The recent times have witnessed a large number of promoter-centric companies failing drastically, from Kingfisher, Gitanjali, Cafe Coffee Day to Yes Bank. On a close introspection, the Companies Act has attempted to address these issues through several mechanisms, one of the most sought is 'Independent Director', yet its effectiveness is questionable. The present research will primarily focus on the role of independent directors, had they been truly 'Independent' and exposed the scams. The recent crisis surrounding Yes Bank stands as an illustration to understand the present research question. The provisions of the Companies Act, 2013 applicable to banks will be looked into, to check if they have been complied with or otherwise to figure out whether there is a lacuna in the text of the law or effectiveness or not. The researchers would also explore the provisions available in other countries' company laws that might be addressing the problem in hand. If such provisions are found, they will analyse whether it can solve the issue concerned or if there is a need for framing new provisions to govern banks and prevent such a problem from arising again to protect the interest of the stakeholders.
Corporate governance is the one which strikes a balance between the company and its shareholders. Corporate governance aims to ensure shareholders’ welfare in the race of profit maximisation of the company. Any company cannot be side-lined as a mere business entity, labourers, environment and money involved makes it more than a business entity. The need for corporate governance is not to breach into the freedom or the commercial judgement of businesswomen but as an extension of that freedom. Freedom here comes with a responsibility towards the society, towards the environment or internally, the minority shareholders’.
Amongst various other mechanisms, the introduction of an Independent Director was a remarkable move towards ensuring that the Board of directors does not lose business values and ethics in the lust for money.
In this endeavour, the Naresh Chandra Committee and Narayana Murthy committee recommended clause 49 of the listing agreement that there should be mandatory procedures followed by the companies concerning the appointment of independent directors. J.J Irani committee recommended the appointment of independent directors to ensure safety to investors, the committee recommended an amendment to 1956 Act and to ensure more measures are taken to ensure corporate governance through provisions of the Act.
The provisions of the 1956 act do not ensure safety to the investors. The JJ committee recommended that the board of a listed company should comprise at least 1/3rd of Independent Directors for the first time in 2004. In line with these, the Companies Act, 2013 through Section 149 has mandated the requirement of one-third directors to be independent directors, for all public listed companies and for public non-listed companies the number to be prescribed by the Central Government.
Rule 4 of the Companies (Appointment and Qualification of Directors) Rules, 2014 has prescribed a minimum number of two independent directors in case of public companies with specified limits of turnover, paid-up capital and liabilities. The provision relating to independent directors, however, does not apply to IFSC public companies and companies incorporated for charitable objects.
The Companies (Appointment and Qualification of Directors) Rules, 2014 also supplements the mandate in Section 149. Schedule IV appended to the Act has provided a separate Code for Independent Directors. The Code is a guide to professional conduct for independent directors. Adherence to these standards by independent directors and fulfilment of their responsibilities professionally and faithfully will promote confidence of the investment community, particularly minority shareholders, regulators and companies in the institution of independent directors.
The Code consists of guidelines of professional conduct, role and functions, duties, manner of appointment, reappointment, resignation or removal, separate meetings and evaluation mechanism. The Delhi High Court in Energy Watchdog v. Union of India & Ors., 2017, has observed that “Schedule 4 to the Companies Act, 2013 titled “Code for Independent Directors” is a comprehensive guide to professional conduct for Independent Directors“.
As firms moved from a general conception of “stakeholders” to shareholder wealth maximization, there was an increasing focus on share prices as an indication of how well the firm was doing. As these Independent Directors are not furthered towards profit, they facilitate the Company in safeguarding the interests of the stakeholders and stand in opposition to any illegal or felonious decision of the Board. Despite this towering structure of corporate governance, this decade has seen the worst corporate failures, frauds and scams, and more so in promoter-driven entities, Kingfisher, Gitanjali, Cafe Coffee Day, and Yes Bank; DHFL, PMC IL&FS form a different cluster.
The idea of this article comes from a single question: what if there had been ‘independent’ independent directors? Could this turmoil be averted? This article deals with the role of independent directors in general and illustratively with Yes Bank Scam.
