EMPOWERING INDEPENDENT DIRECTORS

SEBI has, over the years, strengthened the institution of IDs through the recommendations of various committees. But despite several measures, concerns about the efficacy of IDs have continued. To further strengthen the overall framework of IDs for equity listed entities, the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘Listing Regulations’) have been amended with effect from 1st January, 2022. The Listing Regulations have further been amended to specifically empower the IDs of ‘high value debt listed entity1’ which would apply on a ‘comply or explain’ basis until 31st March, 2023, and on a mandatory basis thereafter. This article seeks to provide an overview of the key aspects emanating from these amendments and the key considerations for the companies and the governance professionals.

DEFINITION OF AN ID

To address the above concerns, especially harmonisation of requirements, SEBI has amended the Listing Regulations and has also inserted additional criteria as follows:

•  Regulation 16(1)(b)(iv) of the Listing Regulations provides that a proposed ID, apart from receiving Director’s remuneration, should not have / had any material pecuniary relationship with the prescribed entities, including the listed entity, its holding and subsidiaries during the two immediately preceding financial years or during the current financial year. Regulation 16(1)(b)(iv) of the Listing Regulations has been amended to extend the cooling-off period to three immediately preceding financial years. Let us consider the following example to better understand the amendment:

Ms Z is proposed to be appointed as an ID in Company XYZ in F.Y. 2021-2022. She noticed that in January, 2019 she had had a material pecuniary relationship (other than remuneration) with Company XYZ. As per the existing provisions, Ms Z could have been appointed as an ID as the relationship existed prior to the cooling-off period of two years. However, since the cooling-off has been extended to three years, she cannot be appointed as an ID.

• Section 149(6)(d) of the 2013 Act provides that a person cannot be appointed as an ID whose relatives have pecuniary relationships / transactions with the listed entity, its holding, subsidiary or associate company or their promoters, or directors including holding any security of or interest and being indebted (in excess of the prescribed amount) during the immediately preceding two financial years or during the current financial year. Regulation 16(1)(b)(v) of the Listing Regulations does not prescribe a list of the pecuniary relationships similar to that provided under the 2013 Act but simply states that the relatives of such proposed ID should not have / had pecuniary relationship during the two immediately preceding financial years or during the current financial year in excess of the prescribed amount.

The list of pecuniary relationships as provided u/s 149(6)(d) of the 2013 Act has been incorporated in Regulation 16(1)(b)(v) of the Listing Regulations – with certain modifications; e.g., the period for determining pecuniary relationship is stated as three immediately preceding financial years (under the 2013 Act – two immediately preceding financial years), and the lower threshold (as per existing norms) for determining pecuniary relationship of relatives has been retained. Let’s understand these key differences with the help of the following examples:

– While assessing his eligibility conditions, Mr. Y noticed that one of his relative owes Rs. 60 lakhs to the Holding Company of the Company ABC. Company ABC is proposing to appoint Mr. Y as an ID in F.Y. 2021-2022. Mr. Y considered that the pecuniary relationships are permitted to the extent of the following:

In the above situation the balance outstanding from the relatives is within the permissible limits under the 2013 Act. However, the outstanding is in excess of the limit prescribed under the Listing Regulations. Hence, Mr. Y cannot be appointed as an ID.

– Mr. X is assessing the eligibility conditions for his proposed appointment as an ID in Company DEF in March, 2022. He noticed that during F.Y. 2018-2019 one of his relatives held equity shares of the Company whose face value exceeded the permissible limit prescribed under the 2013 Act and the Listing Regulations. A cooling-off period of two years and three years, respectively, has been prescribed under the 2013 Act and the Listing Regulations. Accordingly, in this case even though the requirement of the two-year cooling period under the 2013 Act is met, Mr. X cannot be appointed as an ID because his relative had held securities during the three-year cooling period prescribed under the Listing Regulations.

• Regulation 16(1)(b)(vi) of the Listing Regulations provides that a proposed ID is a person who (neither himself nor whose relatives) holds or has held the position of a key managerial personnel or is or has been an employee of the listed entity or its holding, subsidiary or associate company in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed. The amended Regulation 16(1)(b)(vi) of the Listing Regulations extends the restriction to employment in any promoter group company. However, the proviso to the Regulation further provides that the cooling-off period will not apply to relatives in employment of the stated entities, provided that they do not hold the position of a key managerial personnel. Accordingly, where relatives of a person holds employment (other than the position of a key managerial personnel) in the listed entity, its holding, subsidiary, or associate company or any company belonging to the promoter group of the listed entity in the preceding three financial years, such person can be appointed as an ID. The following example illustrates the amendment for better understanding:

While assessing her eligibility conditions, Ms Q noticed that her spouse is the Managing Director in a promoter group company of Company LMQ which is proposing her appointment as an ID in February, 2022. Since a relative of the proposed ID holds the position of a key managerial personnel in a promoter group company, Ms Q cannot be appointed as an ID in Company LMQ. If her spouse held an employment (other than the position of a key managerial personnel) such as Sales Executive, she can be appointed as an ID pursuant to the relaxation as per the proviso to Regulation 16(1)(b)(vi) stated above.

