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November 16, 2020

Know Rules for becoming an Independent Director of a Company

by CA Shivam Jaiswal in Corporate Law

Know Rules for becoming an Independent Director of a Company

A company acts through two bodies of people – its shareholders and its board of directors. The board of directors are in charge of the management of the company’s business; they make the strategic and operational decisions of the company and are responsible for ensuring that the company meets its statutory obligations. The directors are effectively the agents of the company, appointed by the shareholders to manage its day-to-day affairs. The basic rule is that the directors should act together as a board but typically the board may also delegate certain powers to individual directors or to a committee of the board.

What do you mean by an Independent Director?

Independent directors act as a guide to the company. Their roles broadly include improving corporate credibility and governance standards functioning as a watchdog, and playing a vital role in risk management. Independent directors play an active role in various committees set up by company to ensure good governance.

According to the provisions of the Companies Act, an independent director in relation to a company, means a director other than a managing director or a whole-time director or a nominee director:

  • who, in the opinion of the Board, is a person of integrity and possesses relevant expertise and experience;
  • who is or was not a promoter of the company or its holding, subsidiary or associate company or is not related to promoters or directors in the company, its holding, subsidiary or associate company;
  • who has or had no pecuniary relationship with the company, its holding, subsidiary or associate company, or their promoters, or directors, during the two immediately preceding financial years or during the current financial year;
  • none of whose relatives has or had pecuniary relationship or transactions with the company, its holding, subsidiary or associate company, or their promoters, or directors, amounting to 2%, or more of its gross turnover of total income or Rs. 50 lakh or such higher amount as may be prescribed, whichever is lower, during the 2 immediately preceding financial years or during the current financial year
  • who, neither himself nor any of his relatives:
    1. holds or has held the position of a key managerial personnel or is or has been employee of the company or its holding, subsidiary or associate company in any of the 3 financial years immediately preceding the financial year in which he is proposed to be appointed
    2. is or has been an employee or proprietor or a partner, in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed, of:
      • a firm of auditors or company secretaries in practice or cost auditors of the company or its holding, subsidiary or associate company; or
      • any legal or a consulting firm that has or had any transaction with the company, its holding, subsidiary or associate company amounting to 10% or more of the gross turnover of such firm
    3. holds together with his relatives 2% or more of the total voting power of the company; or
    4. is a Chief Executive or director, by whatever name called, of any non-profit organisation that receives 25% or more of its receipts from the company, any of its promoters, directors or its holding, subsidiary or associate company or that holds 2% or more of the total voting power of the company;
  • who possesses such other qualifications as may be prescribed;

Does the Companies Act mandate having an independent director?

  • It is mandatory that every listed public company shall have at least one-third of the total number of directors as independent directors and the Central Government may prescribe the minimum number of independent directors in case of any class or classes of public companies. Any fraction contained in such one-third number shall be rounded off as one.
  • Also, the following classes of companies shall have at least 2 directors as independent directors:
    1. Public Companies with paid-up share capital of Rs. 10 crores or more; or
    2. Public Companies with turnover of Rs. 100 crore or more; or
    3. Public Companies with aggregate outstanding loans, debentures, and deposits, exceeding Rs. 50 crores.

How long can an independent director hold term for?

  • Such independent director shall hold office for a term up to five consecutive years on the Board of a company, but shall be eligible for reappointment on passing of a special resolution by the company and disclosure of such appointment in the Board’s report.
  • No independent director shall hold office for more than two consecutive terms, but such independent director shall be eligible for appointment after the expiration of three years of ceasing to become an independent director
  • However, an independent director shall not, during the said period of three years, be appointed in or be associated with the company in any other capacity, either directly or indirectly.

What is the procedure for appointment of an independent director?