An Overview Of The Failure Of Yes Bank
The phrase “failure of Yes Bank” has now become a misnomer because it is one among the many promoter-driven entities failing, despite the might of Corporate Governance through the Companies Act, 2013. On March 5, 2020, the Central Bank placed Yes Bank’s management under Mr Prashant Kumar from State Bank of India, as an administrator removing Co-founder/CEO Mr Rana Kapoor. RBI placed it under a moratorium, capping the daily withdrawals to Rs. 50, 000. The private bank went on a loaning spree with advances rising by 33.4% between F.Y.201 and 2019, many started defaulting.
The gross NPA% zoomed to 7.93% till 2019, highest among any comparable bank. Also, the bank failed to make necessary provision for bad debts and doubtful debts too. There was a gradual run on the bank, resulting in Credit-deposit ratio crossing 100%, i.e., it lent more than it received. The Loan spree and NPA gauged by Yes Bank’s sinking returns on assets led to a free fall in the stock prices of the bank.There is a combination of challenges faced by the Bank, such as the excessive NPAs (though compared to Public Banks it was less in nominal terms) for the strength of a private commercial bank, and the sudden and incessant falls of shadow banks like IL&FS and DHFL.
But this has to be understood from the prism of the larger issue in the Indian Banking Sector, the public sector banks have a deep customer base in the country, the new private banks coming to the sector to increase their presence have lured the customers with high-interest rates on depositors and undertake high-risk loans. Contrary to the fundamental principles of Banking, the Indian private banks have adopted an aggressive business model. Even the failure of Punjab & Maharashtra Co-operative Bank Limited is a follow-up of this larger issue. But this may not be the end of the tunnel, there may be another entity or bank or shadow bank fail because of a slow-gradual felony of a promoter/director.
The intent of the legislation in introducing independent directors was exactly to internally counter these felonies but, unfortunately, there is still a flaw in the system as the commonality in all these failures and scams is the fact that there has been some form suppression of truth, non-compliance, colourable actions leading to a dent in the ideal state of business affairs.
Role Of Independent Directors Vis-A-Vis Yes Bank Crisis
Corporate governance is primarily to have transparency of operation, accountability towards shareholders and fairness in dealings. It is a system of rule, practices and process by which a firm is directed and controlled, corporate governance essentially entails balancing the interest of the company, the stakeholders, such as shareholders, management, customers, suppliers, financiers, government and the community. Since corporate governance also provides the framework for attaining the company’s objectives, it encompasses practically every sphere of management from action plans and internal controls to performance management and corporate disclosure.
This has initially been invoked in the UK but it has come into focus in India after the failure of much high profile corporate more especially M/s. Satyam Computer Services episode involving fraud and financial irregularities. The Independent Directorship is at the centre of corporate governance, playing their designated role to nurture the financial health of the company and to protect the interest of various stakeholders, particularly the minority shareholders. Kumar Mangalam Birla Committee, Naresh Chandra Committee and Narayana Murthy Committee have emphasised the innovation of Independent Directors in the Board of Indian companies.
This was seconded by J.J. Irani Committee, which conclusively sealed the need for The IDs do not keep pecuniary interest in the company and thereby he is independent regarding representing the interest of the shareholders. The Companies Act, 2013 has by way of Section 149(6) incorporated the Independent Directors, and The Companies (Appointment of Directors) Rules, 2014 under rule 5 provides that an independent director shall possess appropriate skills, knowledge and experience, in at least in his core area including law, management, marketing, sales etc. or other disciplines related to the company.
They do not keep pecuniary interest in the company and thereby he is independent regarding representing the interest of the shareholders. The role that independent directors may play in the context of controlled companies: (1) serving monitoring, or “watchdog” function on behalf of public shareholders and (2) serving as a strategic advisor to the controlling shareholder. But both of these functions are inherently contradictory.
The “watchdog” function is carried out even though they do not have any voting function but is through the power to make public any wrongdoing, and while the controlling shareholder could remove the director or take other retributive measures, such actions likely cause unwanted public scrutiny. In another word, by way of whistle-blowing measures. Unfortunately, most independent directors do not perceive their roles to be that of a “watchdog”.
