Author: Devina Srivastava
The concept of social distancing, being widely practiced as a safety measure against Covid-19, is not all that new in the world of corporate governance. Independent directors have been ideated as directors who are distanced from the promoters / management and are free from any vested interest in the company. To strengthen their role, the Securities and Exchange Board of India (“SEBI”), in March 2021, released a consultation paper, identifying certain provisions of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR”) that required amendments. On August 3, 2021, SEBI amended the LODR to give effect to the recommendations contained in the consultation paper, subject to the comments received from the public. The amendments come into effect on January 1, 2022. This article compares the key recommendations contained in the consultation paper with the amendments effected to the LODR, and critically analyses the new framework.
Definition of Independent Director
As per the extant LODR provisions, one of the qualifying criteria to be appointed as an independent director is that neither the person himself / herself, nor any of his / her relatives, should have held the position of a key managerial personnel (“KMP”) or been an employee in the company or any of its holding, subsidiary or associate companies, in the three financial years preceding the appointment. The consultation paper recommended that this restriction be extended and KMPs or employees of any promoter group company as well as relatives of such KMPs, be restricted from acting as independent directors. Further, the consultation paper noted that while the cooling off period in case of a person being an employee / KMP is three years, the cooling off period where a person holds a material pecuniary relationship in the company or its holding, subsidiary or associate company, is two years. The consultation paper proposed harmonisation of this cooling off period to three years. Both these recommendations have been given effect to in the LODR amendments.
However, a possible shortcoming is that the harmonisation is limited in scope. While the cooling off period has been harmonised between (i) the restriction on KMPs / employees, and (ii) the restriction on persons having a material pecuniary relationship, acting as independent directors, the scope of the latter has not been expanded to cover all promoter group companies. SEBI could consider widening the scope of the material pecuniary relationship restriction to cover persons having a material pecuniary relationship with any of the promoter group companies (and not only the holding, subsidiary or associate companies).
Role of the NRC in Appointment
At present, the nomination and remuneration committee (“NRC”) recommends the name of a person for appointment as an independent director, who is then appointed by a decision of the board. The appointment is required to be approved by the shareholders of the company by way of passing an ordinary resolution (special resolution for re-appointment). Given that there is lack of transparency about the criteria followed by NRC in recommending candidates, it was recommended that the NRC (i) should prepare a description of the role and capabilities required for an appointment, (ii) may engage external agencies for identifying candidates, and (iii) disclose the description prepared and agencies engaged, together with how the proposed candidate meets the set out criteria, in the notice of appointment. In case the recommendation is coming from a person, the category of such person (e.g. promoter) should also be disclosed. This recommendation has also been fully adopted in the LODR amendments.
While the proposal concerning disclosing the source of the recommendation is praiseworthy for curbing promoter influence, the recommendation concerning the NRC setting out a criteria for assessing eligibility has been criticised for being excessively prescriptive. It may result in the company losing out on competent independent directors as senior candidates may not be willing to take a series of eligibility tests. In any case, the requirement is repetitive. Schedule II, Part D(A)(1) of the LODR already states that the NRC is required to formulate a criteria for determining the qualifications, positive attributes and independence of a director. The proposal contained in the consultation paper only appears to re-iterate and expand on this by prescribing the requirement to evaluate the balance of skills, knowledge and experience.
The consultation paper noted that the present system of appointment / removal of independent directors may be influenced by the promoters, by virtue of their shareholding in the company. Taking inspiration from countries such as Israel and the UK, the consultation paper proposed a dual approval system, as per which, the appointment / removal should be approved by (i) majority of all shareholders, and (ii) majority of the minority shareholders (other than the promoter and the promoter group). In the event that either of the resolutions does not come through, the company may propose the appointment / removal for a second vote of all shareholders, passed by a special resolution, after a cooling off period of 90 – 120 days. SEBI reported that this proposal was met with criticism on the ground that it would cause practical difficulties and delays. Accordingly, the LODR amendments did not adopt the dual approval system and instead provided that the appointment / removal of an independent director should be subject to the approval of shareholders by way of a special resolution.
The LODR amendment seems to be a step backwards from SEBI’s original intention of protecting minority shareholders. It has been criticised for failing to place India among the community of advanced jurisdictions having the dual approval system. At a time when most independent directors are said to be ‘friends’ of the promoters, giving minority shareholders a separate say in their appointment / removal process, may have encouraged them to be informed participants in corporate processes. Moreover, dual approval by the majority shareholders (who mostly comprise of promoters in Indian companies) as well as minority shareholders, would have ensured that independent directors remain unbiased watchdogs and are able to balance conflicting interests of stakeholders, a duty prescribed under Schedule IV to the Companies Act, 2013. Instead, SEBI appears to have side-tracked the push for shareholder activism and neutral directors, to prevent practical difficulties.
Furthermore, as per the prevailing practice, independent directors are mostly appointed as additional directors and shareholders’ approval is taken at the next shareholders meeting. To prevent a scenario where a person is appointed as an independent director immediately after the annual general meeting (“AGM”) and then continues on the board till the next AGM, the consultation paper proposed that independent directors should be appointed only with prior approval of the shareholders and in case of a casual vacancy, shareholders’ approval should be obtained within three months. The LODR amendment prescribes a uniform requirement for the appointment to be approved by the shareholders within three months, in case of both, a fresh appointment and casual vacancies. This remedies the shortcoming identified by the consultation paper, with an approach that is slightly more liberal than that proposed.
