Independent Directors: Functions,
Responsibilities & Accountability.
Dimensions of the office of the Independent
Director in India.
Governance Challenges in Contemporary Business
Environment
Corporate Reporting:
Enhanced disclosures &
Responsibility
Greater focus on strategy,
long-term value creation and
Reputation
Stakeholder value,
Responsibility Towards Society
Board composition, diversity
and boardroom effectiveness
Shareholder Engagement &
Activism. Heightened Proxy
Advisory interventions
Key
Governance
Issues for
companies in
2015
Independence in Law
What defines an Independent Director?
• Integrity. Threshold defined under the
Integrity
Companies Act (CA), 2013 and additionally
assessed by the board of directors and selfattested by the ID.
• Independence. Assessed in terms of an
Expertise
Independence
IDs relationships with the company/
promoters/ management. Not having held
relationships
(personal,
professional,
familial) excluded under CA 2013.
• Expertise. a combination of subject matter
expertise, industry exposure and past board
experiences.
Independent Director is defined u/s 149(6), CA 2013, as a director other than
managing director, whole-time director or a nominee director, one who
qualifies the tests of Integrity, expertise and experience and fulfils the
exclusionary relationships test, as laid down under the law.
Independence defined …
 A person of Integrity
 Integrity is not defined in law. Black’s Law Dictionary defines integrity of a
person to mean soundness of moral principles and character.
 The test of Integrity is done through an subjective assessment by the
Nomination Committee and the board of directors against minimum legal
standards or enhanced standards.
 Relevant expertise and experience
 Independent Directors should possess an appropriate balance of skills,
experience, and knowledge of one or more areas like finance, law, management,
sales, marketing, administration, research, corporate governance.
 Exclusionary Relationships – Section 149(6), CA 2013 – e.g.
 An Independent Director must not be related to the promoters of the company,
and must be independent of the management of the company.
 Apart from director’s remuneration, has or had no pecuniary relationship with the
company, its holding, subsidiary or associate company, or their promoters, or
directors, during current as well as two immediately preceding financial years
 Restrictions on company shareholding. (self plus relatives shareholding < 2% of
company’s total voting power).
 No restricted professional relationships current or previously held.
Legal Duties of Independent Directors
Fiduciary Duties
Independent directors hold their position in a fiduciary capacity.
Their legal duties are embodied by the principles of fiduciary duty.
The expression “fiduciary capacity” implies a relationship that is
analogous to the relationship between a trustee and the
beneficiaries of the trust. It extends to all such situations as place
the parties in positions that are founded on confidence and trust on
the one part and good faith on the other. Sri Marcel Martins vs. M.
Printer & Ors. (SC)
The fiduciary is expected to act in confidence and for the benefit and
advantage of the beneficiary, and use good faith and fairness in
dealing with the beneficiary or things belonging to the beneficiary.
CBSE and Anr. Vs. Aditya Bandopadhyay and Ors. (2011) 8 SCC
497
Fiduciary duty is broadly categorized into, Duty of Care and Duty of
Loyalty.
Duty of Care
 Duty of care entails that decisions by directors are made after
due deliberations, balance in judgement and in awareness of key
facts and information. Section 166 (3), CA 2013.
 Duty of care imposes upon directors a duty of competence or skill
– to act with a certain level of skill, and a duty of diligence.
 Duty of care requires directors to inform themselves of “all material
information reasonably available to them,” prior to making a
business decision. Smith v. Van Gorkom, 488 A.2d 858, 872 (Del. 1985).
Directors must “act in an informed and deliberate manner” prior to
making a business decision. Gross negligence is the standard in
determining if there has been a breach of the duty of care. In re
Walt Disney Co. Derivative Litigation, 906 A.2d 27, 53 (Del. Ch.
2006).
Duty of Care – as established by Indian Courts
• Duty of care entails a duty to act with reasonable prudence,
includes duty to seriously deliberate matters that comes before
them.
• It includes the duty not to be oblivious to what is obvious. Supreme
Court in Official Liquidator v. PA Tendolkar (AIR 1973 SC 1104), held:
“… a director cannot shut his eyes to what must be obvious to everyone who
examines the affairs of the Company even superficially. If he does so he could
be held liable for dereliction of duties undertaken by him and be compelled to
make good the losses incurred by the Company due to his neglect even if he is
not shown to be guilty of participating in the commission”.
• Test of Reasonable Prudence calls for exercising prudence as
expected of a person having equivalent knowledge and experience.
