The Independence of Directors

Cyrus Mistry’s removal as chairman of Tata Sons Ltd. and his subsequent letter to the Board, highlighting amongst other things, the “failure on the part of the directors to discharge their fiduciary duty owed to the stakeholders of Tata Sons” brings to the fore what Mistry himself describes as a “total lack of corporate governance.” Mistry notes in his letter that, he is surprised that some Independent Directors voted for his removal, especially since they recently lauded his performance. Mistry’s letter will lead to scrutiny of many aspects of corporate functioning, particularly within the Tata Group, and in public companies in general. One of the areas likely to come up for questioning is the role of Independent Directors and their ability to balance conflicting interest amongst stakeholders.

The Board of Directors or Board as defined under the amended Companies Act, 2013 (the “Act”) means the collective body of directors of the company. The word ‘collective’ is a new addition which recognizes that the Board of Directors can only act collectively. Notably, the Board is the highest decision making body of any company and central to a company’s governance process. The law makers believed that, since the Board has to balance various responsibilities, the presence of Independent Directors would improve corporate governance. The law recognizes that despite directors having a fiduciary responsibility towards the shareholders, the directors may still be confined to the perspective dictated by the specific interests they represent on the Board. Hence, it was felt that Independent Director would bring objectivity to a Board.

Public companies, listed or unlisted, which have a paid-up share capital of ten crore rupees or more or a turnover of one hundred crore or more are required to have at least 2 Independent Directors. An Independent Director is broadly defined as a director, other than a managing director or a whole-time director, who in the opinion of the Board is a person of integrity and possesses relevant expertise and experience. And as stipulated in the Act, an Independent Director must possess appropriate skills, experience and knowledge in one or more fields of finance, law, management, sales, marketing administration, research corporate governance technical operations or other disciplines related to the company’s business.

For the first time, the Act lays down a code and duties for Independent Directors and in doing so, follows the two-fold role of Independent Directors as applied in the United Kingdom, namely to contribute towards business strategy and scrutinize management’s performance. The Act provides guidance about the standards that Independent Directors should maintain and requires that Independent Directors should truly be independent and should not be related to a promoter or other directors of the company and should have no pecuniary relationship with the company or its subsidiary or holding company. Markedly, the Act excludes the proprietor or partner of a legal or consulting firm that has or had any transaction with the company in any of the preceding three years, amounting to 10% of the gross turnover of such firm, from being an Independent Director.

Some key duties of Independent Directors include to up-hold ethical standards of integrity and probity, to act objectively and constructively while exercising the duties and to exercise responsibilities in a bona-fide manner in the interest of the company. The law further stipulates that Independent Directors should help in bringing an independent judgment to the Board’s deliberations especially on issues of strategy, performance, risk management, resources, key appointments and standards of conduct. Independent Directors are expected not to allow any extraneous considerations that will vitiate his exercise of objective independent judgment in the paramount interest of the company as a whole.

Mistry’s letter and the counter attack from the Tatas are sure to raise questions on whether the Tata Sons Ltd. Board acted in accordance with the statutory requirements. But, legality aside given Tata Groups stellar reputation, what is most discomforting is the potential damage to the Tata brand.

If Mistry’s letter presents a true picture of the functioning of the Board, then the role of the Independent Directors is definitely going to come up for questioning. The Act clarifies that,  an Independent Director shall only be liable in respect of acts of omissions or commission by the company which occurred with his knowledge, attributable through the Board processes and with his consent or connivance or where he had not acted diligently. However, it should also be noted that, if an Independent Director does not initiate action even upon knowledge of any wrong, then he shall be held liable. To attribute knowledge, reliance will have to be placed on the Board process – Board agenda, Board notes and the minutes, all of which will play a vital role in such determination. Interestingly, some of these notes are beginning to emerge.

Something that is necessary to highlight and which has not been noted anywhere so far in relation to the Tata fallout is that, Independent Directors of a company are required to hold at least one meeting in a year, without the attendance of non-independent directors and members of management of the company. At such meeting, termed a “separate meeting”, the Independent Directors are required to review the performance of non-independent directors and the Board as a whole. They are also to review the performance of the Chairperson of the company, taking into account the views of executive directors and non-executive directors. Further, they are to assess the quality, quantity and timeliness of flow of information between the company management and the Board that is necessary for the Board to effectively and reasonably perform their duties.

Did the Independent Directors of Tata Sons Ltd. hold the required “separate meeting”? If Mistry had indeed deviated from the Tata culture and ethos, did the Board raise this with Mistry directly or at a board meeting any time prior to Mistry’s removal? Have the Independent Directors reviewed Mistry’s performance and sought the views of others? Equally, did Mistry raise the issue of the alleged intervention of non-board members in the decision making ever before? Did he record his dissent and if not, why not?

It is indeed unprecedented for a chairman of a large conglomerate to be removed in the manner that Mistry was. But it is equally unprecedented for a chairman to himself make such scathing indictments regarding the governance of a company he headed for many years. And while the Tata-Mistry feud will most likely eventually get resolved, the real fallout will be on the shareholders and investors of public companies who are likely to lose confidence in the governance structures of large companies. If it can happen at the house of Tatas, it can potentially happen anywhere else!

Satvik Varma is a graduate of Harvard Law School, currently practicing as a corporate commercial lawyer in New Delhi