The Detachment Dilemma: Cooling-off period for 2 term Independent Directors
Avinash Shetty, Manager l corplaw@vinodkothari.com
| Table of contents |
| Introduction |
| Role of IDs |
| Appointment and Tenure |
| Cooling Off period |
| Conclusion |
Introduction
The year 2024 will witness one of the first and biggest board transitions when it comes to Independent Directors (“IDs”) serving for a decade in the Indian public companies, either listed or unlisted. This is because the applicability of Section 149 of the Companies Act, 2013 (“Act”) became applicable from the 1st of April, 2014 wherein IDs were allowed to hold office for a maximum tenure of upto 5 consecutive years and be associated as such for not more than 2 such terms. The tenure of IDs held before the applicability of the Act was grandfathered.
Following the conclusion of the two terms on March 31, 2024 (or, if the appointment was effective till the 2024 AGM, then the AGM date), more than 130 IDs across nearly 75 companies have ceased their roles[1]. As of March 31, 2023, there were 198 companies within the NIFTY 500 that had 375 IDs whose tenure exceeded 10 years. Notably, 14 of these directors had served on their respective boards for 30 years or more.[2] As the maximum tenure for IDs is two consecutive terms of five years each, followed by a cooling-off period of 3 years, an extremely pertinent question comes up on the continued association of these outgoing IDs with such companies.
Role of IDs
If corporate governance is all about rising above the interests of limited stakeholders, IDs as an institution form the very lynchpin of corporate governance. IDs perform a number of critical functions, including but not limited to bringing independence,, expertise and objectivity to Board discussions, balancing stakeholder interests, and offering unbiased opinions during board discussions on issues such as risk management, related party transactions and board performance. Appointment and participation of IDs in decision-making proceedings have been kept at a higher pedestal as compared to other categories of directors when it comes to board independence and ensuring a proper mix of independent and non-independent directors.
Several requirements are linked with appointment and presence of IDs under the Act as well as the SEBI Listing Regulations, including the following:
- The presence of IDs is a must to constitute a quorum for the meetings of the Board of Directors of top 2000 listed entities.
- The composition of the Audit Committee, Nomination and Remuneration Committee (“NRC”), Stakeholders Relationship Committee, and Risk Management Committee of listed entities must include IDs.
- Only IDs have the power to approve Related Party Transactions (RPTs) of listed entities in Audit Committee meetings.
- IDs of listed entities are required to be appointed to the Boards of their material subsidiaries[3].
- IDs are also responsible for reviewing the performance of non-IDs and the Board as a whole.
- Whistleblowers have direct access to the Chairman of Audit Committee, who is responsible for addressing their concerns/ grievances, including potential fraud allegations.
- The committee of IDs is required to provide a report, which is to be filed with the stock exchange, recommending the draft scheme of arrangement, ensuring that the scheme is not detrimental to the shareholders of the listed entity and has compensated the eligible shareholders for fractional entitlement.[4]
Appointment and Tenure
The appointment of IDs on the Board of an unlisted public company requires an ordinary resolution to be passed by the shareholders and a special resolution in case of re-appointment, based on the recommendation of NRC and the approval of the Board.
In case of listed entities, the appointment and re-appointment of an ID on the Board will require the approval of shareholders by way of a special resolution. However, if the resolution for the appointment of an ID fails to be passed by a special resolution, it may still be considered passed if the following dual conditions are satisfied:
- There is an ordinary majority of all the shareholders, including the promoters and promoter group;
- There is an ordinary majority of the public shareholders, that is, disregarding the voting of the promoters and promoter group.
Cooling Off Period
The cooling-off period for IDs is prescribed under the Act as well as Listing Regulations. It can be categorized as: (a) Pre-appointment cooling-off period and (b) Post -appointment cooling-off period.
Pre-appointment cooling-off period for an ID:
- The Act prohibits IDs from having any pecuniary relationship with the company, its group, their promoters or directors, during the present or past two preceding financial years preceding the appointment. However, remuneration as a director or any other transaction not exceeding 10% of IDs total income is permitted.
