Appointment of independent directors

Appointment of Independent Directors under the Companies Act, 2013 – Can it be through Board Process or through General Meeting - Some grey areas visited.

Introduction

Recognizing the need to elevate the levels of corporate governance not only in the context  of listed companies but also in unlisted companies which satisfy the prescribed criteria, the Companies Act,2013(hereinafter referred to as “The Act”) has ushered in the requirement of appointing  Independent Directors (IDs) by companies belonging to the above genre. Readers are aware that prior to the introduction of the Act ,only the Boards of listed Entities had to have the required number of IDs to fall in line with the requirements of Clause 49 of the Listing agreement relating to Corporate Governance.

Rule 4 of the Companies (Appointment and  Qualifications ) Rules,2014, read with Section 149(4) of the Act  provides that the following classes  of companies shall have at least two IDs–

i. public companies having a paid-up capital of Ten Crore Rupees or more or

ii. public companies having turnover of one hundred crore Rupees or more or

iii. public companies which have, in aggregate outstanding loans, debentures and deposits exceeding fifty crore Rupees.

The above thresholds being mutually exclusive, any public company which satisfies any one of the above conditionality will fall within the ambit of the above requirement. We would hasten  to add that in as much as the term ”public company” as defined under Section 2(71) of the Act has an extended connotation to bring within its ambit ,the Subsidiary of a public Company, those companies which are subsidiaries of a public company which satisfy any one of the above thresholds, will have to appoint IDs.

It is also pertinent to note that as   Section 149 in the Act was made operative from April, 1, 2014, companies impacted by the above requirements, had to appoint IDs   latest by March, 31,2015 pursuant to the gateway extended by Section 149(5) in the Act.

In this exposition, it shall not be   our endeavour to analyse the nuances of the law where it comes to the attributes of an ID but to introspect over the procedure laid down in the Act for appointing  IDs  which we will soon discover throws up several contentious issues , thus opening up the field for controversy and  healthy debate.

Appointment of ID to be approved by General Meeting

Section 150(2) of the Act   provides, inter alia, that the appointment of ID shall be approved by the company in General Meeting. For facility of analysis, the above provision is reproduced below with emphasis supplied where considered necessary.

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“The appointment of Independent Director shall be approved (emphasis supplied) by the company in general  meeting as provided in sub-section(2) of Section 152  (emphasis supplied) and the explanatory statement annexed to the notice for the general meeting called to consider the said appointment shall indicate the justification for choosing the appointee for appointment as Independent Director”.

Unquote

From the above, it is clear that Section 150(2) is not intended to  be read in isolation. As it has to be  has to be read conjointly with sub-section (2)of Section 152,it would be appropriate to analyse the provisions in tandem and for this purpose sub-section(2) of Section 152 is reproduced below as under:

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Section 152(2)

“Save as otherwise expressly provided in this Act (Emphasis supplied), every Director shall be appointed by the company in general meeting. “

Unquote.

From a plain and conjoint reading of the above two provisions, the following postulates emerge:

1. The appointment of an ID has to be approved at a General Meeting in the manner provided in Section 152(2).

2. Such appointment at General Meeting shall be subject to the exceptions contemplated in the Statute in view of the existence  of the words save as otherwise expressly  provided in this Act in Section 152(2).

It follows from the above that the requirement of appointing a director including an ID at a general meeting shall be subject to the exceptions expressly carved out under the Act as contemplated in Section 152(2).

It would be foolhardy and premature to conclude that the appointment of a Director can be made only through the process of approval by members at general meeting.