In the present case, Yes Bank being a Bank is governed also by the provisions of Banking Regulation Act, 1949 and is under the direct supervision of the Reserve Bank of India. Section 10A, of the Act of 1949, reiterates the provision of independent directors in the board of banks. But in essence, the sphere of corporate governance in both the Acts are intact and mutatis mutandis(Latin phrase meaning:- ‘with things changed that should be changed’). In January 2020, Mr Uttam Prakash Agarwal, an independent director of Yes Bank Ltd, resigned from the board of directors of Yes Bank and stepped down as head of its audit committee citing major corporate governance concerns.
This raised the eyebrows of the Reserve Bank of India, it immediately appointed Shri. R Gandhi, one of its former deputy governors, to the board of the bank.
The Working Of Independent Directors In Comparative Jurisdictions
The Banking Regulation Act, 1949 stipulates that people with special knowledge or practical experience in fields such as accountancy, agriculture, banking, rural economy, economics, finance, law, co-operation, small-scale industry, should constitute not less than fifty-one per cent of the board of directors. This implies that any banking institution will have a minimum of fifty-one of its board members with expertise in the field of this operating enterprise. It also says that such fifty-one per cent members shall not have any substantial interest in any company or firm that carries on any trade, commerce or industry or have any connection with an employee of the above mentioned.
They also cannot be the owner of any commercial, industrial, trade concerns. This provision helps in making efficient governance of the institution by clearing out the possibilities of any conflict of interest that may arise. This provision applies to all banking companies notwithstanding anything contained in any other law. The Companies Act, 2013 requires that one-third of the directors in any public listed company should be independent directors, who have no relation with the promoters of the company, has not been a promoter of the company, has no pecuniary interest in the company, have any relatives with pecuniary relation in the company, have not been an employee or managerial person in the company.
Section 149(7) of the Companies Act requires independent directors to submit a declaration affirming that he or she meets the conditions of independence as required under section 149(6). In Indian perspective these are the requirements concerning the Companies Act and Bank Regulation Act, various other disqualifying factors have also been specified in the provisions. Independent directors are also part of the audit committee and the nomination and remuneration committee, stakeholders relationship committee, risk management committee as per the SEBI listing regulations 2015.
Section 25 of the SEBI listing regulations have laid down the obligations of the independent directors. Each year all the independent directors are to meet at least once without the non-independent directors. Independent directors are made liable for acts made with their knowledge and consent and where their due diligence has been refuted. Under the Companies Act, 2013, the liability of an independent director or a non-executive director exists only for acts of omission or commission by a company that occurred with the director’s knowledge attributable through board processes and the director’s consent or connivance or where he or she failed to act diligently.
However, the liability of a director under these legal standards is not identifiable. This is because questions such as whether a director acted diligently and whether knowledge could be attributed to a director by the mere presence at board meetings are not clearly defined. The position that the liability of any director in a company is restricted to actions of omission or commission committed by the company which had taken place with the knowledge and consent, whether explicit or implied, of such director.
Regulation 16 of the SEBI (Listing Obligations & Disclosure Requirements) Regulations, 2015 prohibits only ‘material’ pecuniary relationships for disqualifying appointment of persons as Independent Directors. Clause 49 of the Stock Exchange Listing Agreement in 2000
sets out the requirement for having independent directors on board of directors; besides, it defines the quality of ‘independence’, and lays out some specific duties obligations of independent directors. Under Clause 49, all publicly traded Indian firms with paid-up capital above Rs. 3 crores are required to have a board composed of at least one- third independent directors. After the enactment of the Companies Act, 2013, regulator SEBI through an official circular has amended Clause 49 of the Listing Agreement to bring it into conformity with the new Act.
SEBI has amended the provisions of Clause 49 of Listing Agreement relating to Corporate Governance, mandating, inter-alia, that the Board of Directors of listed entities shall have an optimum combination of executive and non-executive directors with at least one woman director. The present-day Clause 49 consists of the applicability requirements,
· Companies with an equity share capital of less than Rs 10 crores;
· Companies having a net worth not exceeding Rs 25 crores;
· Companies listed on SME and SME-ITP platforms of the stock exchanges.
Section 150 of the Companies Act, 2013 has bridged one of the biggest gaps or insecurities which the authors have pointed out in the loudest terms. It provides for the ‘Manner of selection of independent directors and maintenance of databank of independent directors’. The apart from Rule 6 of Appointment and qualification of directors Rules, 2014 recently the Central Government has notified The Companies (Creation and Maintenance of databank of Independent Directors) Rules, 2019 in fulfilment of the requirements of section 149 of the Act.
