1. Director removal: Need for reforms?

Director removal: Need for reforms?

The power of shareholders to remove directors is possibly the most patent instance of the principle of ‘corporate democracy’, exemplifying the idea that the management of a company, ultimately, is under the control of the shareholders of the company.

Published: February 20, 2017 12:38 PM
Under Indian company laws, the shareholders have been vested with the power to remove directors by way of resolution passed by the simple majority, subject to compliance with certain prescribed processes. (Reuters) Under Indian company laws, the shareholders have been vested with the power to remove directors by way of resolution passed by the simple majority, subject to compliance with certain prescribed processes. (Reuters)

The power of shareholders to remove directors is possibly the most patent instance of the principle of ‘corporate democracy’, exemplifying the idea that the management of a company, ultimately, is under the control of the shareholders of the company. Should the directors, despite being vested with wide powers to manage and run the affairs of the company be subject to removal with an ordinary resolution? Does it imply a shareholder’s authority as the owner of the company?

Earlier this month, the Securities and Exchange Board of India (“SEBI”) released a guidance note on evaluation criteria of board members for listed companies and recently, in a press release issued on 14 January 2017 after the meeting of its International Advisory Board (“IAB”), IAB panel of SEBI has also proposed increase in transparency in the appointment and removal of directors. Given the increased focus of good governance practices in recent times especially in the context of public listed companies, whether such principles should also extend to shareholder actions needs introspection.

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Regulatory overview

Under Indian company laws, the shareholders have been vested with the power to remove directors by way of resolution passed by the simple majority, subject to compliance with certain prescribed processes (for instance, the directors’ right to make representations). Although the Companies Act, 2013 has introduced certain additional safeguards in relation to the process of removal – (i) the director sought to be removed must be accorded a reasonable opportunity of being heard and (ii) a ‘special notice’ is required to be moved for removal of any director – the power of the majority shareholders to remove directors remains unchanged.

It is important to note that the provision on removal of directors applies to all directors including independent directors, except directors appointed by the Tribunal. The Courts have applied this provision even to include permanent directors or life directors appointed by the articles of association of a company. Therefore, under the law, while the directors have the right to make a representation and be heard, the final decision rests with the shareholders. The majority shareholders, if they so desire, thus have an ability to remove any director including independent directors.

Need for introspection

The provisions dealing with removal of directors were adopted on the basis that “the general body of shareholders should have greater powers to remove a director with whom they are dissatisfied whether such director is under a contract of service or not.” The intention was that the shareholders, who ordinarily have little to no role in managing the day to day affairs of the company should have the power to intervene and assert their authority, if they are dissatisfied with the management.

To look at this from director’s perspective, the roles and responsibilities of directors have evolved over time. The law requires them to comply with fiduciary obligations towards all stakeholders including employees, community etc. and not ‘just’ shareholders. Further, independent directors are expected to bring independent judgment and protect interests of minority shareholders under law. This may often lead to a situation of conflict. A director following his expected role under law may still be removed if his action does not find agreement with the majority shareholder. This issue has also been acknowledged by SEBI in its ‘consultative paper on review of corporate governance norms in India’ published in January 2013 wherein in the context of appointment/removal of independent directors it was observed that “they occupy their position at the pleasure of the controlling shareholders and may therefore be prone to act in accordance with the will of the major shareholders. This, in effect, may hinder their “independence” and may limit their efficacy, which would defeat the purpose of appointment of independent directors.”

The law also provides for recourse against domineering behaviour by majority shareholders – relief against oppression and mismanagement can be claimed. Further, the directors do have a right to make a representation and an opportunity to justify themselves in a shareholders’ meeting. Interestingly, while High Courts have given due weightage to a director’s right to make representations, and even insisted on shareholders to justify the removal with reasons, the Supreme Court in a subsequent decision has upheld the removal of directors even in a case where no grounds for removal were furnished by the shareholders. In these circumstances, the practical effectiveness of a director’s ability to make representations and ‘be heard’ before the shareholders at the meeting is debateable in the absence of objective tests.

Global practices

As far as laws prevalent on removal of directors in other countries is concerned, it appears that, barring deviations in processes, the legal regime for removal of directors is similar across common-law countries such as UK, USA, Canada, Australia and Singapore including India. They all recognise the absolute right of the shareholders for removing directors. For example, in the United States, the Delaware Model Law provides that shareholders may remove directors, with or without cause, subject to specific statutory exceptions. Having mentioned that, it is also important to note that the corporate setup in most of these countries generally consists of a uniform blend of retail and institutional investors and rarely of controlling-shareholder groups, as opposed to the promoter-driven corporate environment in India. Hence, the comparison is reduced to being merely academic in nature and holds little significance practically, given the completely contrast corporate landscapes in these jurisdictions.

Reforms in the pipeline?

The position with respect to removal of directors, at least statutorily, seems to be quite ideal. In practice, however, it may not be so. Although the law does have appropriate mechanisms to remedy the minority stakeholders, such a position raises serious questions over directorial independence and integrity in companies driven by promoter shareholders. In these circumstances, reforms in relation to the process of removal of directors is the need of the hour.

The discourse in the IAB meeting may perhaps be a step in this direction. The Regulator has also laid impetus on the evaluation of directors and wants it to be more than merely a ‘box-ticking exercise’. Thus, along with guidance on evaluation criteria and disclosures that SEBI has proposed, it is imperative that concrete measures are introduced to make the removal process more transparent and fair. One suggestion may be to include an additional safeguard for removal of directors, at least independent directors – in addition to an ordinary resolution of shareholders, removal should also require an approval of majority of the public shareholders. Perhaps, this would achieve more ‘democratic’ results and minimise the possibility of abuse.
Authors

Kalpana Unadkat (Partner) and Pranay Bagdi (Senior Associate) are lawyers with the corporate and M&A practice at Khaitan & Co. The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the authors.

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