Section 161 –Appointment of Additional Director, Alternate Director, Nominee Director and director to fill up a casual vacancy

Section 161 of the Act confers on the Board the power to appoint, subject to the existence of enabling provisions in the company’s Articles, a person as a Director in the following situations:

i. As an Additional Director who shall hold office up to the date of the next annual general meeting or the last date on which the annual general meeting should have been held, whichever is earlier. The rider for such appointment is that the proposed appointee should be a person other than a person who fails to get appointed as a director in a general meeting.

ii. As an Alternate director for a Director during his absence for a period which is not less than three months from India. The condition precedent to be satisfied by the appointee is that he should not be holding already any alternate directorship for any other director in the company,  whilst being considered for such appointment.

iii. The  Board can appoint any person as a Director nominated by any Institution pursuant to the provisions of any law or any agreement or by the Central Govt. or State Govt.  by virtue of its shareholding in a Govt. company.

iv. To  fill up the casual vacancy in the office of a director appointed in general meeting which is caused before the expiry of the term of his office in the normal course. Such appointment can be made by the Board in a public company at a duly convened meeting. It is pertinent to note there exists an obvious drafting anomaly in Section 161(4) which defies both reason and logic, in consequence of which  a casual vacancy caused in the office of a Director cannot be filled up in a private company except   through the process of approval at a general meeting. It would have been appropriate if the above anomaly had been set right along with the slew of exemptions which were issued by the MCA for private companies vide notification  F.No.1/1/2014-CL.V dated 5.6.2015.

Therefore, notwithstanding what is stated in Section 150(2) reproduced above, the law does provide for situations where   a Director can be appointed with the authority of the Board, Articles permitting, albeit for limited periods of time as applicable to each situation carved out in Section 161 above.

The moot question that therefore comes up is whether the Board can appoint a person as an Independent Director in the capacity of an Additional Director or to fill up a casual vacancy caused by the resignation or otherwise of a previous incumbent. Of course any person appointed as a “Nominee director” cannot be considered as an Independent director in view of the definition contained in the Explanation under Section 149(7).In the same vein, one cannot appoint a person as an Independent director in the capacity of an Alternate Director in view of the requirement that the incumbent has to vacate office simultaneous with the return of the original Director to India. In our view, the answer would be an unequivocal “yes” given the fact that an Independent Director is in the first place , a Director , with the only additional attribute being that as an ID, he has to satisfy the requirements of Section 149(6) of the Act.

Rule 4 of Companies (Appointment and Qualification) Rules,2014 and Schedule IV of the Act

The   above view also stands fortified by the fact that   the second proviso under Rule 4 of the companies(Appointment and Qualification)Rules 2014 contemplates that any  intermittent vacancy of  an ID shall be filled up by the Board at the earliest but not later than the immediate next Board Meeting or three months from the date of such vacancy, whichever is later.

The relevant proviso under Rule 4  ibid is reproduced below for ease of reference:

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“Provided further that any intermittent vacancy of an Independent Director shall be filled up by the Board at the earliest but not later than immediate next   Board meeting or three months from the date of such vacancy, whichever is later.”

Unquote

The above proviso clearly provides for the appointment of an ID to fill up intermittent vacancies by the Board within the time lines stipulated above.

Schedule IV of the Act which has been carved out under Section 149(8) of the Act also provides the recipe for appointment of IDs to fill up vacancies caused by resignation or removal. Clause (2) under paragraph VI in the above Schedule IV reads as under:

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“An Independent Director who resigns or is removed from the Board of the company shall be replaced by a new Independent Director within a period of not more than one hundred eighty days from the date of such resignation or removal as the case may be”

