Independent Director under Companies Act 2013

[dropcap]An[/dropcap] independent director is a director who is not appointed as an executive director in a company. In general words, an independent director means a director other than a managing director or a whole-time director or a nominee director who does not have any material or pecuniary relationship with the company or members or other directors.

Legal Provisions

Section 2(47) of the Companies Act, 2013 provides that the “independent director” means an independent director referred to in sub-section (6) of section 149 of the Companies Act, 2013.

Who can be an Independent Director?

Section 149(6) of the Act prescribes the criteria for independent directors which are as follows:

(a) Who in the opinion of the Board (Ministry or Department of the Central Government which is administratively in charge of the company, in case of Government company), or as the case may be, the State Government, is a person of integrity and possesses relevant industrial expertise and experience;

(b) Such individual shall not be a promoter or related to the promoter of the company or its holding, subsidiary, or associate company;

(c) Such an individual who has or had no pecuniary relationship, other than remuneration as such director or having transaction not exceeding ten percent. of his total income or such amount as may be prescribed, 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—

(i) is holding any security of or interest in the company, its holding, subsidiary, or associate company during the two immediately preceding financial years or during the current financial year:

Provided that the relative may hold security or interest in the company of face value not exceeding

Rs. 50 Lakh (fifty lakh rupees) or 2% (two percent) of the paid-up capital of the company, its holding, subsidiary or associate company or such higher sum as may be prescribed;

(ii) is indebted to the company, its holding, subsidiary or associate company or their promoters, or directors, in excess of such amount as may be prescribed during the two immediately preceding financial years or during the current financial year;

(iii) has given a guarantee or provided any security in connection with the indebtedness of any third person to the company, its holding, subsidiary or associate company or their promoters, or directors of such holding company, for such amount as may be prescribed during the two immediately preceding financial years or during the current financial year; or

(iv) has any other pecuniary transaction or relationship with the company, or its subsidiary, or its holding or associate company amounting to two percent. or more of its gross turnover or total income singly or in combination with the transactions referred to in sub-clause (i), (ii) or (iii);

(e) He must not either directly or any of his relatives:

(i) hold or has held the position of key managerial personnel or is or has been an 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;

Provided that in the case of a relative who is an employee, the restriction under this clause shall not apply for his employment during the preceding three financial years.

(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) the 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 percent. or more of the gross turnover of such firm;

(iii) holds together with his relatives two percent or more of the total voting power of the company; or

(iv) is a Chief Executive or director, by whatever name called, of any non-profit organization that

receives 25% or more of its receipts from the company, any of its promoters, directors or its holding, subsidiary or associate company or that holds 2% or more of the total voting power of the company; or

(f) who possesses such other qualifications as prescribed in Rule 5 of Companies(Appointment and Qualification of Directors)Rules,2014 as an independent director shall possess appropriate skills, experience, and knowledge in one or more fields of finance, law, management, sales, marketing, administration, research, corporate governance, technical operations or other disciplines related to the company’s business.

None of the relatives of an independent director, for the purposes of sub-clauses (ii) and (iii) of clause

(d) of sub-section (6) of section 149:

(i) is indebted to the company, its holding, subsidiary or associate company or their promoters, or directors; or

(ii) has given a guarantee or provided any security in connection with the indebtedness of any third person to the company, its holding, subsidiary or associate company or their promoters, or directors of such holding company, for an amount of fifty lakhs rupees, at any time during the two immediately preceding financial years or during the current financial year.”

Clause (c) of Section 149(6) shall not apply in case of Government company i.e. no such restriction levied on Government Company related to Pecuniary relationship of Independent director – Notification dated 5th June 2015.

Which companies should appoint Independent Directors?

Section 149(4) read with Rule 4 of Companies (Appointment and Qualification of Directors) Rules, 2014 and SEBI(LODR) Regulations, 2015 provides the following companies to have a specified number of independent directors.

Which companies are not required to appoint Independent Directors?

The following classes of an unlisted public company shall not be required to appoint an independent director under sub-rule as above

•  a joint venture;
•  a wholly-owned subsidiary; and
•  a dormant company as defined under section 455 of the Act.

In case a company covered under this rule is required to appoint a higher number of independents directors due to the composition of its audit committee and then they shall appoint such a higher number of independent directors.

Further, if there is any intermittent vacancy of an independent director then it shall be filled up by the board of directors within 3 months from the date of such vacancy or not later than the immediate next board meeting, whichever is later.

Once the company covered under above sub-rule (i) to (iii) of Rule 4 of the Companies (Appointment and Qualification of Directors) Rules, 2014, ceases to fulfill any of three conditions for three consecutive years then it shall not be required to comply these provisions until such time as it meets any of such conditions.

