In an earlier article under the ‘Gatekeepers of Governance’ series, the authors had discussed how the regulatory architecture under the Companies Act, 2013 (“Act”), and the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR”), places ‘independent directors’ (“IDs”) at the forefront of India’s quest for better corporate governance. However, it is often forgotten that along with IDs, even non-executive non-independent directors (“NENIDs”) on the Board can play a pivotal role in acting as a ‘watchdog’, and safeguarding stakeholder interest.
The NENIDs on the Board represent the promoter/ majority shareholder. In most cases, they are senior executives in one of the group companies of the promoter/ majority shareholder, having domain knowledge of the industry and vast corporate experience. The NENIDs also have greater ‘skin in the game’, as their performance on the Board of the group company would serve as an important marker while assessing their overall contribution to the business group.
Unlike the extensive statutory prescriptions for IDs, the roles/ responsibilities of NENIDs are underarticulated. Moreover, the role of the NENID on the Board is most misunderstood and their duties/ responsibilities are often forgotten. This is despite the fact that an NENID’s role assumes special relevance in the Indian context, where majority of large companies are a part of business houses, with a common promoter/ majority shareholder who exercises control over all the group companies.
However, given that NENIDs represent the promoter/ majority shareholder, it is almost assumed that they do not have any fiduciary duty to ensure better governance – and have no role to play in safeguarding stakeholder interest. The law under Section 166 of the Act and Regulation 4 of the LODR imposes the same fiduciary duties on all directors, irrespective of whether they are ‘independent’ or not. The regulatory architecture also does not distinguish between the liability of NENIDs, vis-à-vis the liability of IDs.
Further, like all other directors, NENIDs are bound to comply with the stringent requirements of the SEBI (Prohibition of Insider Trading) Regulations, 2015, which brings to light the contentious issue of sharing unpublished price sensitive information (“UPSI”) with the parent company/ majority shareholders.
In this article, the authors delve deep into the role of NENIDs on the Board, discuss key issues and suggest certain reforms that can be made to strengthen this institution.
Appointment and Remuneration
The appointment of NENIDs is regulated under Section 152 of the Act and requires shareholders’ approval by an ordinary resolution. The grounds for disqualification and vacation of office prescribed under Sections 164 and 167 of the Act are also applicable to NENIDs. However, unlike IDs, the Act and the LODR do not prescribe any specific eligibility criteria for NENIDs. The remuneration paid to NENIDs broadly consists of (i) sitting fees, for attending Board/ Committee meetings; (ii) commission based on net profits; and (iii) fees for any professional service rendered to the company. In the event of loss/ inadequate profits, the remuneration payable to NENIDs is subject to the limits prescribed under Schedule V of the Act.
Further, if an NENID on the Board of a listed company receives remuneration that is more than 50% of the total remuneration that is payable to all non-executive directors, payment of such remuneration will require shareholders’ approval by a special resolution.
Section 166 of the Act prescribes the same fiduciary duties for all directors. Given that NENIDs represent the promoter/ majority shareholder, it is often assumed that they have no fiduciary duty towards the company, and their fiduciary duty is only towards the promoter/ majority shareholder, who has nominated the NENID on the Board.
However, it is pertinent to note that in the Rolta judgment, the Bombay High Court held that every director’s fiduciary duty towards the company attains primacy. Hence, an NENID wears only one hat when he sits on the Board and has a fiduciary duty to act in the best interests of the company and all its stakeholders.
It is pertinent to note that the regulatory architecture and even the judiciary do not make any distinction between the liability of NENIDs and IDs. The safe harbour provision under Section 149(12) of the Act provides them with the same grounds for immunity, when compared to IDs. Significantly, the vicarious liability clauses under various statutes, dealing with offences committed by companies, places NENIDs on the same pedestal as other directors.
They are equally liable for all acts/ omissions committed by the company and they cannot defend themselves on the ground that they were only acting on the diktats of the majority shareholder.
In this regard, it is interesting to note that in a recent judgment, the Madras High Court held that even NEDs of a pharma company (who are not involved in the day-to-day management of the company) would be liable under the Drugs and Cosmetics Act, 1940, in the event of production of sub-standard drugs by a company.
An NENID’s value addition on the Board
Improving the quality of deliberations during Board meetings and contribution towards the overall Board process
As NENIDs have domain knowledge of the entire business group and are well-versed with the risk profile, strategic objectives, and aspirations of the controlling shareholders/ parent company, their contribution towards improving the quality of deliberations at the Board/ Committee meetings is crucial. Especially in case of group companies of a large business house/ conglomerate, they play an important role in ensuring that the Board is aligned with the risk appetite and strategic objectives of the controlling shareholders.
In many situations, NENIDs provide perspective during Board meetings, and assume the role of a lead director, where the controlling shareholder ultimately exercises the voting power, and is a key decision-maker on important proposals dealing with capital raising, M&A, corporate restructuring, etc.
In many cases, the corporate policy of many business houses/ groups provides that since NENIDs draw normal remuneration from a group company where they serve as senior executive/ KMP, they will not be drawing any sittings fees and/ or commissions as an NENID. Hence, they are totally ‘objective’ and ‘impartial’ in ensuring that the financial results reflect a ‘true and fair view’ of the state of affairs of the company, as they have no incentive in showing artificially inflated profits to earn more commission.