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There exist certain subtle differences as between the proviso to Rule 4  referred to above and the relevant clause of Schedule IV of the Act Section 149(8) of the Act especially  in the matter of the time span which can be taken for filling up a vacancy in the office of an ID , caused by his resignation or removal. Whereas Clause (2) in paragraph VI in Schedule IV to the Act  provides  that an ID who resigns or is removed from the Board shall be replaced by a new ID within a period of not less than 180 days from the date of resignation or removal as the case may be,  the proviso under Rule 4 provides for an interval not exceeding three months or the date of the next Meeting of the Board whichever is later. In addition, Rule 4 speaks about the filling up of intermittent vacancies in the Board caused by any eventuality be it death, resignation or removal of the incumbent. On the other hand, Schedule IV speaks only about filling up vacancies caused by resignation or removal of the incumbent. Finally, Rule 4 puts the onus of filling up intermittent vacancies on the Board while Schedule IV stops short of stating whose responsibility it would be – whether it is  the Board or the Members who should  fill up the vacancy. However  , considering the limited   time span of 180 days given in Schedule IV , an inference can be drawn that the onus of filling up the vacancy rests with the Board. The paraphernalia   associated  with  convening a General Meeting  in a large listed entity having a sizeable number of members is considerable and a time line of 180 days may not really be adequate to go through the process if it is assumed that the vacancy has to be filled up only at the  General Meeting of the Members. Besides, the cost involved in holding a General Meeting for  a large company is quite high and such costs may not be at all justified if the limited Agenda for the General Meeting is the appointment of an ID!. In our view, therefore the scales of justice would appear to   be   heavily tilted in favour of an appointment through the  Board process,given also the flavor of the language used in the operative portion of Schedule IV.

Dichotomy between Schedule IV and the Proviso under Rule 4 – which  provision will prevail?

From the above discussion, it is clear that there is a divergence between Clause (2) in para VI of Schedule IV and the second proviso in Rule 4 above as regards the time span within which the vacancy in the office of an ID is to be filled up. Whereas Schedule IV provides for an interval of 180 days  , Rule 4 speaks about a period of 90 days or before the next meeting of the Board whichever is longer. The question that comes up for consideration is as to which provision will have greater legal strength and force.

Schedules which are appended to Statutes form part of the statute as held by the Apex Court in  Ujagar  prints vs. Union of India (AIR 1989 SC 516 at page 531). Schedules are added towards the end and their use is made to avoid encumbering the Sections in the Statute with matters of excessive detail.

Rules on the other hand, being in the nature of delegated legislation  are  sub-ordinate to the Act and are subject to challenge on the ground that they are contrary to other statutory provisions or that it cannot be said to be in conformity with the Statute or it has been made in bad faith.(Indian Express Newspapers Vs union of India(1985 1 SCC 641).

The above being the legal position, it can be stated that in the face of a conflict between Schedule IV and Rule 4 , the contents of  Schedule IV will have greater force and  shall prevail. We can therefore state that in the event of a vacancy being created in the office of an ID caused due to resignation or removal, the company can fill up the vacancy within a period of 180 days or the date of the next meeting of the Board whichever is later.

Issues relating to appointment of IDs

In the foregoing discussion, we have conclusively demonstrated that the appointment of an ID can also be approved by the Board through the route of appointment as an Additional director or to fill up a casual vacancy as contemplated by Section 161 of the Act.

Where an ID is appointed by the Board in the capacity of an Additional Director, as we know, he remains in office only till the date of the next Annual General Meeting. His appointment can however be regularized through the process laid down in Section 160 of the Act. Similarly when someone is appointed  as an ID to fill up a casual vacancy caused by the resignation of the previous incumbent,  he can hold office only up to the date up to which the director in whose place he is appointed would have held office if it had not been vacated. In  this  instance,  also the appointment can be regularized through the process laid down in Section 160 of the Act. The above situation gives rise to another issue . Section 149(11) of the Act provides that an ID cannot hold office for more than two consecutive terms. Each term cannot exceed a period of five consecutive years. The question that comes up is whether the length of office held by an ID appointed by the Board either in the capacity of an Additional director or to fill up a casual vacancy be considered as a term. If the answer to the above is in the affirmative and  in case the incumbent’s appointment is regularized by appointment at General Meeting by the members say for a period of five years, it would mean that he cannot be eligible for a further term without cooling his heels for a period of three years  after the expiry of the term of five years as stated in Section 149(11). Readers are aware that an ID is eligible for appointment for two terms each not exceeding a period of five consecutive years.Viewed against this perspective, it would be unfair to consider the fractured term of office as   an ID in the capacity of an Additional Director as a single term. Unfair as it may sound, the law having being structured in this manner there is little that can be done to salvage the situation unless enabling amendments are made to the law.