Declaration by an Independent Director: For What & When?

Section 149 (7) of the Companies Act, 2013, prescribed that every independent director shall give a declaration that he meets the criteria of independence when:

• he attends the first meeting of the Board as a director;
• thereafter at the first meeting of the Board in every financial year and
• whenever there is any change in the circumstances which may affect his status as an independent director.

Additionally, for listed entities, SEBI vide notification dated 9th May 2018 (effective from April 1, 2019) provides that every independent director shall, at the first meeting of the board in which he participates as a director and thereafter at the first meeting of the board in every financial year or whenever there is any change in the circumstances which may affect his status as an independent director, submit a declaration that he meets the criteria of independence and that he is not aware of any circumstance or situation, which exist or may be reasonably anticipated, that could impair or impact his ability to discharge his duties with an objective independent judgment and without any external influence.

The board of directors of the listed entity shall take on record the declaration and confirmation submitted by the independent director after undertaking the due assessment of the veracity of the same.

With effect from October 1, 2018, the top 500 listed entities by market capitalization calculated as on March 31 of the preceding financial year, shall undertake Directors and Officers insurance (‘D and O insurance’) for all their independent directors of such quantum and for such risks as may be determined by its board of directors.”

What remuneration will be paid to an Independent Director?

According to Section 149(9), the independent director is entitled to receive:

• sitting fee for Board/Committee meetings as may be prescribed under the second proviso under Section 197(5);
• reimbursement of expenses for attending the board/committee meetings;
• commission related to profits of the company subject to the provisions of Section 197 and 198 (one percent of the net profits if there is a Managing Director or Whole-Time Director or Manager and three percent of the net profits in any other case). The net profits shall be computed in accordance with Section 198.

 The independent director, however, shall not be entitled to receive any “stock option”.

Is an Independent Director required to be appointed by Section 8 Companies and Specified IFSC Public Companies?

MCA has exempted section 8 companies vide notification dated June 05, 2015, and Specified IFSC public company vide notification dated 4th January 2017 from the provisions of section 149(4) to (11), Section 149 (12) (i) and Section 149(13).

Thus Section 8 companies and Specified IFSC public companies are exempted from the requirement of independent director and definition or other provisions relating to the independent director shall not apply to such companies.

What will be the tenure of an Independent Director?

As per Section 149(10) of the Act, subject to the provisions of Section 152, an independent director can be appointed for a term of up to five consecutive years on the Board.

However, in case of his reappointment for a further five years then a special resolution passed in the general meeting and disclosure of such appointment is made in the Board’s report shall be required.

Section 149(11) further provide independent director can be considered for re-appointment (after two consecutive terms) only after the expiration of three years of ceasing to become an independent director but he must not be appointed/associated with the company directly or indirectly in any other capacity during the said period of three years. Any tenure of an independent director on the date of commencement of this Act is not considered for the above term.

It has been clarified that as such while the appointment of an Independent Director for a term of fewer than 5 years would be permissible, an appointment for any term (whether for 5 years or less) is to be treated as one term.

Further, under section 149(11) of the Act, no person can hold the office of Independent Director for more than two consecutive terms such a person shall have to demit office after two consecutive terms, even if the total number of years of his appointment in such two consecutive terms is less than 10 years. In such a case the person completing ‘consecutive terms of less than 10 years’ shall be eligible for appointment only after the expiry of the requisite cooling-off period of 3 years.

What is the role of an Independent Director?

Independent directors are required because they perform the following important role:

• Balance the often conflicting interests of the stakeholders.
• Facilitate withstanding and countering pressures from owners.
• Fulfill a useful role in succession planning.
• Act as a coach, mentor, and sounding board for their full-time colleagues.
• Provide independent judgment and wider perspectives.

As per Schedule IV of the Companies Act, 2013, the Independent Director shall –

• uphold ethical standards of integrity and probity;
• act objectively and constructively while exercising his duties;
• exercise his responsibilities in a bonafide manner in the interest of the company;
• devote sufficient time and attention to his professional obligations for informed and balanced decision making;
• Not allow any extraneous considerations that will vitiate his exercise of objective independent judgment in the paramount interest of the company as a whole, while concurring in or dissenting from the collective judgment of the Board in its decision making;
• Avoid abusing his position to the detriment of the company or its shareholders or for the purpose of gaining a direct or indirect personal advantage or advantage for any associated person;
• Refrain from any action that would lead to the loss of his independence;
• Inform the Board immediately whose circumstances arise which makes an Independent Director lose his independence;
• Assist the company in ensuring the best corporate governance practices.