A considerable portion has been dedicated by the authors on the issue of lack of any training material to create a perception of the ‘watchdog’ function, but this has also been bridged by the inception of Schedule IV(III)(1), reads that the independent directors shall undertake appropriate induction and regularly update and refresh their skills, knowledge and familiarity with the company, and a similar provision is envisaged in Regulation (4)(2)(f)(iii)(4), SEBI LODR Regulations.
The OECD principles highlight the conditions laid down by case laws and national policies where it is recommended to have a majority of the members of the board as independent or at least sufficient of them. It is the responsibility of the board to disclose the reasons as to why a member is considered independent and that it is ultimately up to the investors to decide whether such grounds are justified. The responsibility to effectively monitor managerial activity and to secure returns to the shareholders and to avoid conflict of interest is on the board, for which board independence is the key factor.
It recommends having significant members of the board to be independent of the management to ensure objective and independent judgment on matters relating to the company. It observes that the conditions laid down by various nations are negative i.e., they prescribe qualities that make a director non-independent. It remarks that listing positive qualities instead of only listing the dismissive ones can help in increasing the independence of the board.
Provision 9 of the UK Corporate Governance Code 2018 lists out the conditions that make a director non-independent such as when a director has been an employee of the company earlier, has had any material business relationship with the company, or has received any remuneration excluding the director fees, has any family ties with the company’s advisories, directors and senior employees, represents a shareholder, has links with the directors by any other involvement through companies and bodies and has been on the board for more than nine years.
Although such characteristics attributing to independence have been listed, it does not act as a bar for one’s appointment, the company is to explain as to why it deems a person as independent even when a condition from the above applies. Provision 11 requires that half of the composition of the board in a company should consist of non-executive independent directors.
On comparing Indian requirements with that of OECD principles, it is found that Indian laws not only provide disqualifying factors but also have specified fields and expertise that makes a director independent, which is reflective of the positive qualifications that the OECD principles recommend in proving effective management. The conditions prescribed by the UK Code and Indian laws are majorly similar except concerning the independent directors in the composition of the board, wherein the requirement in the UK is half, whereas in India it is one-third.
“Independence” is neither a qualification nor expertise, but the inherent ability or characteristic of being free from the shackles of the management. There is a renewed discourse on the ‘independence’ of independent directors post-Yes Bank crisis. The positives ahead of Yes Bank are the increased understanding of the need for independent directors by the shareholders and retail investors, this will act as implied shareholder accountability. Nonetheless, on a legal plane, the on-going enquiry against Mr Rana Kapoor and his close business aides will provide an insight into the factual explanations.
Thus, it is pre-mature to factually attribute responsibility on any one individual or the then management and it is for regulators and government agencies to present a clear picture on the same, any further speculations may provide counter-intuitive results.
The Companies Act, 2013 provides adequate factors that make a director non-independent. SEBI listing rules lay down their duties and responsibilities. Section 10-A of the Banking Regulation Act mentions the professional qualifications required in a director of banking institutions. Clause 49 of SEBI listing agreement requires the companies to make an annual report on their compliance with corporate governance. The board is to lay down the code of conduct of directors consistent with Companies Act.
The aforesaid provisions act as safeguards to the interest of the stakeholders involved in the company. But despite having such outlined policies that regulate the code of conduct of independent directors, they are unable to function independently of the management. OECD recommends that listing expected skill sets from independent directors along with listing out disqualifying factors can help in strengthening corporate affairs of the institution. A uniform code of conduct can be laid down by the regulating authorities. Yet again code of conduct is very subjective.
This is not the case of lacunae of law in spelling out responsibilities and duties of the independent directors but is a case of it being implemented in spirit. Failure of corporate governance cannot be attributed to one part of the system alone. It’s a collective state of breach of ethics and morals. The independent directors are unable to execute their duties as they are hampered from doing so by the interested people in the Board and Company. In other words, the ‘independent’ nature of independent directors is not protected; the sanctity attached to it is not maintained.
Independent directors carry a burdensome load of responsibilities and duties. Hence, it should be made easier for them to execute them with ease and not restrained in any way. Therefore the interim solution would be to provide for a provision that protects independent directors from harassment and threats.