Appointment of IDs - Confusion galore in the transitional year

There is another situation which companies have had to confront in the year gone by due to the introduction of Section 149 effective from April, 1, 2014.As stated before, the specie of an ID was not recognized in   the previous act of 1956.This becomes clear also from the Explanation under Section 149(11) of the Act which states that the tenure of an independent director on the date of commencement of the Act shall not be considered as a term for the purposes of subsections (10 ) and (11). Listed companies which have pre-existed the Act, as on April,1, 2014 already had on board, their  complement of Independent directors in deference to the requirements of clause 49 of the Listing Agreement. Sub-section (5) of section 149 provides that every company existing on or before the commencement of this Act, shall within one year from such commencement or from the date of notification of the Rules in this regard as may be applicable, comply with the requirements of sub-section (4) which envisages   that every listed company should have at least one-third of the total number of directors as Independent directors.  It is also pertinent to note that persons appointed as IDs in listed companies were liable to retire by rotation under the erstwhile Act,whereas under the 2013 Act, as provided in sub-section (13) of Section 149 they are not liable to retire   by rotation. In the face of such contrasting provisions as between the 1956 Act and the present Act, the status of Independent directors who pre-existed before the enforcement of the 2013 Act was rendered somewhat ambiguous and uncertain in the transitional year post April 1 2014. The other related question was whether as of April, 1, 2014 they could be considered as IDs, given that they had not been appointed as IDs under the new Act. The associated legal uncertainties led to a myriad of procedures being adopted by companies ,none of which could be considered as being entirely wrong or right. Some companies, taking cognizance of the fact that the existing IDs as on April,1,2014 were liable to retire by rotation ,took to the route of regularizing their appointment as IDs not liable to retire by  rotation at the first  Annual General Meetings( AGMs) held after the new Act had become enforceable. At the AGMs, Ordinary Resolutions were proposed for their appointment as IDs not liable to retire by rotation   for periods of five years each through notices received  from members   under Section 160 of the Act proposing their candidature for IDs not liable to retire by rotation. In the case of some companies, resolutions were proposed at their   first   AGM   held under the new Act for appointment of all the surviving IDs for terms of five years each. Another variant procedure was to appoint at the  first AGM  under the new Act,  as Non-retiring IDs   those directors who were liable   to retire by rotation as per the predecessor Act . None of the above procedures could be considered as entirely right or wrong   , as an element of uncertainty without an iota of doubt hung over the status of the surviving IDs upon the onset of the new Act. Given the fact that   their appointments were regularized under the regime of the new Act well after the end of one year from the date of its introduction, the question that will remain unanswered eternally as it were, is whether their continuance as IDs in the respective companies   was valid and within the   four corners of law till the date of their appointments under the new statute. If so, whether the period of their office post April,1,2014 till their appointment afresh would be considered as a term. It would be interesting to see the response of the MCA to the myriad procedures followed once they are subjected to an inquest.

The divergence in procedure and the kaleidoscopic  hues that it has given rise to, could in our view ,have  been avoided if the introduction of Section 149 had been made prospective from a  later date and not with effect from April 1,2014.

Conclusion

An elaborate discussion on a relatively innocuous issue of appointing Independent Directors would not have been   perhaps warranted if there was enough clarity in the Act as to the procedure to be adopted. Unfortunately the new Act has belied all expectations of being user-friendly and has opened up, a  Pandora’s box. Corporate India is still struggling   to come to grips with the complexities and endeavoring to unravel the many   mysteries  of the   new law. It is about time that the new enactment is subjected to a comprehensive overhaul instead of being tinkered with, in bits and pieces, a is being done in recent times, through a slew of notifications and Rules issued by the MCA.

Ramaswami Kalidas