• Regulation 16(1)(b)(viii) of the Listing Regulations provides that ID is a person who is not a non-independent director of another company on the Board of which any non-independent director of the listed entity is an ID. An explanation has now been inserted to provide that a ‘high value debt listed entity’ which is a body corporate that has been mandated to constitute its board of directors in a specific manner as per the law under which it is established, the non-executive directors on its Board would be treated as IDs. Similar requirement has also been prescribed for ‘high value debt listed entity’ which is a Trust.

ENHANCING TRANSPARENCY IN THE ROLE OF THE NRC

The NRC of Company DEF comprises six members – with equal representation by IDs and other Directors. Company DEF does not have outstanding superior rights equity shares. Hence the representation of IDs should be increased from the existing three to four IDs – so that 2/3rd of the NRC comprises IDs pursuant to the revised norms as stated above.

Clause A to Part D to Schedule II of the Listing Regulations provides that the role of the NRC includes formulation of the criteria for determining qualifications and positive attributes of a Director. Notwithstanding such requirements, SEBI was of the view that there is a lack of transparency in the process followed by NRCs. Therefore, a need exists to prescribe disclosures for selection of candidates for the post of an ID. These disclosures are expected to increase the transparency in the functioning of NRCs and would also be good from the governance perspective. SEBI accordingly introduced Clause 1A in Part D to Schedule II of the Listing Regulations to provide that:

•     For every appointment of an ID, the NRC should evaluate the balance of skills, knowledge and experience on the Board of Directors;

•     On the basis of such evaluation, the NRC should prepare a description of the role and capabilities of an ID. The person recommended to the Board for appointment should have the capabilities identified in such description;

•     The NRC has the option of using the services of external agencies to consider candidates from a wide range of backgrounds (having due regard to diversity) and consider the time commitments of the candidates.

SEBI also introduced Regulation 36(f) in the Listing Regulations to provide that the shareholders’ notice should include the disclosures regarding the skills and capabilities required for the role and the manner in which the proposed person meets such requirements.

Further, amendments were made to Regulation 36(d) to provide that the shareholders’ notice for appointment of a new Director or reappointment of a Director should include the names of listed entities from which the person has resigned in the past three years.

COMPOSITION OF THE AUDIT COMMITTEE

For example, the Audit Committee of Company PQR comprises six members – four IDs and two other Directors. Company PQR does not have outstanding superior rights equity shares. So it can continue with the present composition of the Audit Committee as it has the minimum number of IDs in the Audit Committee as per the revised Regulations. Since the revised Regulations prescribe the minimum composition, Company PQR may choose to appoint a higher number of IDs on the Audit Committee.

Regulation 23(2) of the Listing Regulations provides that all related party transactions require prior approval of the Audit Committee. SEBI felt a need to further enhance the scrutiny around related party transactions. Accordingly, a proviso was added to Regulation 23(2) which provides that only those members of the Audit Committee who are IDs should approve related party transactions.

APPOINTMENT, REAPPOINTMENT AND REMOVAL OF IDS

Accordingly, to give more say to the minority shareholders in the simplest manner possible, SEBI introduced Regulation 25(2A) in the Listing Regulations to extend the requirement to obtain shareholders’ approval through a special resolution for appointment and removal of an ID. Thus, as per the revised requirements, the appointment, reappointment or removal of an ID should be subject to the approval of shareholders by way of a special resolution.

APPROVAL OF SHAREHOLDERS WITHIN A STIPULATED TIMEFRAME

Accordingly, Regulation 17(1C) was introduced in the Listing Regulations to provide that approval of shareholders for appointment of any person (including that arising due to casual vacancy) on the Board of Directors should be taken at the next general meeting or within three months from the date of appointment, whichever is earlier.

INSURANCE FOR IDS

The Listing Regulations were further amended to provide that a ‘high value debt listed entity’ should undertake D and O insurance for all its IDs for such sum assured and for such risks as may be determined by its Board of Directors.

COOLING OFF PERIOD – TRANSITION OF AN ID TO AN EXECUTIVE DIRECTOR

Hence, Schedule III was amended to provide for disclosure of the resignation letter of an ID along with the names of listed entities in which the resigning Director holds Directorships, indicating the category of Directorship and membership of Board committees, if any. It may be noted that the new requirement to disclose the entire resignation letter is only an extension of the existing requirements which require disclosure of detailed reasons for resignation along with a confirmation as aforesaid.

SEBI also observed cases where IDs have resigned and have then joined the same company as Executive Directors. While there may be valid reasons for transition from an ID to an Executive Director, such instances where an ID knows that he / she may move to a larger role in the company in the near future may practically lead to a compromise in independence. SEBI felt that a cooling-off period should be prescribed to reduce potential impairments to an ID’s impartiality in decision-making in instances where an ID knows that he / she may move to a larger role in certain companies in the near future.

Thus, Regulation 25(11) was introduced in the Listing Regulations to provide that an ID who has resigned from a listed entity cannot be appointed as an Executive / Whole-time Director on the Board of the listed entity, its holding, subsidiary or associate company or on the Board of a company belonging to its promoter group, unless a period of one year has elapsed from the date of resignation as an ID.

TIME-PERIOD FOR FILLING UP CASUAL VACANCY OF IDS