Vital role on the NRC
An NENID on the Nomination and Remuneration Committee (“NRC”) has a pivotal role to play, as he can convey the views of the promoter/ majority shareholder (regarding appointment/ re-appointment of the CEO, CFO, etc.) to other NRC members. This is vital as the NRC’s recommendations on matters relating to appointment/ re-appointment of MD/CEO, WTDs and other directors will have no effect unless the promoter/ majority shareholder supports the recommendations at the general meeting.
By facilitating alignment between the NRC and the promoter/ majority shareholder, NENIDs play an important role in succession planning for the positions of MD/ CEO, CFO, etc. Further, NENIDs are also better placed to provide the NRC and the promoter/ majority shareholder with candid feedback about the performance of the MD/ CEO, CFO, etc. They also play a crucial role in situations where the CEO of a group company is under-performing and needs to be replaced.
Role on the Audit Committee
NENIDs bring better perspective to the Audit Committee’s deliberations, by delineating the business justification on matters like RPTs with group companies, inter-corporate investments, etc. For instance, given their domain knowledge of the group, NENIDs may be in a better position to delineate synergies/ economies of scale and the larger commercial justification for proposed RPTs to be entered into between group companies.
Bridge between the management team, controlling shareholders and independent directors
On many occasions, NENIDs have played an important role in ensuring a healthy relationship between executive directors and IDs, by acting as an impartial arbitrator. Often, MD/ CEOs and other WTDs take their advice seriously, as they represent the views of the controlling shareholder.
NENIDs play an important role in preventing any communication gap between the controlling shareholder, the top management, and the IDs, by taking steps to ensure parity of information on important proposals and key issues facing the company. This can be illustrated with the following examples.
First, let us say that the management team of a company deems it appropriate to raise funds by way of a rights issue. NENID’s inputs on this issue would be most vital as he/ she provides key insight on whether the controlling shareholder would support such a rights issue.
Second, if the management team is considering a major acquisition proposal, the NENID is effectively placed to (i) convey his honest view on the merits/ demerits of the proposal to the promoter/ majority shareholder; and (ii) provide the management team with the promoter’s views on the proposal.
Sharing of UPSI with the controlling shareholders
The above discussion on ‘communication’ between NENIDs and the controlling shareholders brings us to the elephant in the room – i.e., sharing of UPSI by the NENIDs with the controlling shareholders.
As the Kotak Committee noted, informal channels for communication of UPSI have always existed, with the promoter being akin to a ‘perpetual insider’. The Kotak Committee also recognised that such sharing of UPSI is generally for sound business reasons, like acquisitions, mergers, divestments, etc., that require promoter support to be successful. Further, it was noted that as the PIT Regulations do not expressly provide a formal green channel for UPSI sharing with promoters/ controlling shareholders, the possibility of an ex post facto regulatory scrutiny cannot be ruled out.
The issues relating to UPSI-sharing also assume special relevance for listed Indian subsidiaries of foreign multinationals – where there are detailed ‘reporting formats’ for information sharing with the foreign parent.
As on date, there is also no jurisprudence that affirms that UPSI sharing with promoters/ controlling shareholders would be regarded as a ‘legitimate purpose’ under Regulation 3 of the PIT Regulations.
One must not lose sight of the fact that on most occasions, there is a legitimate business justification to such sharing of UPSI. It enables the controlling shareholders to take a reasoned and well-informed decision on aspects such as fund-raising, strategic acquisitions, divestments, etc.
Given that informal channels of communication already exist, it would be advisable for the regulator to formally recognise such UPSI-sharing, by suitably amending the PIT Regulations on the lines indicated in the Kotak Committee Report.
Keeping in mind the value that NENIDs bring to the Board, certain reforms can be considered, for giving greater teeth to this institution.
Dissent recorded by NENIDs should be disclosed in the Board’s report
Under the existing legal architecture, if an NENID dissents from any decision taken by the Board, and records a dissent note, this will only be recorded in the Board/ Committee minutes and would not be disclosed to the stakeholders. Given the vital role played by NENIDs in safeguarding stakeholder interest, as a starting point, the Act should be amended to make it mandatory for companies to disclose details of any dissent recorded by NENIDs in the Directors’ Report for the financial year.
Whilst the regulators cannot be over-prescriptive on this aspect, it will be helpful to prescribe certain objective parameters for performance evaluation of NENIDs – that can serve as a starting point for the NRC.
Code for NENIDs
Akin to the Code for IDs, the Act can also be amended to prescribe a Code for NENIDs, that can inter alia prescribe guidelines for professional conduct, roles and functions, process for information sharing with the controlling shareholders, etc.
Along with acting as a guidepost for NENIDs, a specific ‘Code for NENIDs’ will provide statutory recognition to their importance under the Indian corporate governance architecture.
 Regulation 17(6)(ca) of the LODR.
 Rolta India Limited v. Venire Industries, 2000 (2) Bom CR 241
 Vikas Rambal v. State, 2022 SCC OnLine Mad 4822. Para 24 of the Madras HC judgment notes as follows – “The offences and the offenders in the case of this nature is manufacturing and distribution of sub-standard drugs by a Company which is managed by its Board of Directors. The decision to manufacture the drugs is the collective decision of the Board of Directors. Therefore, the Directors cannot claim that they are not directly involved in the product of the drugs, when the decision to produce the drugs itself is the outcome of their decision. Therefore, the case of Directors signing the cheque on behalf the Company and the case of Directors participating in the decision to produce sub-standard drugs are not one and the same to hold that these petitioners are not involved in day-to-day affairs of the Company”.
 Kotak Committee Report, at Page 49 and Page 50.