Applicability on appointing an independent director
Listed Public Company
Every listed public company is required to have at least one-third of its total directors as independent directors. Any fraction resulting from this calculation should be rounded up to the nearest whole number.
Unlisted Public Company
According to Rule 4 of the Companies (Appointment and Qualification of Directors) Rules, 2014, certain unlisted public companies must appoint at least two independent directors:
- Public companies with a paid-up share capital of Rs. 10 crore or more.
- Public companies with a turnover of Rs. 100 crore or more.
- Public companies with aggregate outstanding loans, debentures, and deposits exceeding Rs. 50 crore.
Points to Note:
- The amounts as per the latest audited financial statements should be considered when calculating paid-up share capital, turnover, or outstanding loans, debentures, and deposits.
- Companies may need to appoint additional independent directors if required to constitute the audit committee.
- Certain unlisted public companies—such as joint ventures, wholly owned subsidiaries, and dormant companies—are exempt from appointing independent directors, even if they meet the financial thresholds.
Each independent director must submit a declaration confirming that they meet the independence criteria at their first board meeting and subsequently at the first board meeting of every financial year or whenever circumstances arise that may affect their independent status. Additionally, the terms and conditions of appointment of independent directors should be made available on the company’s website.
Qualifications of an independent director
The individual should possess relevant experience, skills, and knowledge in one or more areas such as law, finance, management, marketing, sales, research, administration, technical operations, corporate governance, or other fields pertinent to the company’s business.
Restrictions on relatives of an independent director:
- They must not be indebted to the company, its subsidiary, holding, or associate company, nor to any of their directors or promoters.
- They must not have provided a guarantee or security related to the indebtedness of a third party to the company, its subsidiary, holding, or associate company, or to their directors or promoters, exceeding Rs. 50 lakhs, at any time during the preceding two financial years or the current financial year.
Restrictions on the individual:
- The person must not be a promoter of the company or of its subsidiary, holding, or associate companies.
- They must not be related to any directors or promoters of the company or its subsidiary, holding, or associate companies.
- They must not have any financial relationship with the company, its subsidiaries, holding, or associate companies, or their directors or promoters, except for remuneration as a director or transactions not exceeding 10% of their total income, during the current or preceding two financial years.
Additional restrictions:
- The person or their relatives must not have served as Key Managerial Personnel (KMP) or as an employee of the company, or any of its subsidiary, holding, or associate companies, in the three financial years immediately preceding the year of proposed appointment.
- The person must not have been an employee, proprietor, or partner in any auditor firm, cost auditor, legal consultancy, or company secretary firm associated with the company, or its subsidiary, holding, or associate companies, in the three financial years immediately preceding the year of proposed appointment.
- The person, together with their relatives, must not hold more than 2% of the total voting power in the company.
- The individual must not serve as Chief Executive or director of any non-profit organisation that receives 25% or more of its funds from the company, its promoters, directors, or its subsidiary, holding, or associate companies, or that holds 2% or more of the company’s total voting power.
Role of an independent director
An Independent Director serves as a guide, mentor, and advisor to the company, enhancing corporate credibility and governance standards while acting as a watchdog to help manage risks. They play a crucial role in ensuring effective governance through active participation in various board committees. Key responsibilities of independent directors include:
- Resisting and countering undue pressures from owners.
- Supporting succession planning within the company.
- Providing independent judgment on matters such as strategy, performance, risk management, resource allocation, key appointments, and standards of conduct.
- Offering an objective perspective when evaluating the board’s and management’s performance.
- Monitoring, scrutinising, and reporting management’s performance against objectives agreed upon in board meetings.
- Protecting the interests of all stakeholders, particularly minority shareholders.
- Balancing conflicting stakeholder interests.
- Ensuring the integrity of financial information, and confirming that financial controls and risk management systems are effectively in place.
- Mediating conflicts between management and shareholder interests to achieve outcomes that are in the best interests of the company.
- Determining appropriate remuneration for executive directors, key managerial personnel, and senior management.
Conduct of an independent director
Independent directors are required to adhere to a strict code of conduct, performing their duties professionally, diligently, and in good faith. Observing these standards fosters trust among investors, particularly minority shareholders, and regulators. The Companies Act prescribes the following guidelines for professional conduct of independent directors:
- Maintain high ethical standards, integrity, and honesty.
- Act constructively and objectively when performing their duties.
- Exercise their powers in a bona fide manner, prioritising the company’s best interests.
- Allocate adequate time and attention to their professional responsibilities to enable balanced and informed decision-making.
- Avoid any external influence that may compromise independent and objective judgment when agreeing or dissenting in board decisions.
- Refrain from using their position for personal gain or for the benefit of associates, to the detriment of the company or its shareholders.
- Avoid actions that could undermine independent decision-making.
