This article has been written by Devina Srivastava, an Associate Editor at TBL. Devina is a final year student of the BBA LLB (Hons.) programme at Symbiosis Law School, Pune. She has an active interest in corporate law, with a special focus on corporate restructuring and governance standards.
An independent director is viewed as an unbiased representative of all stakeholders of a company. He/she is independent of the management, and therefore an objective third-person capable of steering the company in the direction of stakeholder-welfare. In the difficult times of COVID-19, this role of independent directors has assumed even greater significance, conferring on an independent director the onus of providing the company’s management with a fitting vision and strategy. This duty, however, is fraught with a number of challenges that are inherent to the office of an independent director. These include managerial distrust, lack of availability of information and data, deficient involvement in decision-making, among others. The question then is – how can an independent director contribute most effectively to the company and fulfil his/her responsibilities, especially during the trying times of COVID-19? And an incidental question would be – what are the liabilities that may accrue to an independent director for any acts or omissions of the company in dealing with the pandemic, and how can such liabilities be avoided? In this post, I attempt to answer both of these questions.
Role, Responsibility and Functions of Independent Directors
Only a few months back, the government had amended several rules under the Companies Act, 2013 (“the Act”) to prescribe a proficiency test for independent directors as a mandatory requirement (this development was analysed in one of our previous posts). It will not be incorrect to say that with the corporate governance reforms being introduced, the government is expecting high-standards of performance from independent directors in acting as watchdogs of stakeholders’ interests. The Code of Conduct of Independent Directors, which can be found in Schedule IV to the Act, captures their role of monitoring the management, inspecting its decisions, and providing the necessary guidance and vision.
This is specifically crucial in times of the pandemic, when businesses are being forced to take a number of difficult decisions and adopt coping measures such as those concerning laying off work-force, keeping the company solvent, going digital, obtaining approvals to conduct business, among others. The strategic role of directors in such cases, as per Mr. G.N. Bajpai, the former chairman of SEBI and LIC, should be to: 1) collect data and information from the management of the company and be informed of the minutest of steps being taken, 2) inspect the data/information received and critically assess the decisions taken/planned, 3) seek expert advice when required, and 4) provide honest views and feedback to ensure smooth functioning of the company and bolster corporate credibility.
However, these tasks may not be as simplistic as they sound. For instance, many of the decisions may not reach the board of directors, and may be taken solely by the management. Therefore, the board is required to be proactive in convening meetings, and asking the management to lay out before it the plans and strategies formulated to cope with the pandemic. It may analyse the ‘standard operating procedure’ adopted, and provide critical views and feedback, based on each director’s individual competency. In case any director is unable to understand the technicalities of any strategy proposed, or is unsure of its legality, he/she should encourage the engagement of an expert to deal with such an issue. Even after exercising all necessary prudence it may not be possible to ascertain the legal soundness of all decisions taken by the management, especially so when a number of directions and orders are being released by governmental authorities each day under various legislations such as the Disaster Management Act, 2005 and the Epidemic Diseases Act, 1897.
For instance, as per the Ministry of Home Affairs notification dated 29 March 2020, all employers are directed to make payment of wages, on time and without any deduction, even during closure of the shop/establishment during lockdown. To deal with such a situation, independent directors may find it prudent to obtain a formal confirmation of compliance with all laws in force from the management itself.
There also exist other inherent issues, as briefly touched upon earlier, which may hinder the fulfilment of an independent director’s role. The management often views independent directors as outsiders and is distrustful of them. It may be unwilling to seek the board’s approval or keep it informed of all steps. It may also be reluctant in sharing information or data with independent directors, hampering their decision-making. The only way to address these complications, innate to the role of an independent director, in my opinion is to establish and nourish a long-lasting relationship of trust between the management and the directors. This may be done by way of informal gatherings or other means designed to establish compatibility between the two groups.