- The Listing Regulations are more stringent and require IDs to have no material pecuniary relationship with the company, its group, their promoters, or directors, during the present or past three financial years preceding the appointment, apart from remuneration.
- Further, the Act and Listing Regulations prohibit the appointment of a person as an ID if he/she is or has been a KMP or employee of the company or group entities during the past three financial years. However, relatives of employees other than KMPs are permitted to become IDs.
- The proposed IDs in the last three FYs should not be an employee, proprietor, or partner of :
- Any legal or consulting firm that has had transactions with the company or group entities amounting to ten percent or more of the gross turnover of such firm.
- A firm of auditors, company secretaries in practice, or cost auditors of the company or group entities.
- In respect of relatives of IDs:
- They should not be indebted to the Company, its group, their promoters or directors beyond a specified amount, nor should they have given a guarantee or provided any security in connection with the indebtedness of any third person to these entities or individuals in the current or past three financial years.
- The pecuniary transaction or holding of securities by relatives in the listed entity or its group should not exceed 50 lakh rupees or two percent of the paid-up capital during the current or past three financial years, nor should they have any other pecuniary transaction or relationship with these entities amounting to two percent or more of their gross turnover or total income.
Post-appointment cooling-off period for an ID:
Unlike the pre-appointment cooling-off period which is evaluated and examined almost every year irrespective of whether there is a new appointment or not, the post-appointment cooling-off period has assumed a never-before noteworthiness. The obvious reason is as mentioned above, i.e. due to the first mega ID transitions on the board of a significant number of IDs in public companies. The relevant extract of Section 149(11) of Act which lays down the requirement is reproduced below:
“(11) Notwithstanding anything contained in sub-section (10), 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:
Provided that 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.”
Going by the language of the law, it seems an ID who has completed two consecutive terms of 5 years cannot be associated with the company in any manner during the cooling-off period. Further, it is understood that the provisions start with a generic reference by saying “no director” but then become specific to say “such independent director”. However, in the proviso, the reference again becomes generic. Also the phrase “any other capacity” is broad, barring any possible positions such as a consultant or an adviser. These positions cannot be occupied indirectly too, the term “indirectly” seems to include the appointment of any company or firm where the ID has a substantial stake. The possible intent of these provisions is that the IDs should not exploit their past relationship with the company (during the time of being an ID) to gain an advantage after their term, as this may create a conflict of interest with their duties as an ID.
This is one possible view, and obviously, a conservative one. This view is premised on the principle that the association of the ID in any form is likely to get his some pecuniary interest, and this continuing pecuniary interest during the cooling off is alien to the whole principle of cooling off. Hence, the cooling off is like sampoorna vairagya.
There is another view, however. This view seeks to connect the cooling off with the “come back director”. That is, the ID who intends to come back after the 3 years’ cooling off and occupy the position as an ID should maintain abstinence during the cooling off. However, for the one who is content at not coming back, there should be no objection to the ID occupying a position other than as an ID.
This interpretation is based on the interpretation of the language of the proviso to Section 149(11). Since, the language of the proviso – it does not say “such independent director shall not”; instead, it says “an independent director shall not”. Therefore, the bar in the proviso is an independent bar, and not a mere qualification of the cooling off period itself.[5]
There are merits in both the views. The first view is grounded on the principle that indispensability is fatal to independence. If the ID during his term creates a continuing necessity of his services, his independence is bound to be questioned. The ID serves limited stint, during which he serves the company with objectivity and independence, and once his twin terms are over, he should allow the inevitable – a change. After all, what could be the justification for the company to lean on him to the extent of needing his services even during cooling-off?
The other view is based on the possibility of the ID having developed an understanding of the company’s business model and its functioning to the extent that losing his association after 10 years will be adverse to the company’s interest. After all, he does not intend to come back as an ID even after 3 years.
