Ratan Tata-Cyrus Mistry Tata Group row: The cost of the fallout

Updated: November 4, 2016 7:35 AM

Shareholders and investors may lose confidence in the governance structures of large companies

ratanMistry’s letter and the counter-attack from the Tatas are sure to raise questions on whether the Tata Sons Ltd. Board acted in accordance with the statutory requirements.

Cyrus Mistry’s removal as chairman of Tata Sons Ltd. and his subsequent letter to the Board, highlighting the “failure on the part of the directors to discharge their fiduciary duty owed to the stakeholders of Tata Sons” brings to the fore what Mistry himself describes as a “total lack of corporate governance.” Mistry notes in his letter that he is surprised that some independent directors voted for his removal, especially since they had recently lauded his performance. Mistry’s letter will lead to scrutiny of many aspects of corporate functioning, particularly within the Tata Group, and in public companies in general. One of the areas likely to come up for questioning is the role of independent directors and their ability to balance conflicting interest amongst stakeholders.

The Board of Directors, as defined under the Companies Act, 2013, means the collective body of directors of the company. The word ‘collective’ is a new addition which recognises that the Board can only act collectively. Notably, it is the highest decision-making body of a company and central to its governance. The lawmakers believed that since the Board has to balance various responsibilities, the presence of independent directors would improve governance. The law recognises that despite directors having a fiduciary responsibility towards shareholders, they may still be confined to the perspective dictated by the specific interests they represent on the Board. Hence, it was felt that independent director would bring objectivity.

Public companies, listed or unlisted, that have a paid-up share capital of Rs 10 crore or more or a turnover of Rs 100 crore or more are required to have at least two independent directors. An independent director is broadly defined as a director, other than the managing director or a whole-time director, who—in the opinion of the Board—is a person of integrity and possesses relevant expertise and experience. And as stipulated in the Act, such directors must possess appropriate skills, experience and knowledge in one or more fields of finance, law, management, sales, marketing administration, corporate governance, operations or other disciplines related to the company’s business.

For the first time, the Act lays down a code and outlines the duties for independent directors and in doing so, follows the two-fold role of independent directors as applied in the United Kingdom, namely to contribute towards business strategy and scrutinise management’s performance. The Act provides guidance about the standards that independent directors should maintain and requires that they should truly be independent and should not be related to a promoter or other directors of the company and should have no pecuniary relationship with the company or its subsidiary or holding company. Markedly, the Act excludes the proprietor or partner of a legal or consulting firm that has or had any transaction with the company in any of the preceding three years, amounting to 10% of the gross turnover of such firm, from being an independent director.

Some key duties of independent directors include upholding ethical standards, acting objectively and constructively while exercising their duties and responsibilities in a bona fide manner. The law stipulates that independent directors should help bring independent judgement to the Board’s deliberations, especially on issues of strategy, performance, risk management, resources, key appointments and standards of conduct. They are expected not to allow any extraneous considerations that vitiate their objective, independent judgement.

Mistry’s letter and the counter-attack from the Tatas are sure to raise questions on whether the Tata Sons Ltd. Board acted in accordance with the statutory requirements. But, legality aside, given the Tata Group’s stellar reputation, what is most discomforting is the potential damage to the Tata brand.

If Mistry’s letter presents a true picture of the functioning of the Board, then the role of the independent directors is definitely going to come up for questioning. The Act clarifies that, an independent director shall only be liable in respect of acts of omissions or commission by the company which occurred with her knowledge, attributable through the Board processes and with her consent or connivance or where she had not acted diligently. However, it should also be noted that, if an independent director does not initiate action even upon knowledge of any wrong, then she shall be held liable. To attribute knowledge, reliance will have to be placed on the Board process—agenda, notes and minutes of meetings, all of which will play a vital role in such determination. Interestingly, some of these notes are beginning to emerge. Something that is necessary to highlight and which has not been noted anywhere so far in relation to the Tata fallout is that, independent directors of a company are required to hold at least one meeting in a year, without the attendance of whole-time directors or members of management of the company. At such a meeting, termed a “separate meeting”, the independent directors are required to review the performance of non-independent directors and the Board as a whole. They are also to review the performance of the chairperson of the company, taking into account the views of executive directors and non-executive directors. Further, they are to assess the quality, quantity and timeliness of flow of information between the company management and the Board, necessary for the Board to effectively and reasonably perform its duties.

Did the independent directors of Tata Sons Ltd. hold the required “separate meeting”? If Mistry had indeed deviated from the Tata culture and ethos, did the Board raise this with Mistry directly or at a board meeting any time prior to Mistry’s removal? Have the independent directors reviewed Mistry’s performance and sought the views of others? Equally, did Mistry raise the issue of the alleged intervention of non-board members in the decision making ever before? Did he record his dissent and, if not, why not?

It is unprecedented for a chairman of a large conglomerate to be removed in the manner that Mistry was. But it is equally unprecedented for a chairman to himself make such scathing indictments of the governance of a company that he headed for many years. And while the Tata-Mistry feud will most likely eventually get resolved, the real fallout will be on the shareholders and investors of public companies who are likely to lose confidence in the governance structures of large companies. If it can happen at the house of Tatas, it can potentially happen anywhere else!

By Satvik Varma

The author is a graduate of Harvard Law School, currently practising as a corporate commercial lawyer in New Delhi

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