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Independent directors – Appointment, roles, functions and liabilities
Independent Directors play a pivotal role in maintaining a transparent working environment in the corporate regime. They constitute such category of Directors who are expected to have impartial and objective judgment for the proper functioning of the company. The Companies Act, 1956 does not expressly provide for Independent Directors, except Clause 49 of the listing agreement that is applicable on all listed companies which mandates the appointment of Independent Directors on the Board. The Companies Act, 2013 aims to strengthen the position of independent directors by giving them greater powers and responsibilities in the governance of the company.

Impact of new Companies Act, 2013
The new Companies Act makes it obligatory for every listed public company to have at least one-third of the total number of directors as independent directors. This will include companies listed on the SME segment of the stock exchange.
Unlisted public companies must appoint at least two independent directors in the following circumstances:
i.If their paid up share capital exceeds Rs. 10 crores.
ii.If their turnover exceeds Rs. 100 crores.
iii.If the aggregate of all the outstanding loans, debentures and deposits exceeds Rs 50 crores.

However, if a company is required to have a higher number of independent directors due to its higher composition of its audit committee, or is required under any other law, the company must appoint such higher number of independent directors. Companies which fail to meet the above mentioned criteria for three consecutive years, will not be required to appoint independent directors till the time they meet the required conditions again.

Existing companies must comply with the requirements within a year. Earlier, in listed companies, the number of independent directors could vary from 1/3rd to 1/2nd of total directors (depending upon executive/non-executive nature of chairman) which was fixed under the listing agreement with the board.
The tenure term of the independent directors must not be more than 5 years and they can be re-elected for a second term. Companies are allowed to appoint an independent director for a period less than 5 years, however, a person cannot be appointed for more than two terms, even if he has been appointed for a period less than 10 years. A cooling period of three years is mandatory after expiry of the second term.

Confirmation procedure for independent directors appointed under earlier Companies Act
The independent directors appointed under the Companies Act, 1956 cannot automatically continue their post. Existing independent directors need to be expressly re-appointed in accordance with the rules under Companies Act, 2013 (including re-issuing appointment letter), within 1 year from 1 April 2014. However, such re-appointment is subject to compliance with the eligibility and other prescribed conditions under the Companies Act, 2013.

Role and functions of independent directors
  • It is mandatory for all independent directors of the company to meet at least once annually (without the presence of non-independent directors and members of the management) - they are required to evaluate the performance of the company’s chairperson, non-independent directors and the board as a whole at these special meetings. This provides the independent directors freedom to assess the company’s performance and take impartial decisions based on it.
  • Independent directors need to be appointed as a member in the CSR committee, Nomination and Remuneration Committee and the Audit Committee of the board. Use the table below to identify the composition of the board committees:
Name of committee Which companies are required to constitute these committees Size of committee and no. of independent directors required
Corporate Social Responsibility Committee
A company which meets the following conditions:
  • Net-worth of INR 500 crores or more
  • Turnover of INR 1000 crores or more
  • Net profit of INR 5 crores or more
3 or more directors - at least one should be an independent director. There is no restriction on the remaining directors being full-time directors.
Nomination and Remuneration Committee Listed companies + unlisted public companies which satisfy any of the following conditions:
○     paid up capital of INR 10 crores or more.
○     turnover of INR 100 crores or more
○     outstanding loans, borrowings, debentures or deposits of INR 50 crores or more
3 or more non-executive directors (with at least half, i.e. 2 or more independent directors)
Audit Committee Same as above. 3 directors - at least one should be an independent director. There is no prohibition on the remaining directors being full-time directors.

Click here to download the above table.

Note: Companies Act also mentions the Stakeholders Relationship Committee – this must be constituted by all companies which have more than 1000 holders of securities (shares, debentures or other securities). The size of the committee can be determined by the board – however, it is essential that the chairperson is a non-executive director (that is, someone who is not involved in day-to-day operations of the company and is not an employee of the company).
  • An independent director must comply with other functions and duties mentioned under Code of Conduct provided under Schedule IV of the Companies Act, 2013. click here to download the Code of Conduct.
Remuneration of independent directors
It is essential that an independent director continues to remain ‘independent’, and hence remuneration is inconsistent with independence, barring certain conditions. An independent director shall not receive any stock option or remuneration except for attending meetings, reimbursement of expenses for participation in the meeting and may receive profits subject to the approval of shareholders. The sitting fee for independent directors shall not be less than the sitting fee payable to other directors. This was to ensure that there is no financial nexus between independent directors and the company. Equating the fee of independent directors and other directors will ensure that they do not feel they are at a disadvantage.
(See Sections 12, 149 and 197 of the Companies Act, 2013)

What are the liabilities of an independent director?
Independent directors shall be held liable only for acts or omissions by a company which occurred with their knowledge, with their consent or connivance or where they did not act diligently. This will ensure that the independent directors can work honestly, and take decisions without the fear of being trapped in a false case.

Removal and resignation of independent director
An independent director shall be replaced within a period of 180 days from the date of resignation or removal. The procedure is identical to removal of other directors – refer to Sections 168 (Resignation of Directors) and 169 (Removal of Directors by the Board).
If an independent remains absent from any board meeting for 12 months period with or without the permission from the board or violates any of the provisions of Section 167, it will be deemed that the seat of director is vacant.

Steps to be followed for appointing an independent director

Step 1: Identification by based on independent criteria
An independent director may be selected from a databank containing names, addresses and qualifications of persons who are eligible for this purpose. This databank is to be maintained by any entity authorized by the Central Government and will be uploaded on the Ministry of Corporate Affairs website. This is only for a facilitative purpose - a company is allowed to select any other person as independent director well, provided the person meets all the eligibility criteria (download the checklist here to identify eligibility conditions for independent directors). The board must ensure that there is appropriate balance of skills, experience and knowledge in the Board for proper and effective discharge of its functions.

Step 2: Shareholder approval
The appointment of Independent Directors shall be approved at the meeting of the shareholders. The explanatory statement attached to the notice of the meeting shall include a statement that the Independent Director proposed to be appointed fulfills the conditions mentioned in the Act.

Step 3: Issue of appointment letter by board and obtaining declaration from director
The appointment of Independent Directors shall be formalized through a letter of appointment which states the term of appointment, expectation of the Board from the Director and fiduciary duties and liabilities accompanying it, code of business ethics that the company expects its Directors and employees to follow, list of actions that the directors should not do while functioning as such in the company remuneration, periodic fees, reimbursements of expenses for participating in the Board meetings etc.
Every independent director shall provide a declaration confirming that he/she has satisfied the entire criterion given that he meets the criteria of independence.

Step 4: Publication of terms of appointment of the independent director
The terms and conditions for appointment of independent director shall be posted in the company’s website.

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