“Duty of care for an independent director calls for exercise of independent
judgment with reasonable care, diligence and skill which should be reasonably
exercised by a prudent person with the knowledge, skill and experience which
may reasonably be expected of a director in his position and any additional
knowledge, skill and experience which he has”. SEBI order in matter of Pyramid
Saimira Theatre Ltd. (2011).
Tests of Due Care, Skill and Diligence
Duty of Reasonable Skill, Care and Diligence
• Due care entails directors to take decisions after due
deliberations, in consideration of key facts, and subject to
verifiable checks.
• SAT in the Pyramid Saimira case (2012), referred to the English case of
Equitable Life Assurance Society [(2003) EWHC 2263 (Comm)], to
establish the dimensions of ‘duty of care’.
• Directors have, both collectively and individually, a continuing duty to
acquire and maintain a sufficient knowledge and understanding of
the company's business to enable due discharge of duties as
directors.
• Whilst directors are entitled to delegate particular functions to those
below them in the management chain, and to trust their competence
and integrity to a reasonable extent, the exercise of the power of
delegation does not absolve a director from the duty to supervise the
discharge of the delegated functions.
Tests of Due Diligence
• According to Words and Phrases by Drain-Dyspnea (Permanent
Edition 13A), “due diligence” in law means doing everything
reasonable, not everything possible’. It means reasonable
diligence; it means such diligence as a prudent man would
exercise in the conduct of his own affairs. Ref. Supreme Court
order in Chander Kanta Bansal v. Rajinder Singh, (2008) 5 SCC 117
• The test of diligence is essentially fact-based.
Tests of Diligence, SAT in the Pyramid Saimira case (2012)
• Demonstrate due care and diligence while verifying documents placed for
approval in board meetings.
• Identify deficiencies wherever possible by employing verification and
scrutiny expected of a prudent man.
• A director cannot take a stand that he has approved the documents totally
depending on the integrity and expertise of the management.
• While functions may be delegated to professionals, the duty of care,
diligence, verification of critical points by directors cannot be abdicated.
Demonstrating Diligence
• Adequate attendance
meetings;
and preparation for the role by attending most
• Have all documents, papers, presentation, minutes
intranet to demonstrate due process
archived in an
• Raise relevant questions at meetings, and seek answers to them;
• Where not satisfied with the answers that affect the overall interests of
the company, express dissent; and adequately record in minutes( needed
under the law);
• Where there are concerns about running of the company or a proposed
action, ensure they are addressed by the Board. Also, insist that the
concerns raised by IDs with respect to the unresolved concerns be
recorded in minutes.
• When any action is delegated, there must be an effective oversight.
• Engage services of an external expert, wherever considered necessary
esp. in matters involving minority interests.
• Since independence is measured in action, act in a manner that is
established by due process
Duty of Loyalty
 Duty of Loyalty requires that directors act “in the interest of the
company”.
 Under Companies Act, 2013, a director is required to act in good
faith to promote the objects of the company for the benefit of its
members and in the best interests of the company, its employees,
shareholders, community and for protection of environment. Section 166(2), CA 2013.
 The definition is broad in the respect that it requires ensuring a
collective benefit of key stakeholders, including its shareholders.
Independent Directors are required to ensure that interests of all
stakeholders, particularly minority shareholders, are duly
considered as part of Board deliberations.
 Duty of loyalty, as interpreted by courts, means that acts and
deeds of directors must be exercised for the benefit of the
company. Dale And Carrington Invt. P. Ltd. vs P.K. Prathapan and Ors.
2004 Supp.(4) SCR 334.
Duty of loyalty …contd.
Duty of Loyalty
 Duty of Loyalty requires directors not to engage in transactions
that involve a conflict of interest.
• Under Section 166(5), CA 2013, a director shall not achieve or attempt to
achieve any undue gain or advantage, either to himself or relatives,
partners or associates.
• Directors have an “affirmative duty to protect the interests of the
corporation, but also an obligation to refrain from conduct which would
injure the corporation and its stockholders or deprive them of profit or
advantage.” Ivanhoe Partners v. Newmont Mining Corp., 535 A.2d 1334,
1345 (Del. 1987).
• The acts of directors in a private limited company are required to be tested
on a much finer scale in order to rule out any misuse of power for personal
gains or ulterior motives. Dale And Carrington Invt. P. Ltd. vs P.K. Prathapan and
Ors. (SC) 2004
• The Delaware Supreme Court in Stone v. Ritter said, ‘[w]here directors fail
to act in the face of a known duty to act, thereby demonstrating a
conscious disregard for their responsibilities, they breach their duty of
loyalty by failing to discharge that fiduciary obligation in good faith. Stone
v. Ritter, 911 A.2d 362 (Del. 2006).
