institution of independent directors in corporate governance has been recognised in law for the first time, amendment of other Acts is necessary for full implementation of the spirit of the new Companies Act. Ideally, Section 149(12) should have begun with the clause Notwithstanding anything contained in this Act or in any other law for the time being in force, instead of Notwithstanding anything contained in this Act. Till such time as the amendments happen, the Ministry of Corporate Affairs should educate other arms of the government on the nuances and the need to avoid harassment of innocent independent directors.

Second, there are several differences between the provisions of the Companies Act 2013 and those of Sebi regulations. True, the Companies Act covers all types of companies, whereas the Sebi regulations are only for the listed companies, but it is this multiplicity of legislations and their contradictions that put India low on the list of ease of doing business.

And third, Section 149(12) speaks about knowledge attributable through board processes. This expression lacks clarity and leaves a lot of discretion in the hands of the investigators. To avoid the vagaries of interpretation, it would be better to make the Act more specific; alternatively, the expression as prescribed could have been added, making it more explicit through subordinate legislation. Perhaps the government can now use the powers under section 470 to remove difficulties if serious issues warranting immediate resolution come up. And the law allows a long period of five years for this, which is bad in theory but good in practice.

The author is a former secretary to the government of India and can be reached at k.mohandas@gmail.com