  • Diligently select a person proposed to be appointed as an independent director and ensure that he possesses appropriate balance of skills, experience and knowledge in the Board. The proposed person may be selected from the database of Independent directors maintained by any body, institute or association authorized by CG.
  • Ensure the proposed person to be appointed as Independent director in the company fulfils the conditions specified in Sec 149(6) and Rule 5 (Companies (appointment and qualification of Directors) Rules, 2014)
  • Ensure that the proposed director is not disqualified under Sec 164 and Sec 165 of the Companies Act 2013.
  • Ensure the individual proposed to be appointed as Independent Director has furnished his DIN to the company and a declaration in Form DIR-8 stating he is not disqualified to become director under the provisions of this Act. (Sec 152(4) and Rule 14 of Companies (appointment and qualification of Directors) Rules, 2014)
  • Before appointment of individual as Independent Director obtain consent to act as Director in Form DIR-2.
  • Issue Notice and agenda of Board meeting or a shorter notice in case of urgent business, in writing to every director of the company at his registered address with company. [Sec 173(3)]
  • Hold a board meeting and ascertain the quorum required under Sec 174 is present and pass the following resolution:
    1. To hold office up to a period of 5 years, subject to approval of Shareholders in the general meeting of the company.
    2. To authorize the Company Secretary or Director of the company to sign, fill the relevant Form and to do such acts, deeds and things as may be necessary to give effect to the resolution.
    3. To Fix day, date time, venue for holding general meeting of shareholders of the company.
    4. To Approve the draft notice of the meeting along the explanatory Statement annexed with notice as per the requirement laid down in Sec 102 of the act.
    5. To authorize the Director or the Company Secretary of the company to sign and issue the notice of the general meeting.
  • Hold the general meeting on the day fixed and pass the ordinary resolution for the appointment of Independent director.
  • As per Schedule IV(IV)(4) to the Companies Act, 2013 the Company will have to issue the appointment letter to Independent Director. Also, the terms and conditions of Independent Director’s appointment have to be posted on the company’s website.
  • Obtain the declaration of the appointed Director regarding his interest in other entities in Form MBP-1 within 30 days of appointment or at the first Board meeting in which he participates as a director., whichever is earlier. [Sec 182(1) read with Sec 182(2)]
  • File Form DIR-12 containing the particulars of the appointment of Director within 30 days of his/her appointment. (Sec 170 (2) and Rule 8 and 18 of the Companies (Appointment and Qualification of Directors) Rules, 2014.
  • The Independent Director has to submit a declaration of independence as per Section 149(6) of the Companies Act, 2013 before his/her appointment. Such declaration has to be placed before the 1st Board Meeting in which he/ she participates as a director and the subsequent first board meeting in each financial year.
  • In case of resolution passed as Special resolution for re-appointment of Independent Director, file a certified copy of special resolution in Form MGT-14 within 30 days of the date of general meeting.
  • Make necessary entries in the register of Directors and key managerial personnel and their shareholding.

What is the role of an Independent Director?

It is the duty of the Independent Director to:

  • give Independent judgement on any matter of the Board
  • prevent the management from taking decisions that is likely to affect the interest of the shareholders as large
  • ensure that there should not any unethical behaviour or fraudulent practices adopted by the board
  • ensure that there should not violation of any company’s policy
  • review the performance of non-independent directors and the Board as a whole;
  • review the performance of the Chairperson of the company, taking into account the views of executive directors and non-executive directors;
  • 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.
  • recommend the CSR Policy to the board;
  • recommend the CSR activities and programs as per Schedule VII;
  • specify the CSR expenditure;
  • monitor the CSR Policy of the Company from time to time
  • recommend for appointment, remuneration and terms of appointment of auditors of the Company;
  • review and monitor the auditor’s independence and performance, and effectiveness of audit process;
  • examine of the financial statement and the auditors’ report;
  • review annual financial statements with reference of accounting policies and practices.
  • determine appropriate levels of remuneration of executive directors, key managerial personnel and senior management and have a prime role in appointing and where necessary recommend removal of executive directors, key managerial personnel and senior management;
  • formulate Succession plan to ensure corporate governance, stability and sustainability of the business;
  • ensure that appointment and succession planning on merit basis.

An independent director has a crucial position in any company and hence its proper appointment is extremely important. By virtue of Section 172 which prescribes punishment for contraventions of any of the provisions of this Chapter (Chapter XI of the Act) and for which no specific punishment is provided therein, the Company and every officer of the company who is in default shall be punishable with fine which shall not be less than Rs. 50,000 but which may extend to Rs. 5,00,000.

The term ‘officer’ includes any director, manager or key managerial person (which includes the CFO and CS) or any other person in accordance with whose directions or instructions the Board of Directors or any one or more of the directors is or are accustomed to act.

As the penalty for non–compliance of the appointment of an independent director is not mentioned separately, the punishment prescribed under Section 172 shall be applicable.

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