Duty of Loyalty (Good faith) – Legal Tests.
• Duty of loyalty requires a director to demonstrate that actions taken
were in ‘good faith’ and in best interests of the company.
• Courts must be convinced that decisions taken were not with a
wrong intent or purpose, and hence not in ‘bad faith’. The test of
purpose behind a decision is used as a measure. “To act in good faith,
a director must act at all times with an honesty of purpose and in the best
interests and welfare of the corporation.” In re Walt Disney Co. Derivative
Litigation 906 A.2d 27, 53 (Del. Ch. 2006).
 A director owes a duty to the company to act in what she/he
honestly considers to be the interests of the company. Madoff
Securities v. Stephen Raven [2013] EWHC 3147 (Comm). A director would
not be held to have failed in fiduciary duty if they act in good faith in
what they believe, on reasonable grounds, to be the interests of
the company. Needle Industries (India) Ltd. and Others Vs. Needle Industries
Newey (India) Holding Ltd. and Others [(1981) 3 SCC 333]
 Honesty in purpose is key to establishing good faith. Demonstrating
good faith depends on facts and circumstances, which must be
backed by evidence.
Duty towards Shareholders
• Duty of loyalty, as established in US, has a duty of disclosure
towards the shareholders.
•
•
•
Directors are obligated to disclose all material information when
soliciting shareholder action. The duty of disclosure is an application
of both the duties of care and loyalty. Pfeffer v. Redstone, 965 A.2d
676, 684 (Del. 2009).
Duty to the shareholders include a duty to make a full and honest
disclosure to the shareholders regarding all matters relating to the
company. Dale And Carrington Invt. P. Ltd. vs P.K. Prathapan and
Ors. (2004). The requirement flows from a director’s duty to act in
good faith and make full disclosure to the shareholders regarding
affairs of a company. Dale And Carrington Invt. P. Ltd. vs P.K.
Prathapan and Ors.
The duty of disclosure is significant in the case of listed companies.
Demonstrating Good Faith
• Setting of Board processes- timing, evidence, recording,
preserving protocols
• Setting the tone for the company and the standards of conduct
• Establishing
oversight
responsibilities
that
operate
independently
• Oversight of controls, risks, information, processes etc.
• Address deviations and demonstrate corrective actions
• Establish principles of fair play and fair pricing especially with
related party or with parties having any significant influence
• Disclose effectively and have err on more than less
Accountability of Independent Directors
Accountability for Independent Directors
• Independent Directors are legally accountable only in respect of such
acts of omission or commission by a company which occurred with
their knowledge, attributable through board processes, and with consent
or connivance, or where he had not acted diligently. [Section 149(12),
CA2013].
• This is equivalent of the ‘business judgment rule, as prevalent in the
United States, where courts have held the court will not second-guess a
board’s decision if it:
1. followed reasonable process
2. took into account key relevant facts
3. Is made “in good faith” - “good faith” requires that the board act
without conflicts of interest and not turn a blind eye to issues for which
is it responsible.
BJR – Tests of Good Faith and Fairness
• The concept of ‘Business Judgment Rule’, as embodied in the safe
harbor provisions for independent directors under Indian laws, is yet to be
tested in Indian courts.
• As held by the Delaware court in Aronson v. Lewis, 473 A.2d 805, 812 (Del.
1984) to avail immunity under BJR:
• directors have a duty to inform themselves of all material information
reasonably available to them.
• the decision must have been taken in good faith
• informed business decisions.
• The presumption of good faith and fairness, may be rebutted, if
• it is shown that a director had a personal financial interest in a
transaction (i.e. lacked independence)
• did not inform her/himself of all information that was reasonably
available,
• failed to exercise the requisite level of care,
• or stood on both sides of the transaction;
• the director must satisfy the stricter standard of ‘entire fairness’.
Board Process Explained
• According to a circular of the Ministry of Corporate Affairs issued
in 2011, board process includes meeting of any committee of the
Board, and any information which the director is authorized to
receive as director of the Board as per the decision of the Board.
• They include formal channels of communication such as circulars,
agenda, resolutions, etc. made available to Board members.
• In determining whether a director had acted in accordance with
law, prosecuting agencies would examine Board minutes of the
company to arrive at a conclusion as to whether the Independent
Director is responsible for any violation of law.
• Minutes that detail a board’s deliberations serve to bolster the
defense against a claimed breach of the director’s duty of care.