Resignation by Independent Directors
As per the extant LODR provisions, in the event of resignation, an independent director had to disclose detailed reasons for resignation, and confirm that there is no other material reason, to the stock exchanges. The consultation paper observed that independent directors often resign citing reasons such as personal reasons or pre-occupation and then join boards of other companies or become executive directors in the same company. To check any incentives due to which the directors may be transitioning to such roles, the consultation paper proposed that the entire resignation letter be disclosed to the stock exchanges. This was adopted by the LODR amendments. However, disclosure of the entire resignation letter does not ensure reporting of the actual grounds of resignation. A director may cite the same grounds as those that he would have previously reported to the stock exchanges.
Further, in case of reasons such as pre-occupation or other commitments, the consultation paper proposed a mandatory cooling off period of one year before the independent director can join another board or transition to the role of a whole-time director in the same company. Identifying the issue with limited applicability of this proposal (a director may resign by citing a non-specified ground and evade the requirement of the cooling off period), the LODR amendment provides a uniform cooling off period of one year, without any qualifier with respect to the reason of resignation.
SEBI has not only made commendable efforts by relaxing some of the stringent recommendations made in the consultation paper, but also taken this opportunity to introduce certain other changes, such as with respect to D&O insurance. Pursuant to Regulation 25(10) of the extant LODR, with effect from October 1, 2018, the top 500 listed entities by market capitalisation are required to obtain Director’s and Officer’s insurance for all their independent directors. The LODR amendment has expanded the scope of the obligation to the top 1000 listed entities and extended the deadline for compliance to January 1, 2022.
The LODR amendments also included some other changes such as those with respect to the audit committee: at least two-thirds of the audit committee members, as opposed to exactly two-thirds, should be independent directors and only those members of the audit committee who are independent directors should approve related party transactions.
SEBI has also stated that it is currently discussing the proposal concerning revising the remuneration structure of independent directors, as contained in the consultation paper, with the Ministry of Corporate Affairs. The recommendation concerned removal of profit-linked commission as a way of remunerating independent directors and the introduction of employee stock options (“ESOPs”) with a long vesting period, such as five years as an alternative. The rationale was that profit-linked commissions encourage short-termism while ESOPs would establish a long-term interest in the company, along with ensuring that the independent directors have skin in the game. However, this proposal is problematic in itself as providing ESOPs to independent directors will allow for creation of an interest in the company and thereby render independent directors, dependent on the company. It has also been opined that ESOPs are not widely common and a long vesting period of five years will not be beneficial for independent directors, who are mostly aged individuals.
Some additional work may still be required for addressing the shortcomings of the effected amendments, such as by way of adopting the dual approval system of appointment and restricting a person holding a material pecuniary relationship with any of the promoter group companies from acting as an independent director. A fresh visit and greater public consultation on the proposal concerning issuing ESOPs to independent directors may also be helpful.
Securities and Exchange Board of India, ‘Consultation Paper on Review of Regulatory Provisions related to Independent Directors’ (1 March 2021) <www.sebi.gov.in/reports-and-statistics/reports/mar-2021/consultation-paper-on-review-of-regulatory-provisions-related-to-independent-directors_49336.html> accessed 24 August 2021
Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) (Third Amendment) Regulations, 2021www.sebi.gov.in/reports-and-statistics/reports/mar-2021/consultation-paper-on-review-of-regulatory-provisions-related-to-independent-directors_49336.html
See Bombay Chambers, ‘Response of Legal & Governance Committee of Bombay Chambers on SEBI’s Consultation Paper on Independent Directors’ (2021) <http://bombaychamber.com/admin/uploaded/Reference%20Material/RESPONSE%20OF%20BOMBAY%20CHAMBERS%20ON%20SEBIS%20CONSULTATION%20PAPER%20ON%20INDEPENDENT%20DIRECTORS.pdf> accessed 24 August 2021
Securities and Exchange Board of India, ‘Review of Regulatory provisions related to Independent Directors’ (July 2021) <https://www.sebi.gov.in/sebi_data/meetingfiles/jul-2021/1626155485805_1.pdf> accessed 23 August 2021
See Umakanth Varottil, ‘SEBI’s backtrack on independent directors’ The Indian Express (14 July 2021) <https://indianexpress.com/article/opinion/columns/tata-mistry-corporate-dispute-nusli-wadia-sebi-appointment-removal-of-independent-directors-7403380/> accessed 23 August 2021
Securities and Exchange Board of India, ‘SEBI Board Meeting’ (29 June 2021) <https://www.sebi.gov.in/media/press-releases/jun-2021/sebi-board-meeting_50771.html> accessed 24 August 2021
See Jayant Thakur, ‘Will SEBI’s proposal on independent directors improve corporate governance?’ Money Control (4 March 2021) <https://www.moneycontrol.com/news/opinion/will-sebis-proposal-on-independent-directors-improve-corporate-governance-6601711.html> accessed 23 August 2021