The recent tussle within the TATA Group has thrown up some interesting corporate governance challenges. One of them relates to independent directors. The institution of independent directors has been one of the noteworthy innovations in the 21st Century, which has been initially buffeted by big corporate frauds. The bulwark of the institution of independent directors is the statutory nudge for independence in independent directors. The recent corporate events in India betray the near collapse of this bulwark. By being enabled by statute to remove independent directors in the same manner as ordinary directors, the cause of directorial independence has been severely compromised.
The Law on Removal of an Independent Director
Schedule-IV to the Companies Act, 2013 contains the code for independent directors. Clause VI of this code says that the resignation or removal of an independent director shall be in the same manner as provided in Section 168 and Section 169 of the Companies Act, 2013. As far as resignation of an independent director is concerned, there is no difficulty in complying with Section 168 of the Companies Act, 2013. The difficulty arises when removal of an independent director is also in the same manner as provided in Section 169 of the Companies Act, 2013 for ordinary directors. Under Section 169 of the Companies Act, 2013 as was the case under Section 284 of the Companies Act, 1956; a director could be removed by an ordinary resolution. An ordinary resolution in law can be passed with a 51% majority, which in other words, means a simple majority.
Since the promoter shareholders in many companies, both listed and unlisted, can easily muster 51% support for removal of an independent director, this may act as a deterrent for an independent director to act with independence on the Board of Companies. While the nascent institution of independent directors is yet to find its feet in India, such deterrence is not desirable at all.
What can be done going forward?
Clause VIII of Schedule—IV provides for performance evaluation in respect of independent directors. According to Clause VIII performance evaluation of independent directors shall be done by the entire Board of Directors, excluding the director being evaluated. It is on the basis of this report of performance evaluation that the continuation or otherwise of an independent director’s term is determined. Keeping the larger purpose in mind, the higher judiciary is legally justified in reading down the removal provision in Section 169 to apply only for a removal pursuant to a poor performance evaluation by the Board of an independent director. Pending such action by the higher judiciary what could be done to remedy the situation? Like what is stated in Schedule—IV that contains the code for independent directors, since the appointment of an independent director is proposed by the Board, the removal of an independent director likewise should also be recommended by the Board of a Company, including a majority of independent directors. Only upon such a recommendation should the shareholders of a company have the power to remove an independent director, by an ordinary resolution under Section 169 of the Companies Act, 2013. This would prevent dominant shareholders, from piloting the removal of an independent director, irrespective of the merit of an independent director. The consensus at the Board level along with the majority of independent directors required for the removal of an independent director would act as a bulwark against any capricious desire of the dominant shareholder to remove independent directors. Under the Indian legal system, it is a settled position that a person who is authorized by statute to do something is also deemed to be authorized to undo what is done. Therefore, it is most desirable that Schedule—IV to the Companies Act, 2013 is amended by clarifying that removal of an independent director should only be done on the recommendation of the Board including that of the majority of independent directors. It may be noted that such an alteration to Schedule—IV can be done by the Central Government under Section 467 of the Companies Act, 2013.
Effective corporate governance in Indian Companies is absolutely necessary for growth and economic resurgence. Without such a statutory backing there is always an existential threat to independent directors. If the hitherto venerable TATA Group could venture to remove an independent director in a seemingly capricious way, what could be said of others?
(L V V Iyer is a Corporate Lawyer and is the Author of a standard book on Company Directors.)