A question comes – can the ID offer one-off consulting services or professional advice to the company during the cooling off? Offering of professional advisory services, without any fixed relationship or commitment, is allowed pre, during and post retirement. As the safe harbour provision under the Act and Listing Regulations allows IDs to have a pecuniary relationship with the company and its group entities upto 10% of their total income, in addition to their remuneration.
Since the word in the proviso is “associate himself with the company in any other capacity”, a person offering one-off professional services does not have an “association”.
The real issue is not professional services. Quite often, these IDs are actually transitioned to other roles in the companies. For example, the erstwhile ID is appointed as NED, or, in some cases, ED. As regards the change of role into an ED, Listing Regulations mandate a cooling-off period of one year for the transition of IDs who have resigned from the Board and then joined as an executive director or WTD in the same company, holding, subsidiary, associate company or any company belonging to the promoter group. SEBI in its Board Meeting[6] noted that there could be valid reasons for an ID to transition to an ED or WTD, such instances where an ID knows that he/she may move to a larger role in the company in the near future, may practically lead to a compromise in their independence.
Cooling-off period in foreign jurisdictions
As far as the cooling-off restrictions in foreign jurisdictions are concerned, one can only notice the pre-appointment cooling-off period and not vice-versa. Some of these have been discussed below:
- The UK Corporate Governance Code, 2018[7] provides the cooling-off condition for the appointment of a non-executive director. The director should not have been an employee of the company or group in last five years; have no material business relationship with the company, either directly or indirectly in last three years; and has not served on the board for more than nine years from the date of their first appointment. However, provisions are required to be followed on a ‘comply or explain’ basis.
- The NASDAQ [8]and NYSE[9] Listing Standards restrict a person from being appointed as an ID, if they have been an employee of the listed company or had a material relationship with the listed company in the past three years.
- The Luxembourg Stock Exchange Principles[10] sets out the criteria to be considered by companies for appointment of ID which requires the director to not be an executive or MD of the company or an associated company in the last five years; should not be an employee in last three years; and has not served on the board for more than twelve years as non-executive or supervisory director.
- The SGX Code of Corporate Governance 2018[11] requires that an ID must not have served as a director or employed in the same company or related corporations for the past three financial years.
Conclusion
The provisions around the pre-appointment cooling-off period are pretty clear in terms of being interpreted and examined, however, that does not seem to be the case for the post-appointment cooling-off period where the letters of law suggest a complete exile for the outgoing ID as far as the concerned public company is concerned. However, the practice by the corporates tends to suggest otherwise. Several companies can be found to have allowed the continued association of their ex-IDs in some sort of other positions so as to avail some sort of services whether in consulting or anything like. Eventually, there is also a conscience call for the ID – can he be said to have compromised his independence, if he nurtures an interest in the company after he demits his office.
[1] https://www.business-standard.com/industry/news/from-ril-to-adani-power-top-firms-see-cessation-of-independent-directors-124040400939_1.html
[2] https://cdn.vahura.com/site/media/docs/the-great-board-refresh-2024-roundtable/The-2024-Board-Refresh-Report-by-IiAS.pdf?v=1696864425
[3] “material subsidiary” shall mean a subsidiary, whose income or net worth exceeds twenty percent of the consolidated income or net worth respectively, of the listed entity and its subsidiaries in the immediately preceding accounting year.
[4] Reg. 37 of LODR r/w SEBI Scheme Circular
[5] Corporate Governance – Miles travelled and miles to go – Vinod Kothari & Company, 2024
[6] https://www.sebi.gov.in/sebi_data/meetingfiles/jul-2021/1626155485805_1.pdf
[7] https://media.frc.org.uk/documents/UK_Corporate_Governance_Code_2018.pdf
[8] https://listingcenter.nasdaq.com/rulebook/nasdaq/rules/Nasdaq%205600%20Series
[9] https://nyseguide.srorules.com/listed-company-manual/09013e2c8503fca9
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