Paradox of privacy
Whether private NBFCs-ML are required to appoint IDs?
– Neha Malu, Associate | finserv@vinodkothari.com
Independent directors have long been regarded as critical instruments of corporate governance. They bring fresh perspectives, specialized knowledge and most importantly, an element of unbiased oversight to board deliberations. Think of them as neutral referees who ensure fair play in business operations and uphold the integrity of boardroom decisions. Their presence helps reduce conflicts of interest, curb excessive promoter influence and encourage more balanced and professionally informed decision-making.
Under the Companies Act, 2013, section 149 read with rule 4 of the Companies (Appointment and Qualifications of Directors) Rules, 2014 lays down the categories of companies that are mandatorily required to appoint independent directors[1]. These categories do not include private companies. The rationale is intuitive: private companies, by their very nature of being closely held, are presumed to function under greater internal control, thereby reducing the perceived need for external board oversight. The whole basis of “privacy” of a private company will be frustrated if there are independent persons on its board.
Further, wholly owned subsidiaries are explicitly exempted from the requirement to appoint independent directors under rule 4(2), regardless of their nature or size.
And accordingly, a point of regulatory discussion arises in the case of (i) private NBFCs and (ii) NBFCs that are wholly owned subsidiaries, classified in the middle layer or above under the SBR Master Directions. While the Companies Act, 2013 does not mandate the appointment of independent directors for private companies and explicitly exempts WOS from such requirement, the corporate governance provisions under the SBR Master Directions require the constitution of certain committees, the composition of which hints towards the presence of independent directors.
This gives rise to a key question: Does a private NBFC or a wholly owned subsidiary, solely by virtue of its classification under the middle layer or above, become subject to an obligation to appoint independent directors?
Committees for NBFC-ML and above, the composition of which includes IDs
Upon classification as an NBFC-ML or above, conformity with corporate governance standards becomes applicable. Below we discuss specifically about the committees, the composition of which also includes IDs:
| Name of the Committee | Composition | Remarks |
| Audit Committee [Para 94.1 of the SBR Master Directions] | Audit Committee, consisting of not less than three members of its Board of Directors. If an NBFC is required to constitute AC under section 177 of the Companies Act, 2013, the Committee so constituted shall be treated as the AC for the purpose of this para 94.1. | As per section 177, an AC shall comprise a minimum of three directors, with Independent Directors forming a majority. Hence, in case the NBFC is not covered under the provisions of section 177, the same may be constituted with any three directors, not necessarily being independent directors. |
| Nomination and Remuneration Committee [Para 94.2 of the SBR Master Directions] | Composition will be as per section 178 of the Companies Act, 2013. | The provisions indicate that the NRC shall have the constitution, powers, functions and duties as laid down in section 178. In this context, Companies Act requires every NRC to consist of at least three non-executive directors, out of which not less than one-half should be independent directors. |
| IT Strategy Committee [Para 6 of the Master Direction on Information Technology Governance, Risk, Controls and Assurance Practices] | The Committee shall be a Board-level IT Strategy Committee (a) Minimum of three directors as members (b) The Chairperson of the ITSC shall be an independent director and have substantial IT expertise in managing/ guiding information technology initiatives (c) Members are technically competent (d) CISO and Head of IT to be permanent invitee | Chairperson of the Committee is required to be an ID. |
| Review Committee [Master Direction on Treatment of Wilful Defaulters and Large Defaulters] | The Composition of the Committee shall be as follows: The MD/ CEO as chairperson; and Two independent directors or non-executive directors or equivalent officials serving as members. | Where the NBFC has not appointed IDs, NEDs or equivalent officials to serve as members of the Committee. |
Divergent Market Practices
With respect to appointment of IDs on the Board and induction in the Committees, two interpretations are seen in practice in the case of private companies and WOS:
First, since the Companies Act does not mandate the appointment of independent directors in the case of private companies and explicitly exempts WOS, private NBFCs and WOS often rely on these statutory exemptions. The SBR Master Directions make a general reference to the Companies Act without distinguishing between company categories, which further supports the view that these entities constitute the relevant committees without appointing independent directors.
Second, given that NBFCs in the middle layer or above have crossed the ₹1,000 crore asset threshold and fall under enhanced regulatory scrutiny, some take the view that such entities should align with the intended governance standards and appoint independent directors, even if not required under the Companies Act.
Closing thoughts
The SBR Framework takes into account the systemic concerns associated with different NBFCs and thus classifies them into different layers. The corporate governance norms are applicable to ML, UL and TL NBFCs, which, given their asset sizes, are expected to operate at huge volumes and carry a great magnitude of risks. Such NBFCs may have access to public funds (by way of bank borrowings, debenture issuance etc.), wherein large lenders or public would have exposures and consequent high systemic risks. Hence, looking at the constitution (that is whether the NBFC is a private limited or public limited) becomes less important, and looking at the size, activity and function becomes more important.
Thus, it may not be right to conclude that NBFCs registered as private companies and WOS can do away with the mandatory composition prescriptions merely due to the constitutional form of their entity. Looking at the intent and idea of SBR Framework, the applicable NBFCs may be required to appoint independent directors irrespective of the form of their constitution. The scale-based regulation emanates from the idea that NBFCs having high risk should be effectively monitored. Thus, the regulations should be followed in spirit to effectively mitigate the risks arising in the course of the NBFC’s functioning.
[1] Pursuant to the provisions of section 149(4) of the Companies Act read with rule 4 of the Companies (Appointment and Qualifications of Directors) Rules, 2014, following companies are mandatorily required to appoint independent directions: listed companies, public companies having paid up share capital of ten crore rupees or more; or turnover of one hundred crore rupees or more; or having in aggregate, outstanding loans, debentures and deposits, exceeding fifty crore rupees as per the latest audited financial statements.
Read more:
What is a non-banking financial company?
Resources on Scale Based Regulations