- Promptly inform the board if circumstances arise that affect their independence.
- Support the company in implementing and upholding best practices in corporate governance.
Duties of an independent director
- Undertake a proper induction and continuously update and refresh their skills, knowledge, and understanding of the company.
- Make reasonable efforts to attend the company’s general meetings.
- Make reasonable efforts to attend meetings of the Board of Directors and board committees of which they are members.
- Possess sufficient knowledge of the company and the external environment in which it operates.
- Report any instances of unethical behaviour, actual or suspected fraud, or violations of the company’s code of conduct or ethics policy.
- Act within their authority to help protect the legitimate interests of the company, its shareholders, and employees.
- Avoid unfairly obstructing the operations of the company or any Board committee.
- Participate actively in Board committees as a member or chairperson.
- Maintain confidentiality and not disclose sensitive information, including commercial secrets, technologies, marketing strategies, or unpublished price-sensitive information, unless authorised by the Board or required by law.
- Ensure that the company has an adequate and functional vigil mechanism and safeguard that the interests of anyone using this mechanism are not adversely affected due to its use.
Overview of independent directors’ provisions in the Companies Act, 2013
Certain companies are required to constitute a Corporate Social Responsibility (CSR) Committee to formulate and oversee the CSR policy. The CSR Committee must comprise at least three directors, including at least one independent director. In cases where a company is not mandated to appoint an independent director, the CSR Committee must consist of two or more directors.
The process of appointing an independent director must be conducted independently of the company’s management. An independent director may be selected from a data bank maintained by an institute, body, or association notified by the Central Government, which contains the names, qualifications, and addresses of individuals eligible and willing to serve as independent directors.
The appointment of the independent director must be approved by the company at a general meeting, and the explanatory statement attached to the notice of the general meeting should provide the justification for the selection of the proposed individual as an independent director.
Every independent director shall submit a declaration confirming that they satisfy the criteria of independence:
- On attending their first board meeting as a director.
- At the first board meeting of each financial year.
- Whenever a circumstance arises that may affect their status as an independent director.
An independent director shall be appointed for a maximum term of five years, which shall not exceed two consecutive terms. Reappointment is permitted only through a special resolution passed by the company.
Any vacancy in the position of an independent director must be filled at the next Board meeting or within three months of such vacancy, whichever is later. A person shall serve as an independent director in no more than seven listed companies simultaneously.
An independent director shall not retire by rotation and shall not be counted in the total number of directors for the purpose of calculating rotational directors.
A small shareholder director shall be considered an independent director if:
- They are eligible for appointment as an independent director under Section 149(6) of the Companies Act.
- They submit a declaration confirming that they meet the criteria of independence as specified under Section 149(7).
Where a board meeting is called at short notice to transact urgent business, the presence of at least one independent director is mandatory. In the absence of any independent director, a decision may be circulated to all directors and subsequently approved by at least one independent director.
Key advantages of appointing independent directors
Appointing independent directors offers several benefits to businesses. Below are the primary advantages:
- Improved governance: Ensure adherence to ethical and legal standards
- Unbiased decision-making: Provide impartial advice and prevent conflicts of interest
- Enhanced stakeholder trust: Boost confidence among investors, employees, and regulators
- Expert insights: Bring diverse expertise and fresh perspectives to board discussions
- Better compliance: Ensure adherence to statutory requirements and reduce regulatory risks
These advantages make independent directors an asset for organisations striving for sustainable growth.
Key disadvantages of appointing independent directors
Despite their benefits, appointing independent directors may pose some challenges. Below are the disadvantages:
- Cost implications: High remuneration and additional administrative costs can strain company budgets
- Limited involvement: Part-time roles may result in a lack of deep understanding of the company’s operations
- Potential delays: Conflicts between independent directors and management can slow decision-making processes
- Resource dependence: Independent directors may rely on company-provided information, limiting their independent analysis
Balancing these disadvantages with the benefits is crucial for effective governance.
Conclusion
Independent directors play a pivotal role in promoting good governance, transparency, and ethical practices in companies, especially public companies. Their impartiality and expertise strengthen decision-making, enhance stakeholder confidence, and ensure compliance with regulations like the Companies Act, 2013. Despite challenges, their advantages significantly outweigh the drawbacks, making them essential for sustainable growth.
Bajaj Finance offers tailored financial solutions, such as a secured business loan or a business loan, to support companies in meeting their governance requirements while focusing on expansion and operational excellence. Businesses can use tools like the business loan EMI calculator to plan repayments efficiently, and check business loan eligibility to understand the documentation and criteria required. With competitive business loan interest rates and flexible terms, companies can leverage these funds to invest strategically.
With independent directors guiding corporate governance, businesses can achieve better compliance, operational efficiency, and long-term success.
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