By Jayant M. Thakur
Chartered Accountant
The new rules notified on 22nd October, 2019 by the Ministry
of Corporate Affairs under the Companies Act, 2013 require independent
directors to pass a test to demonstrate their knowledge and proficiency in
certain areas for board-level functioning in corporates. They need to score at
least 60% marks to qualify. They also need to enrol their names in a database
maintained for the purpose. The intention appears to be that companies should
choose independent directors from this databank. The above are the principal
requirements notified by the new rules.
BACKGROUND
It may be recalled that the Companies Act, 2013 requires listed
companies and certain large-sized public companies (in terms of specified net
worth, etc.) to have at least one-third of their boards peopled by independent
directors. SEBI has made similar requirements but with some differences (its
requirements apply to listed companies and provide for a higher proportion of
independent directors).
QUALITIES OF INDEPENDENT DIRECTORS
The qualities that make a person an ‘independent’ director have been
laid down in great detail in the law. However, these focus largely on their
independence from the company and its promoters but do not prescribe any
minimum knowledge, educational qualifications, etc., except when they are a
part of the Audit Committee. They occupy a high position in a company and are
expected to provide well-informed inputs on matters of governance, strategy and
so on to the company and its management. They are also expected to keep a
watchful eye on the finances, accounts and performance of the company by
exercising their skill and diligence. A failure on their part can be harmful to
the company and to themselves, too, since they may face liability and penal
action in many forms.
Against this background, the new requirement of minimum knowledge is
surely welcome. A designated institute (the Indian Institute of Corporate
Affairs) will publish the study material for directors to prepare for the test.
It will also conduct the prescribed test.
Often, independent directors have a background of law, accountancy,
etc., but there are also many directors chosen for their experience in a
relevant industry, for their technical knowledge and administrative expertise.
But such persons may not have knowledge and experience about how companies are
governed. It is possible that they may not even have rudimentary knowledge of
accounting. Such basic knowledge, duly confirmed by a test which they have to
pass, would help them and the company as well. This is particularly so since
the obligations placed on them are fairly comprehensive.
When do the new rules come into force?
The new rules come into force from 1st December, 2019 and are
spread over several notifications, one of which introduces a full set of rules,
another modifies an existing one and yet another notifies the institute that shall
oversee the teaching and the test. Three months’ time has been given to
independent directors to enrol their names in the databank and a period of one
year from enrolment to pass the test. Companies are required to ensure
compliance with this requirement and an independent director is also required
to confirm he is compliant in the filings made by him.
Who will administer the tests and maintain databank?
The new rules may be an attempt to provide a basic level of financial
and regulatory literacy. The institute notified (the Indian Institute of
Corporate Affairs) has to serve several functions. It has to release
educational material for independent directors that they can use to prepare for
the exams. It is also required to conduct the online test for them. (The scope
of the test covers areas such as company law, securities law, basic
accountancy, etc.) Apart from the qualifying exam, the institute is required to
conduct an optional advanced test for those who wish to take it.
The Institute is also required to maintain a databank of independent
directors containing detailed information of each such person. Companies
seeking to appoint independent directors can access such information on payment
of a fee to the institute. Interestingly, the institute is required to report daily
to the government all the additions, changes and removals from the databank.
This makes one wonder why would the government want to monitor this databank so
closely and so frequently.
To whom do these new requirements apply?
The requirement of enrolling in the database and passing the qualifying
test applies to existing as well as new independent directors. Existing
independent directors are given some time to enrol themselves in the database
and thereafter pass the qualifying test. New independent directors will have to
first enrol in the database.
Are any persons exempted from the requirements?
A person who has acted as an independent director or key managerial
personnel for at least ten years in a listed company or a public company with
at least Rs. 10 crores of paid-up capital, is exempted from the requirement of
passing the test. However, he would still have to enrol in the database.
