New rules notified by the ministry of corporate affairs on 22 October 2019 require independent directors to pass test to demonstrate their knowledge and proficiency in certain areas for board level functioning in corporates. They need to score at least 60% marks in this test to qualify. They also need to enroll their name in a databank maintained for this purpose. The intention seems to be that companies should choose independent directors from this databank. These are the principal requirements notified by these new rules.
The new rules would come into force from 1 December 2019 and are spread over several notifications, one of which introduces a full set of rules, another modifies an existing one and yet another notifies the Institute that shall oversee all the teaching and test. A time of three months has been given to independent directors to enroll their name in the databank and a period of one year from date of such enrolment to pass the test. Companies are required to ensure compliance of this and an independent director is also required to confirm he is compliant in the filings he makes.
It may be recollected that the Companies Act, 2013 requires listed companies and certain large sized public companies (in terms of specified net worth) to have at least one-third of board to constitute of independent directors on their board. market regulator Securities and Exchange Board of India (SEBI) has made similar requirements though with some differences. Their requirements apply to listed companies and provide for a higher proportion of independent directors on the board.
The qualities that make a person an “independent” director have been laid down in great detail in the law. However, these focus largely on how they are independent from the company and its promoters. No minimum knowledge, or educational qualifications have been specifically prescribed for them, except when they are part of the audit committee.
They occupy a high position in a company and are expected to provide well-informed input on matters of governance, and strategy to the company and its management. They are also expected to keep a watchful eye on the finances, accounts and performance of the Company. They are expected to exercise skill and diligence. A failure on their part can be harmful to the company and to themselves since they may face liability and penal action in many forms.
Why New Rules?
The new rules may be an attempt to provide a rudimentary level of financial and regulatory literacy. An institute has been notified (Indian Institute of Corporate Affairs-IICA) for this purpose. Such institute has to carry out several purposes. It has to release education material for independent directors that they can use for preparing for the exams. It is required to conduct online test for independent directors. The scope of the test covers areas such as company law, securities law and basic accountancy. Apart from this minimum qualifying exams, it is required to conduct an optional advanced test for those who wish to take it.
Enrollment and Daily Reporting by IICA
The Institute is required to maintain a databank of independent directors that would contain detailed information of each such person. Companies seeking to appoint independent directors can access such information on payment of a fee to the Institute. Interestingly, the Institute is required to report daily to the government all additions, changes and removals in this databank. This makes one wonder why would the government want to monitor this databank so closely and so frequently.
Independent directors are required to enroll on such databank by providing required information and payment of a fee. Existing independent directors are required to do this within three months, or by 1 March 2020. A person seeking appointment as an independent director is required to enroll himself before being appointed. They are required to pass the prescribed test, with at least 60% marks, within one year of such enrolment. The enrolment can be for one year, five years or for lifetime. The test has to be passed only once in a lifetime. Directors, presumably, will update the knowledge of rapidly changing laws on their own.
A person, who has acted as independent director or key managerial personnel for at least 10 years in a listed company or a public company with at least Rs10 crore of paid up capital is exempted from the requirement of passing such test. However, he would still have to enroll in the databank.
Companies are required to ensure and report compliance with such requirements.
These new requirements will ensure that a person may be a top lawyer or chartered accountant (CA) with decades of experience, or a senior bureaucrat or a professor of a repute college and yet he will have to pass this test with at least 60% marks. Except for persons with 10-years’ experience as specified earlier, there is no exception provided.
What Happens to Existing Independent Directors?
The law has some gaps and is ambiguous at some places. It is not clear whether existing directors will vacate their office if they do not pass such test or if they do not enroll in such databank. Will the appointment of an independent director whose name does not appear in such register be invalid or will this be merely a violation of law?
Similar question can be raised for a person who has not passed the test with the minimum percentage of marks. The intention appears to be that such persons cannot be appointed and in respect of existing independent directors, they may vacate their office. However, this is not said in so many words expressly and clearly.
Similarly, the wording of the law is ambiguous on whether a company has to select an independent director from such databank only. The purpose of the database may get defeated if a company can appoint someone not enrolled in the databank, but yet, this is not specifically and clearly laid down.
Pros & Cons of the New Rules
The new requirements can be praised to some extent in the sense that independent directors will now be required to have such minimum relevant knowledge to do justice to their roles.
On other hand, it is also seen that, thanks to constant tweaking of requirements, the number of independent directors required are ever increasing. Their obligations and potential liabilities are also enormous and continue to increase.
Their remuneration, however, is not guaranteed and can be often very nominal with minimal sitting fees. The new requirements are not expected to be costly.
Even the fees payable to the Institute for the enrolment are required to be ‘reasonable’. It could be argued that the effort and costs would pay off in terms of knowledge.
Nevertheless, no attempt has been made to increase the powers of independent directors or ensure they have at least such minimum remuneration that makes doing their jobs worthwhile.
Independent Directors Have No Real Powers
An independent director today individually or even collectively has very poor powers. He is often provided with some minimal information as statutorily required for board meetings. Some directors can of course attempt to use his personal and moral force to get his queries answered during board meetings and sometimes in between but success is occasional. If he is not happy, the eventual recourse he has is to resign. He may go public but he risks legal action since usually he may not have adequate information and documentation to back his claims.
There is no institutional or legal process he can take advantage of to express his views (preferably anonymously) and see that wrongs are corrected. Independent directors may also be often treated with contempt by management and as an unavoidable nuisance.
I would not be surprised if the allegations (as yet unsubstantiated) in Infosys case where two independent directors are said to have been referred as ‘Madrasis’ and a woman director referred to as ‘diva’.
Thus, neither from remuneration point of view, nor from personal satisfaction point of view, is the office of being an independent director so very worthwhile.
Then there is the issue regarding the fast track implementation of these provisions. As of now, even the Institute and database or even the educational material or test system does not seem to be fully ready for the new requirements.
While some time has been given for the transition, this would still make it difficult for many to comply. If the rules are taken literally and narrowly, it is possible that many independent directors would become disqualified and some may vacate their office.
Clearly, some clarification and relaxation both in terms of time and requirements is needed. Generally, the office of independent directors also needs a holistic relook, lest most of the cream of the crop quietly leave the scene being underpaid, underpowered, under-respected and over-obligated.
(Jayant Thakur, a Chartered Accountant with an experience of over 25 years, is proprietor of Jayant M Thakur & Co. Mr Thakur also advises several listed and non-listed companies and intermediaries on SEBI laws.)
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