Independent directors: Why they need to stand up and be counted

In the past few earnings season, there has hardly been a board meeting of listed companies which did not pause in their deliberations to discuss the ramifications of the recent disputes in one of India’s most trusted business groups on the corporate…

Independent directors: Why they need to stand up and be counted
'Directors, especially independent directors, need to demonstrate that they acted in good faith while exercising their business judgement.'

In the past few earnings season, there has hardly been a board meeting of listed companies which did not pause in their deliberations to discuss the ramifications of the recent disputes in one of India’s most trusted business groups on the corporate governance matters. These discussions were varied, engaging and included deliberations on the role, objectivity and probity of independent directors in promoter-controlled companies or in companies with dispersed ownership in matters relating to conflicts between the boards and their listed subsidiaries, and how control is exercised by the principal owners who are in minority, etc.

We have recently seen diverse display of conduct by the independent directors in two of the iconic companies and groups in India. In the case of one, the non-executive chairman openly canvassed with the promoters for removal of a director prior to a shareholders meeting and was rewarded for this with multiple board positions soon after the voting. There were other directors within the group who steadfastly took positions of what they believed to be in the best interest of the company and not what the promoters desired. Their position later got voted out by a dispersed group of shareholders in a general meeting.

The other board conversation involves the role the independent directors played in determining the fair value and dealing with conflict of interest of the CEO in an acquisition, especially when the CFO has dissented on the transaction. Laws around the world categorise directors (including promoters) as working, non-executive or independent based on the asymmetry of information that exists and their ability to control decisions. Working directors often have significant influence in the decisions to induct outside directors and hence the assumption that outside directors are beholden to them.

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Expectations from independent directors tend to be exaggerated. Investors, regulators and public often expect them to arbitrate in every matter of conflict, oversee controls, delineate risks and strategise and give directions in all aspects involving the business and operations, some of which go beyond the realm of their legal duties and responsibilities.

What should we expect from independent directors?

Under the Companies Act of 2013, a director on the board of a company, whether is a principal owner/promoter, nominee of an investor, working whole time or independent needs to act in good faith and in the best interests of the company, its employees, shareholders, community and environment. Law does not rank the priority of such interests of varied stakeholders and one may assume that they rank pari passu or equally with each other in enjoying the responsibilities of directors towards them. However, some constituents like employees, shareholders, etc, have a distinct privity of contract which often gets precedence over other stakeholders.

Directors act as a collegium working collectively towards the best interests of the stakeholders; responsibilities and liabilities follow every role a director is expected to perform. In setting up strategies, budgets or oversight of policies directors have a collective responsibility, shared across the board. Working directors have additional responsibilities and liabilities under various laws for any operational or legal breach, while independent directors are responsible only for those acts which are done either with their consent or through a board process. If, however, information is deliberately concealed or not presented through a board process or acts have been done without their knowledge, the law protects an independent director who does not have to bear the responsibility or consequences arising out of such executive actions.

One consistent chorus that follows every corporate scandal in the world is why did the independent directors not discover the scam? Did they do enough? Were they compromised?

Directors are expected to act with due care, skill and diligence and exercise independent judgement on all matters affecting the company whose interests are paramount. Directors, especially independent directors, need to demonstrate that they acted in good faith while exercising their business judgement.

In order to determine what an independent director is responsible for one can seek the construct of the law which makes them specifically responsible for acts and imposes punitive consequences for slippage. For example, members of an audit committee work as experts in that role and need to demonstrate their expertise in discharge of audit duties. Courts and regulators have consistently held that where due care and diligence was not exercised, no immunity from prosecution can be granted if directors have repeatedly disregarded red flags, not paid heed to complaints raised by whistle blowers or simply did not spend time necessary to support their decisions.

In matters of ambiguity like determining fair value in case of acquisition or sale or for dealing with conflict of interests of the CEO or promoters, depth of judgement needs to be explicit and may include documented deliberations, use of independent experts, counsel etc. to support their conclusions. Boards in their quest for answers swing from being prolonged and obtuse to being almost reckless in decision making and that causes anguish for regulators, small shareholders and other investors, knowing well that they have liabilities which are both civil and criminal in case of a breach.

When is a breach of diligence?

Independent directors cannot hide behind the guise of circumstances and claim to not knowing what an otherwise reasonable person sitting in a similar position should know. While information asymmetry in the case of an independent director could be a challenge, the test of diligence on the part of an independent director is considered fulfilled if she has made all reasonable attempts to get the information which will help take a balanced view.

All directors, including independent ones, must cater to the interests of the shareholder. While this duty is not towards any individual shareholder, the law requires directors to act in a manner which will be in the company’s best interests. While this duty is a collective duty of the board, independent directors have a duty to differ with the majority if the board acts in a manner contrary to the interests of the shareholders importantly the minority. This right must be exercised by independent directors not only in their affirmative actions backed by reasoned judgement, but also through dissent during a vote in case of an impasse.

Once the directors have consented to a resolution, which is also reiterated through the minutes, it is assumed that the decision has gone through a due and fair process of diligence in an independent manner without favour or fear of any other person exercising control or influence. This balance is difficult to achieve, even for individuals who have been extremely successful and have significant reputation to protect.

Demonstration of independence by boards and independent directors has been disparate, at times just perfunctory which in turn creates a unique governance challenge since the corporate dice is always loaded in favour of the promoters and their nominees. Independent directors are the trustees of good corporate governance. If they do not stand up to be counted when required, the society loses one of its strongest pillars of good governance. In recent years, we have seen a welcome change in the way independence is being demonstrated in India’s board rooms but we have miles to go before we cement our faith in the institution.

The author is a founder of Thought Arbitrage Research Institute, a non- profit think tank on corporate governance, economics and public policy. Views are personal

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First published on: 24-02-2017 at 04:32 IST