Under the Act, the roles and responsibilities of directors, more generally, are spelled out in Section 166. Clause (2) of the Section provides that the directors of a company must promote the objects of the company in the best interests of “its employees, the shareholders, the community, and for the protection of the environment.” This is problematic, and especially so for an independent director, who is required to be the custodian of all stakeholders’ interests. Without any clear hierarchy of whose interests command precedence over the other, the directors are left to grapple in protecting multiple and potentially conflicting interests. For example, at a time such as today when companies have limited financial resources, it may be difficult to choose between allocating funds for digitalisation of the business (which is in the interest of the company and may keep it solvent), or choosing to retain all employees and paying them full salaries (which is in the interest of the employees), or cutting down on dividends and making larger contributions to CSR funds (which is in the interest of the community in general).
The problem arises due to the insufficiency of resources and the resulting (and highly realistic) possibility of conflicting interests of various stakeholders. Interestingly, as per Schedule IV of the Act, it is the function of independent directors to “balance” such conflicting interests. However, at a time when this may not be possible, there is a greater possibility of creation of liability for independent directors. A potential solution could be a legislative reform providing guidance on the precedence of the various stakeholder’s interests.
Liabilities of an Independent Director
As per Section 149(12) of the Act, an independent director can be held liable only for such acts or omission of the company: (1) of which he/she had knowledge (attributable through board processes); and (2) which had been conducted with his/her consent or connivance or where he/she had not acted diligently. The Ministry of Corporate Affairs (“MCA”), has in its circular dated 2nd March 2020, stressed on this provision being invoked only when the given criteria is strictly met, and not in cases such as those involving failure of filing information with MCA, maintaining registers or minutes of meetings etc., which are not strictly a part of the job description of independent directors but that of executive members of the company. MCA has insisted on the availability of sufficient evidence, such as documents available with the company, records filed with the Registrar etc., to establish the involvement of a director in the commission of an offence, before initiating action against him/her.
In case of any doubts regarding the liability of any person against whom proceedings may be initiated by the Registrar, guidance may be sought from MCA, and only upon due receipt of authorisation from the ministry, can such action be commenced. Though the notification has been severely criticised for shielding independent directors from liability and undermining the vision of the Act, it does provide a relief to independent directors who may already be facing a harsh time managing corporate affairs.
The emphasis of the circular lies on ‘documentary evidence’ to support the involvement of a person in the illegal act / omission of the company. This provides independent directors the opportunity to shield themselves from unwarranted liabilities by recording their views, observations, comments and more importantly, dissents with managerial decisions, in the minutes of the meetings of the board. Due to the COVID-19 outbreak, the MCA has provided relaxations with respect to conducting of board meetings virtually through video conferencing or other audio visual means. Thus, most board meetings are being conducted online and their video recordings being preserved. An independent director should be cautious in conducting himself/herself and not hesitate to voice and record any concerns that he/she may have with the company’s decisions. If he/she is not well-versed with the matters at hand, the director should abstain from deliberating on the issue and insist on the appointment of an expert.
Despite all precautionary measures, it is entirely possible for independent directors to come under the scanner, or even incur liabilities. This is especially the case when the law itself contains loopholes, such as the non-viable responsibility of independent directors to balance conflicting interests, and also when the highest standards of integrity and credibility are expected of them. To minimise the resulting risks, it is best to obtain a comprehensive D&O insurance policy, and be vigilant about the risks covered by it and the total insured amount under it. Since such policies sometimes expire, or automatically terminate upon retirement, it may be useful to review the policy and have it run through a reliable expert. Such a policy would enable independent directors to work efficiently without the fear of facing the repercussions of any unintended actions.
The responsibilities and functions of independent directors have increased manifold in wake of the pandemic. Independent directors must act with the highest standards of vigilance and prudence, and be attentive and tactical in avoiding unnecessary liabilities. The trying times should be used to build the highest standards of professionalism and accountability, and improve governance standards.