Board independence is seen as a corner stone of accountability and the presence of independent directors in the board room has been hailed as an effective deterrent to fraud, mismanagement, inefficient use of resources, inequality and unaccountability of decisions.
(Independent Directors – a Hand Book – The Companies Act 2013 series – The Institute of Company Secretaries of India)
With corporate governance becoming the new watchword for business management, and the evident emphasis placed on it by the law makers, regulators and judiciary; risk exposures and resultant concerns of the independent directors are undoubtedly on the rise. In the Indian context, genesis of the institution of independent director can be traced to DESIRABLE CORPORATE GOVERNANCE- A CODE which was released by CII in April 1998.
This has evolved with the passage of time and the Companies Act 2013 has touched upon various aspects of this institution. Let us look at the definition and liability of independent director under Companies Act.
SEC 149(6): INDEPENDENT DIRECTOR DEFINED
An independent director in relation to a company, means a director other than a managing director or a whole-time director or a nominee director,—
(a) who, in the opinion of the Board, is a person of integrity and possesses relevant expertise and experience;
(b) (i) who is or was not a promoter of the company or its holding, subsidiary or associate company; (ii) who is not related to promoters or directors in the company, its holding, subsidiary or associate company;
(c) who has or had no pecuniary relationship with the company, its holding, subsidiary or associate company, or their promoters, or directors, during the two immediately preceding financial years or during the current financial year;
(d) none of whose relatives has or had pecuniary relationship or transaction with the company, its holding, subsidiary or associate company, or their promoters, or directors, amounting to two per cent. or more of its gross turnover or total income or fifty lakh rupees or such higher amount as may be prescribed, whichever is lower, during the two immediately preceding financial years or during the current financial year;
(e) who, neither himself nor any of his relatives—
(i) holds or has held the position of a key managerial personnel or is or has been employee of the company or its holding, subsidiary or associate company in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed;
(ii) is or has been an employee or proprietor or a partner, in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed, of— (A) a firm of auditors or company secretaries in practice or cost auditors of the company or its holding, subsidiary or associate company; or (B) any legal or a consulting firm that has or had any transaction with the company, its holding, subsidiary or associate company amounting to ten per cent. or more of the gross turnover of such firm;
(iii) holds together with his relatives two per cent. or more of the total voting power of the company; or
(iv) is a Chief Executive or director, by whatever name called, of any nonprofit organisation that receives twenty-five per cent. or more of its receipts from the company, any of its promoters, directors or its holding, subsidiary or associate company or that holds two per cent. or more of the total voting power of the company; or
(f) who possesses such other qualifications as may be prescribed.
The word independent director is differently defined in different jurisdictions while the intention is to ensure that the relationships with the corporates are such that they are not pulled down by any other influences and can offer free, unbiased and professionally sound advice.
Let us now look at the liability of an independent director under Companies Act.
Sec 149(12) : LIABILITY OF AN INDEPENDENT DIRECTOR:
Notwithstanding anything contained in this Act,—
(i) an independent director;
(ii) a non-executive director not being promoter or key managerial personnel,
shall be held liable, only in respect of such acts of omission or commission by a company which had occurred with his knowledge, attributable through Board processes, and with his consent or connivance or where he had not acted diligently.
These provisions no doubt safeguard independent directors from the harmful ramifications arising out of the non-independent directors’ activities, as they can be implicated only for offences committed with their knowledge, involvement or negligence. But, this cannot be taken as a Carte blanche protection, as independent directors can be questioned not only for errors of commission and omission but also for passive negligence. If any independent director has attended or participated in board meetings or has merely received minutes of such meetings and has failed to record his or her concerns or objections, then such an independent director cannot escape prosecution claiming that decision was not taken with his concurrence and knowledge. Further, this immunity is specific to proceedings under Companies Act. It is not that all the statutes in the country necessarily distinguish between independent director and non –independent director.
There is not much case law on the personal liabilities faced by the independent directors in the Indian context. However, it is axiomatic that independent directors have serious personal exposures, which only become more worrying when the operations of the company, they work for, are subject to multiple jurisdictions in terms of their investment, footprint, revenue/ contracts and if they are “asleep at the wheel”. Let us look at some cases where there were proceedings against independent directors. Satyam case is too well known for any further mentioning. While in the final adjudication, the independent directors may come unscathed- yet, they need to live through the trials and tribulations bearing a lot of mental anguish and legal bills.
- The roles played by independent directors and the audit committee of United Spirits (USL) are being examined by the market regulator following parent Diageo agreeing to pay Vijay Mallya $75 million for exiting the company and protecting him from any liabilities stemming from inquiries into its books.(The Economic Times -22ND March 2016).
- SEBI bans 3 independent directors of Pyramid Saimira for 2 yrs(PTI Mar 11, 2011).
- Nimesh Kampani faces arrest: Nagarjuna Scam( rediff.com – 13/04/2009)
Independent directors are necessary, as they are both conscience keepers and whistle blowers on the board. They bring transparency and objectivity to the board process. The need for independent director arises from the necessity to have a robust ecosystem of corporate governance in the functioning of the company. They are expected to bring about improvement in corporate credibility, governance standards, and the risk management of the company.