Invoking safe harbour provisions
When can an ID invoke
safe harbor provisions
seeking immunity from
wrongful acts of omission
or commission
Section 149(12), CA 2013
• Was not aware of essential facts and circumstances
leading to the illegal decision, but had through
legitimate means (attributable through Board
process) tried to access information regarding the
same.
• Did not give consent to the decision or had not
connived. This must be supported through
dissenting views recorded in board minutes, in case
the ID was aware of the decision being taken.
• Had acted in due diligence. (in which case an ID
must demonstrate that he had acted with due
diligence).
Liability of Independent Directors
Liability for Independent Directors
• Independent directors function with a common goal of achieving higher
standards of corporate governance, by working as a collective team.
• In terms of determining liability, however, every independent director is
personally accountable towards due discharge of her/his responsibilities.
• The liability for violation of laws is contingent upon two tests—
o Substantive Assessment: Whether an Independent Director is at
default, by active association?[Definition of ‘officer in default’-Section
2(60), CA2013]
o Demonstrative Assessment: If an Independent Director has effectively
discharged her/his duties — essentially a test of diligence and good
faith?.
• The substantive liability would weigh upon an ID if was party to the default,
or was in knowledge of its occurrence (gained in accordance with board
process), or had consented/ connived in its decision making process.
Liability for Independent Directors … contd.
•
•
•
•
Officer who is in default [Section 2(60), C2013] includes any person on
whose advice, directions, or instructions the Board of Directors of the company
is accustomed to acting. It also includes every director who is aware of a
contravention by virtue of the receipt by her/him of any proceedings of the
Board or participation in such proceedings without objecting to the same, or
where such contravention had taken place with her/his consent or
connivance.
The liability on an ID will be deemed established if as a member of a Board
Committee (Audit, Nomination & Remuneration Committee, CSR, etc.) they
provide to the Board of Directors, advice/ recommendation with respect to an
action which is illegal.
The liability can even arise when an ID is aware of an illegality, in which case it
needs to be established if the ID was aware of the contravention taking place.
Breach of company law generally entails civil and criminal liabilities under a
number of sections including punitive action under section 447, CA 2013
(defining fraud) which provides for imprisonment from 6 months to 10 years and
a fine up to the amount of fraud to a maximum of three times the amount under
question for fraud or false disclosure in any returns, report, financial statement,
or prospectus.
Mitigating Liability for IDs
•
•
The liability provisions under the scope of ‘officer of default’ [Section 2(60),
CA 2013] can be mitigated if the ID can satisfy the courts that decision was
taken with due diligence and good faith in action.
Based on the “business judgment rule,” immunity safeguard, as applicable in
India, courts are unlikely to doubt the credence of an Independent Director is
she/he has discharged responsibilities by:
• application of an independent mind, recorded in Board deliberations and
evidenced through properly maintained minutes
• applying knowledge as expected of her/him, a test of prudence of an
ordinary person with an equivalent level of knowledge/ expertise
• acting on an informed basis, (availed of sufficient and credible
information, as provided through legitimately accessed Board
documents).
• not being party to the commission of the offence.
Functions of Independent Director
Independent Directors – Primary Functions
Independent Directors is categorized broadly into as:
– Advisory: consult with management regarding strategic and
operational direction of the company.
– Oversight: monitor management actions to ensure they act in
sync with company objectives and policies.
 Advisory functions by Independent Directors covers issues of
strategy, performance, risk management, resources, key
appointments and standards of conduct.
 Oversight
functions include scrutiny of management
performance, monitor reporting of performance and providing
objective opinion in the evaluation of the performance of the
board and the management.
Areas of Intervention for IDs
Role of independent directors includes the following, categorised into :
Strategy. Constructively challenge and help bring an independent
judgement on Board’s deliberations on issues of strategy.
Performance. Review the performance of management in meeting
objectives and monitor the reporting of performance. Bring an objective
view in the evaluation of performance of Board and management.
Financial Reporting, Internal Controls and Risk. Ensure the integrity
of financial information and the adequacy of financial controls and
systems risk management.
People. Bring independent judgement with respect to Board’s
deliberations on key appointments and standards of conduct.
Determining remuneration of executive directors in management
succession planning and in appointing and where, necessary,
recommend removal of executive directors, KMPs, senior management.
Responsibility towards Stakeholders
 Under section 166 of CA2013, directors are required to take
actions in the best interests of the company, its employees,
shareholders, and towards protection of the environment.
 Independent Directors are additionally required to safeguard the
interests of all stakeholders, particularly the minority
shareholders. (Schedule IV, CA 2013).
 Stakeholders not defined under the law. Hence, responsibility lies
towards all who face a direct or indirect impact due to a company’s
operations.
