The recent circular issued by the Ministry of Corporate Affairs with regard to prosecution of directors is expected to provide much needed respite to non-executive and independent directors. It should also bolster corporate governance because they would have some shield in case of wrong doings by the executive management without their knowledge/connivance. Interestingly, the amendment is being made effective with retrospective effect and could benefit even past instances
CRUCIAL ROLE
The non-executive Directors play a crucial role in implementing the principles of effective corporate governance. The presence of independent representatives on the board, capable of challenging the decisions of the management, is perceived as an effective instrument to protect the interests of stakeholders. They are obliged to be active contributors and not passive recipients in the governing process. Indian Inc has gone global and has stakeholders from around the world. The aftermath of some global corporate disasters and evolving mindset of investors, regulators and other stakeholders have contributed in equal measure to the growing realisation of the need to have independent directors.
The Securities & Exchange Board of India (SEBI), the capital market regulator, introduced certain amendments to the Listing Agreement. Clause 49 of the Agreement requires listed companies to have a blend of executive and non-executive Directors. The office of the Chairman of Audit Committee has to be manned by an independent director. Certain board committees are mandated to include independent directors. SEBI's domain, however, is restricted to listed companies. In the Companies Act, 1956, there is one single and isolated reference to Independent Directors with regard to Remuneration Committee applicable in case of certain public companies.
The new provisions under the Companies Bill, 2009 (the Bill)provides recognition to the institution of Independent Directors and tries to bring consistency between the Listing Agreement and Companies Act. Further, the Central Government is empowered to prescribe minimum number of directors in case of other public companies also. The Bill proposes to make the presence of independent director mandatory in board meetings held at a shorter notice to transact urgent business.
Liability Regime
The Indian law does not explicitly distinguish between executive and non-executive directors when it comes to determining penal consequences. There are severe penalties prescribed under Securities Contract Regulation Act for contravention of Listing Agreement. However, Section 5 of the Companies Act 1956 (the “Act”) limits the liability for contravention of the Act only to those directors and other officers who are in charge of, or concerned with the management, or are directly responsible for compliance with that particular provision of the Act that has been contravened. Courts have the authority under Section 633 of the Act to provide relief for “honest and reasonable” conduct in case of negligence, default, misfeasance or breach of trust.
However, the above cited defences can be resorted only during the course of legal proceedings. Going through the entire process of prosecution is in itself a turbulent experience and could act as a serious disincentive to join the board. In cases of prosecution under Negotiable Instruments Act for dishonour of cheques, violations under Standards of Weights & Measures Act, a non-executive director may have precious little to do. However, he would still have to undergo the process of summoning and filing response.
Non-executive Directors have reason to be apprehensive about their potential liability. They are not involved in the day-to-day operations of the company which gives rise to the fear of unknown. The current legal ecosystem comprising plethora of legislations and multiple regulators poses its own challenge. There is an increasing propensity today for meting out punishment to directors, including non-executive and independent ones. Punishing those who are not in direct line of responsibility would be unfair and self-defeating. This approach is fraught with undesirable ramifications and could potentially hamper induction of talent on the board.
MCA Directive
It is in this background that the recent directive issued by the government seems to be laudable. It may not and cannot be a panacea for all the ailments but is definitely a step in the right direction. The authorities have been advised to initiate proceedings against non-executive members of the board only after proper consideration and prima facie belief in their culpability. The government thus, has done a fine balancing act. There is no blanket immunity; yet there is shield available to the non-executive directors in case of honest discharge of responsibility with due diligence and in good faith. One hopes that the good intent in the legislation is not lost in its implementation.
A lot needs to be done to strengthen the institution of independent directors and make them truly independent. Selection and on-boarding process, ceiling on number of directorships, remuneration and compensation are some of the areas that need immediate ironing out, in order to help achieve corporate democracy in the right spirit. With second generation of economic reforms strengthening India's position as a preferred destination for foreign investment, this is an opportune time to do so.
(S. Berera is Executive Director and P. Tewari, Senior Manager – Internal Audit, PwC India.)