Independent directors required to enrol in the database
Independent directors are required to enrol by providing the required
information and payment of a fee. Existing independent directors are required
to do this within three months, i.e., by 1st March, 2020. A person
seeking appointment as an independent director is required to enrol before
being appointed. He is required to pass the prescribed test with at least 60%
marks within one year of enrolment. The enrolment can be for one year, five
years or for a lifetime. The test has to be passed only once in a lifetime.
Directors, presumably, will update the knowledge of rapidly changing laws on
their own.
Companies are required to ensure and report compliance with these
requirements.
IMPLICATIONS OF THE NEW REQUIREMENTS
These new requirements will ensure that a person may be a top lawyer or
a chartered accountant with decades of experience, or a senior bureaucrat, or a
professor of a reputed college, yet he will have to pass this test with at
least 60% marks. Except for persons with ten years’ experience as specified
earlier, there is no exception provided.
GREY AREAS IN THE REQUIREMENTS
The law has some gaps and is ambiguous at a few places. Section 150 of
the Companies Act, 2013 pursuant to which these new requirements were
introduced was really for the maintenance of a database of independent
directors. This would help a company to search for such a director from the
database if it so chose. It did not make it mandatory that such a director must
be chosen from this database.
It is not clear whether existing directors will vacate their office if
they do not pass the test or if they do not enrol in the database. Will the
appointment of an independent director whose name does not appear in the
register be invalid, or will this be merely a violation of law? A similar
question can be raised for a person who has not passed the test with the
minimum percentage of marks. The intention appears to be that such persons
cannot be appointed; and in respect of existing independent directors, they may
have to vacate their office. However, this is not stated clearly in so many
words. Similarly, the wording of the law is ambiguous on whether a company has
to select an independent director only from the database. The purpose of the
database may get defeated if a company can appoint someone not enrolled, but
this is not specifically and clearly laid down.
BENEFITS AND BURDENS OF THE NEW REQUIREMENTS
The new requirements can be praised to the extent that independent
directors will now be required to have minimum relevant knowledge to do justice
to their roles. On the other hand, thanks to the constant tweaking of
requirements, the number of independent directors required is ever increasing.
Their obligations and potential liabilities are also enormous and continue to
increase. Their remuneration, however, is not guaranteed and can often be very
nominal with minimal sitting fees. The new requirements are not expected to be
costly. Even the fees payable to the institute for the enrolment are required
to be ‘reasonable’. It could be argued that the effort and the costs would pay
off in terms of knowledge. Nevertheless, no attempt has been made to increase
the powers of independent directors or ensure that they have at least such
minimum remuneration that makes doing their jobs worthwhile.
An independent director today, individually or even collectively, has
very few powers. He is often provided with some minimal information as
statutorily required for board meetings. Some directors can of course attempt
to use their personal and moral force to get their queries answered during
board meetings and sometimes in between, but success is not frequent. If he is
not happy, the eventual recourse he has is to resign. He may go public but he
risks legal action since usually he may not have adequate information and
documentation to back his claims. There is no institutional or legal process he
can take advantage of to express his views (preferably anonymously) and see that
wrongs are corrected. Independent directors may also often be treated with
contempt by managements and as an unavoidable nuisance. I would not be
surprised if the allegations (as yet unsubstantiated) in the Infosys case where
two independent directors are said to have been referred to as ‘madrasis’ and a
lady director as a ‘diva’ are true. Thus, neither from the remuneration point
of view, nor from the personal satisfaction point of view, is the office of
independent director worthwhile.
HASTY IMPLEMENTATION?
Then there is the issue regarding the fast-track implementation of these
provisions. As of now, even the institute and database or even the educational
material / test system does not seem to be fully ready for the new
requirements. While some time has been given for the transition, this would
still make it difficult for many to comply.
CONCLUSION
If the new rules are taken literally and narrowly, it is possible that
many independent directors would become disqualified and some may vacate their
office. Clearly, some clarification and relaxation both in terms of time and
requirements is needed. Generally, the office of independent directors also
needs a holistic relook, lest most of the cream of the crop quietly leave the
scene being underpaid, underpowered, under-respected and over-obligated.