 Role of IDs towards safeguarding stakeholders’ interest entails
them to ensure that concerns of the minority shareholders or other
stakeholders are not curbed and not left unaddressed.
Managing Stakeholders’ Conflict …
• Independent Directors required to resolve stakeholder conflicts.
• Balancing conflicting interests of all stakeholders is difficult and may need
strategic prioritisation based on circumstances of a particular situation
and assessment of the medium to long-term impact of a decision.
• Discussions and deliberations are the keys to achieve such a
balance.
• Pursuing the long-term interests of the company on a sustained basis
could address the potential conflict areas between one group of
shareholders and others.
• Stakeholder value creation is important in dealing with concerns
over conflicts between stakeholders.
• Independent Directors all through must ensure a balanced
treatment of all stakeholders, and convince the management to
pursue policies that blends a harmonious relationship among all
stakeholders.
Independent Directors in Board
Committees
Board Committees and Independent
Directors
Board Committees
• Board Committees are carved out among existing Board members, based on the
degree of expertise. Independent directors form an essential part of Committees,
for their specialized subject-matter knowledge and relevant industry experience,
and for imbuing independent thinking.
• Board Committees function independently but are required to bring their
recommendations on key issues before the full board for approval.
• Board Committees share greater responsibility as they are primarily in knowledge
of facts and circumstances leading to the decisions taken.
Rights and Privileges
• Committees have operational freedom, subject to areas defined in their Charter.
• They are entitled to hire, at company’s cost, services of experts, as felt required to
meet their standards of duty.
Board Committees function under powers delegated by the Board. Board Committees look into
operational aspects of matters under consideration, and base their judgement accordingly. The
role of Committee’s goes into fact-finding and analysis of a subject under consideration. Audit
Committee’s cannot plead ignorance of missing out on essential facts leading to a decision. The
onus of correctness of a decision lies with the Committee and members who form part of it.
Role as an Expert
• Role of Independent Directors is not generalist in nature. They are
specialists in their respective fields. Under CA2013, Finance, law,
management, sales, marketing, administration, research, corporate
governance, technical operations, or disciplines related to company’s
business have been listed out as fields of study for Independent
Directors.
• The level of expertise expected of an ID vary according to the committee
they are associated with. For instance, Audit Committee members must
have ability to read and understand financial statements. [Proviso to
Section 177(2), CA2013].
• While the law recognizes the technical competence, expertise and
experience of an ID, this recognition is subject to enabling factors, like,
whether she/he was coerced into a decision, or whether all data/
information leading to the decision were available.
• So long, an independent director establishes that the decision taken was
prudent, reasoned/ justified (based on available facts) and was taken with
due regard to existing tests of due care, diligence and good faith, an
Independent Director can claim recourse under the Business Judgement
immunity.
Expertise of an ID
Does being a specialist or an expert in a committee create a
greater risk for Independent Director?
• In the US, in a case relating to a class action suit, in Tischler v. Baltimore
Bankcorp 801 F. Supp. 1493 (D. Maryland 1992), it was held that the
overall responsibility for supervising the management of Bancorp and
verifying the assets, collateral, loan values, and determination of
appropriate loan-loss reserves and write-downs of non-performing loans
and assets, was limited to Independent Directors alone, because of their
specialized knowledge and expertise.
• The court, while allowed the motion against those directors who were
experts and sat in the Audit Committee, and disallowed the motion
against others who did not have such expertise.
• Similar position exists in India, as Sebi in its orders have disallowed ID’s
from taking a defence over lack of understanding of financial statements
resulting into errors.
• Independent Directors, particularly those sitting in Audit Committees,
must fulfil the higher standards of accountability commensurate to their
expertise and experience.
Expertise of an ID ...contd.
In Pyramid Saimira Case, Independent Directors overlooked several red flags
in the trends in revenues, profits, receivables, advances, etc., which enabled
the company to inflate its revenues and profits by fictitious entries in its
accounts, and failed to disclose these in quarterly and annual accounts of the
company.
SEBI, in its order, noted that such aberrations in financial numbers could not
be missed by an Independent Directors in the normal course, as was argued.
Such gaps would alert a man of ordinary prudence, and an independent
director who is part of Audit Committee, .
IDs, sitting on Audit Committee or any other committees with respect to
matters of financial statements, accounting, internal controls, etc , face a
higher risk of liability by their expert role.
Similarly, ID’s fulfilling an expert role in any other committee or process, would
have similar liabilities.
Thank you
Thought Arbitrage Research Institute
C 16, Qutab Institutional Area
New Delhi - 110016