Newsletter Category: 2018

The universe of Independent Directors is grappling with the implication of the orders passed by the Hon’ble Supreme Court of India in the case of Jaiprakash Associates Limited (JAL).

On 11.09.2017, the Hon’ble Supreme Court of India, in a writ petition filed by Chitra Sharma and others against the Union of India and others, directed, inter alia, that “the Managing Director and the Directors of Jaypee Infratech Limited (JIL) and JAL shall not leave India without the prior permission of the Court. Any person who was a Director or Managing Director of JIL or JAL on the date of the institution of the insolvency proceedings against JIL, as well as the present Directors/ Managing Director shall also not leave the country without prior permission of the Court. The foregoing restraint shall not apply to Nominee Directors of lending institutions (IDBI/ICICI/ SBI)”.

On 22.11.2017, the Hon’ble Supreme Court of India further directed, inter alia that “neither the Independent Directors nor the Promoter Directors shall alienate their personal properties or assets in any manner, and if they do so, they will not only be liable for criminal prosecution but contempt of the Court.” The Court also directed that “the properties and assets of their immediate and dependent family members should also not be transferred in any manner, whatsoever.”

While listing the matter to be heard on 10.01.2018, the Hon’ble Court also directed that on that day, all the Independent Directors and Promoter Directors of JAL shall remain present.

The question uppermost in the minds of Independent Directors is whether their non-executive status should lead to their being visited with the same liabilities and consequences as Promoter Directors. Heightening their insecurity is the fact of their being clubbed with Promoter Directors, while Nominee Directors have not been subjected to similar restraints.

The Companies Act, 2013 (the Act) provides a differential treatment to Independent Directors and Non-Executive Directors who are not Promoters or Key Managerial Personnel. Section 149(12) of the Act states that such a Director 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. Simply stated, the statute would seem to hold Independent Directors liable only for what they get to know through Board processes or where they had not acted diligently.

It is beyond the province of this article to speculate on whether the Independent Directors of JAL , the holding company, had , through Board process, information regarding the alleged irregularities of the subsidiary company, JIL, in not providing houses to persons who had made payments therefor. Suffice it to say that if relevant information had travelled to the Board, or if there was lack of due diligence, the Independent Directors will find it hard to escape liability.

The orders passed by the Hon’ble Supreme Court of India afford an opportunity to revisit the responsibilities and liabilities of Independent Directors. The institution of Independent Directors was first recognized in India through Clause 49 of the Listing Agreement. With the coming into force of the Companies Act, 2013, the institution of Independent Directors now has a statutory basis. This institution is seen as the instrumentality which, among other things, seeks to protect the interest of minority shareholders and other stakeholders.

Schedule IV of the Act, which contains a long laundry list of dos and don’ts, is intended as a guide to professional conduct of Independent Directors to ensure that the confidence of the investment community, particularly minority shareholders, regulators and companies, in the institution of Independent Directors is promoted.

Even prior to the passing of the above cited orders by the Hon’ble Supreme Court, Independent Directors had started to exit Boards owing to what was perceived as the high risk associated with the position, with meagre compensation. Therefore, it is possible to conclude that subsequent to the instant directions, only the very brave or the foolhardy would accept the position of Independent Director on Boards. Should a significant exodus take place, the regulator or lawmaker will be left with one less effective instrument to bring a balance to boardroom discussions and decisions. It is therefore necessary to consider what Independent Directors should do to protect themselves, while adding value to the Boards on which they sit.

Committing quality time to Boards and Committees is a non- negotiable requirement. Constructive engagement with managements, within and outside of, boardrooms is a threshold condition for an effective Independent Director. Asking the right questions and getting the minutes to correctly reflect the discussions and decisions is an absolute must. Where an illegality or an irregularity is observed, or even suspected, the pushback must be strong and effective. Shying away from recording a dissent, when it is merited, can cause considerable damage.

The lawmakers on their part, should recognize that Independent Directors must be provided legitimate protection. One possible safeguard could be a screening mechanism on the lines of the Advisory Board for Bank Frauds, where eminent and experienced persons, carefully chosen, go into the acts or omissions of Independent Directors, before the latter are thrown to the wolves. Failing this, Independent Directors could, sooner rather than later, become an extinct species.

Remember the baby and the bathwater!

“I was invited to join the Board. I did not apply for this position. Why should I be evaluated?”

To any serious student of Corporate Governance, it must seem strange that the evaluation of Boards and their constituents would need justification. The Board of Directors is the instrumentality through which it is sought to ensured that the company is run in a manner consistent with the interests of all stakeholders. That being so, it stands to reason that the competence and commitment of the Board and its members must be periodically evaluated.

The overly prescriptive arrangement for evaluation, detailed in Schedule IV of the Companies Act, 2013 has raised the hackles of many corporate chieftains. The resultant empty exercises that masquerade as Board evaluation are not much different from giving a dog a bad name before hanging it.

In this background, a roundtable was organised by us for invited participants to deliberate on “Seeing value in evaluation”. The major takeaways from that candid conversation are captured in this newsletter.

The purpose, although obvious, of Board evaluation, is a good starting point. With the Board of Directors, as the ultimate arbiter of a company’s destiny, it is non-negotiable that its performance as an entity, tasked with superintendence, direction and control, should be dispassionately assessed. There is, presently, near unanimous acceptance of the need to move away from “evaluations” that use unimaginative questionnaires and lead to politically correct responses. An honest appraisal led by the Chairperson of the Board or of the NRC is clearly the course of action to embark on.

Not with standing the high maturity level of the average Board member, it is important to recognize and respect sensitivity while undertaking the exercise of evaluation. The inability or unwillingness of Board members to accept deficiencies, when pointed out, should not lead to a suboptimal exercise that shies away from working on areas for improvement.

On the question whether outside expertise is required for an honest objrctive assessment, there is presently no agreement. Concerns of confidentiality are often mentioned as reasons for not inducting external evaluators. This is obviously a matter that can be addressed by putting in place an appropriate non-disclosure agreement.

The related issue, and one that is most critical, is the expertise and experience that an external evaluator brings to the process. Mere theoretical knowledge or a text book approach will yield no worthwhile outcome. It is imperative that the external evaluator should have considerable boardroom experience as also the maturity to carry on a meaningful conversation with the members of the Board and other possible respondents.

Reengaging the same expert for many years on the trot, is an avoidable preposition. Familiarity, over time, and the pulling of punches, will translate to conclusions that the Board likes to hear and not what the Board needs to know. To obviate this shortcoming, it could be considered whether external experts should be rotated out after three or four years.

Yet another approach could be for evaluation to be done in-house every alternate year, and by an outside expert every alternate year. This could enable the benchmarking of the in-house exercise.

While companies have undertaken evaluation of Boards and, on occasion, of the Board Committees, some of them have avoided evaluation of individual directors and the Chairpersons, on the specious plea that it could lead to a collegial and cohesive Board being destabilized. In omitting this vital aspect of evaluation, such companies are clearly in default of legal and regulatory provisions.

Across the board, the question that remains unaddressed is “What happens after evaluation?” It is necessary to remember that evaluation is a means to an end, which can be achieved only when feedback is given to those who have been evaluated. This must be done, preferably in one-on-one conversations, by the Chairperson of the Board or of the NRC. Failing this, the entire process would be sterile. The day is not far off when the investors will factor in an evaluation premium. Equally, when things go wrong, and a Board is in the dock for sleeping on its job, two questions will necessarily arise -“Who did the evaluation?” and “How was it done?’ Are the answers, my friends, blowing in the wind?