While the role and contribution of the independent directors is well appreciated, if adequate safe guards and protection shields are not made available to them, they may become risk averse and may not be able to contribute their best for the development of the organizations they work for. If they do not get the required protection, most of they may press the exit button which is what has happened some time back. In order to avoid and face potential litigation, should it becomes necessary, independent directors may consider the following
- Indemnity provisions in the letter of appointment: While negotiating the terms of appointment, they may seek appropriate and adequate indemnity provisions – indemnity against all losses and expenses incurred by them in relation to the discharge of their duties unless such loss/ expense is caused by their own dliberate and malicious actions. It pays to be explicit.
- Opportunity to seek professional advice: It is also prudent to insist on a provision for seeking independent professional advice. There may be complex situations when independent directors need professional advice in furtherance of their duties at the Company’s expense. The Company needs to reimburse the cost of expenditure incurred in accordance with the Company’s policy.
- Since the primary responsibility stems from the board process, it is absolutely necessary to review the minutes for the factual and unambiguous incorporation of the decisions taken. The importance of minutes in corporate governance is neatly explained by Justice Heydon:
.“ It is fundamental to the running of (a) large and important … organization … that the records of its central decision making organ be correct, lest the foundation on which its future affairs rested be left to the vagaries of corporate memory and changing personnel”
(James Hardie High Court Appeal Decision – Australia)
- If there is any pecuniary interest involved and conflict of interest foreseen, it is better to excuse oneself from participation in the proceedings.
- Review litigation and non-compliance alerts and notices. Apart from catching the early signals which helps in nipping them in the budding stage, concern and attention on compliance issues and their monitoring of the actions taken will make the management more careful and reduce the possibility of violations. It is also necessary to pay adequate attention to the risk management process. Independent directors need to insist on obtaining details of notices received by the company for non-compliances and demand course correction.
- Unusual items on the agenda need to be thoroughly analysed and understood. These can be potentially troubling items. Hence, they call for complete analysis and comprehensive understanding.
- Insist on a good D&O liability insurance policy with adequate limit and comprehensive coverage. It is interesting to note that a reference is made to D&O insurance under the code for independent directors in the Companies Act. The appointment of independent directors shall be formalised through a letter of appointment, which shall set out, besides other things, provision for D&O insurance, if any.
D&O liability insurance plays an important role for protection of directors. A good Directors and Officers liability insurance cover aims to provide relief to directors and officers, who may, notwithstanding all their best intentions and sound business practices, end up in some negligent acts – actual or alleged.
D&O liability insurance affords protection to directors and officers from liability arising from actions connected to their corporate responsibilities. The policy provides indemnity to the directors and officers in respect of:
- Legal costs in defending proceedings brought against them alleging wrongful acts.
- Any damages awarded to the claimants against the Directors and Officers, including out of court settlements.
Whilst on the D&O liability insurance, it is necessary to understand the coverage, exclusions and conditions so as to avoid unpleasant surprises and contract unpredictability when the policy gets tested in the event of a claim. At the time of buying the policy, it should not be seen as a form filling exercise, as it concerns the personal liabilities of the directors and officers. While the coverage including the exclusions needs to be understood fully, with reference to the independent directors, the following merit attention:
- If the D&O policy has an entity extension (protection to the company as against the directors and officers), it needs to be seen whether adequate limits are available for directors and officers, as the entity protection has the potential to dilute the limit available to the D&Os.
- Special excess protection for independent directors. This limit is offered over and above the limit of the policy. This is useful when the limit of indemnity gets exhausted because of the claims already lodged.
- Life time cover in the event of non-renewal and cancellation of cover: This is useful when the current D&O policy is not renewed or cancelled. By virtue of this provision, Policy will provide an unlimited extended reporting period to cover for a retired director or officer for any claim that arises from wrongful acts that were committed before the effective date of the non-renewal/ cancellation of this policy. It needs to be understood clearly that the coverage is only for the acts committed during their tenure/ policy period and not later.
- Non cancellation: The policy should be made non-cancellable by insurance company. This is not a major issue currently, as most of the D&O policies are written on non-cancellable (by Insurer) basis.
- Order of payments should be incorporated under the policy which will prioritize the payment of claim in situation where separate insuring clauses are applicable.
- M&A: In the event of a merger or acquisition taking place, run off cover for the entity merged or acquired needs to be considered.
Independence is a state of mind and not presence and absence of a specified relationship. Independent directors need to think genuinely independently and act diligently taking into account the benefits of all stake holders while of course ensuring conformance, both in letter and spirit, to the prevalent rules and regulations. That clearly is the first line of defence.
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P.Umesh
Currently an independent consultant pursuing interest in liability insurance.
Disclaimer: The information contained and ideas expressed in this article represent only a general overview of subjects covered. It is not intended to be taken as advice regarding any individual situation and should not be relied upon as such. Insurance buyers should consult their insurance and legal advisors regarding specific coverage and/or legal issues
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