Given how much money went down in the IL&FS fubar, public outrage against everyone connected with the company was to be expected. That said, the sheer volume of venom that targeted Independent Directors seemed unfair. Does anyone here still think such positions are anything but a well-deserved lifetime achievement award a.k.a. sinecure? Beyond the twitter tantrums lurks the terrifying question that corporate governance asks of our company law: ten years after Satyam, why do we all collectively continue to pretend that this institution of independent directors will serve its intended purpose?
To understand the evolution of this intended purpose, let’s start at the very beginning, in a world before 2013. In the scheme of our 1956 Company law, no individual director had either power or responsibility. Executive power was exercised in the collective wisdom of the Board. In 2001, SEBI took the first timorous steps to enforce a stricter norm of fiduciary responsibility by introducing Clause 49 of the Listing Agreement. It could not work for at least two reasons, and it didn’t. First, independent directors were defined as people who had no “other material pecuniary relationship” with the company which “in the judgment of the Board may affect independence of judgment of the directors”. When conflict of interest is a matter of opinion, you have the perfect inconclusive case. Second, the law let independent directors off the hook except in circumstances where an “offence has been committed by the connivance or is attributable to any gross negligence of the officer” (Sec 21 SCR Act). It’s not often you get that standard of evidence into any case.
The era of credible deniability ended with the new company law of 2013. Section 149 now set out a comprehensive definition of who was qualified to be an independent director and Schedule IV created a whole new role for them. Speaking compositely, the new law did four things. First, it identified independent directors as GRC drivers. The upshot of this was that the man who sat on the outside with no money in the company carried the moral burden of the company. Second, it enjoined independent directors to become protectors of minority shareholders, a sort of hostile infiltrator opposing the will of the majority. Third, it asked independent directors to have an independent voice expected to “scrutinise the performance of management in meeting agreed goals and…monitor the reporting of performance”. In short, the Promoter was expected to appoint and pay is bitterest critic. Finally, it expected independent directors to hold separate meetings in the absence of both management and promoter nominee directors, and review the performance of the rest of the Board. By definition, you could say that every independent director was asked to spy on the promoter! That’s how the law still stands today.
Now, you can see that by definition, independent directors are incapable of performing the role assigned to them and not only because the promoter bankrolls their performance. The problem is compounded considerably by the attitude of the courts. In my 38 years of court experience, I have seen Independent Directors sued aplenty when companies fail to pay statutory dues but I have never seen them receive any substantial empowerment for their core role. This became obvious the very year we legislated the new Company law in 2013. The Tata-Mistry spat broke in late October, and India got to find out if the role of independent directors in corporate governance was quite what the pre-legislation rhetoric projected it would be.
Recall that Indian Hotels, Tata Motors, Tata Chemicals, Tata Consultancy Services and Tata Steel were and remain listed companies. Early in the game, on November 4th, 2013, all six independent directors of Indian Hotels’ came out in support of Mistry. The Tatas reacted by claiming that Mistry was trying to deviously take over Indian Hotels amongst others with the support of independent directors. On November 10, the Tata Chemicals’ independent directors came out in full support of Mistry because they believed he had done a good job. The company reacted by calling an EGM for December 23rd to remove Mistry and independent director Nusli Wadia from the Board. On November 12, three of six independent directors of Tata Steel came out in support of Mistry. The Tatas reacted by claiming Wadia was galvanising other independent directors to act against the Tatas. The company has called an EGM on December 21st to remove Mistry and Wadia from this Board as well. Shortly thereafter, Nusli Wadia was removed from the Board of Tata Chemicals, Tata Steel and Tata Motors. By early January 2014, the other independent directors had fallen in line. Darius Pandole and Analjit Singh of Tata Global Beverages were the only ones to quit of their own accord.
To get this in context, let us remember that the law wants all independent directors to act in accordance with their fiduciary duties and protect the best interest of the company as they see fit in their individual judgement. Yet, when they did so in the Tata-Mistry spat, the majority shareholder made all manner of alarming allegations putting the independent directors in the awkward position of becoming players in a war that wasn’t theirs to fight. If we were to follow the law at that point, it didn’t matter what motives these directors had. It’s a job the law wanted them to do but when they did, India’s most respected business house decided that such independence of judgement is simply unacceptable and moved to have them ejected from the boards. Where did that leave our new corporate governance norms in 2013?
Eventually, the matter found its way to court. NCLT sealed the matter by viewing Mistry from the prism of ‘his’ shareholding which made removal a matter of ‘corporate democracy’. Inevitably, it viewed independent directors through the same prism. It summarized its position thus:
“The holders of the majority of the stock of a corporation have the power to appoint, by election, Directors of their choice and the power to regulate them by a resolution for their removal. And, an injunction cannot be granted to restrain the holding of a general meeting to remove a director and appoint another.”
To put it bluntly, keepers of the corporate temple and protectors of the GRC faith became servants of the unwashed millions. At that point, it was already clear that the Independent Director’s compliance construct was toast.
My ongoing experience with sub judice case in the years since is pretty much the same. Cut to the present, by way of illustration, a Japanese company has acquired the majority equity in an Indian company and has contracted to acquire the balance equity in the coming years based on a price to be determined by the company’s performance in the interim. The exiting Indian shareholder allege the company’s performance is being deliberately undermined because the loss of profit in this scheme is considerably lower than the price the Japanese owner will pay for the remaining shares if the company performs at peak. When the majority shareholder shut down an entire business vertical, Independent Directors sat up and protested. Clearly, this was not in the interest of the company though it was doubtless in the best interest of the majority owner. In retaliation, the majority shareholder called a shareholders meeting and purported to remove the Independent Directors. The matter found its way to NCLT. The decision is still some time away but it is already clear that NCTL takes a very majoritarian view of the matter. If the majority of shareholders don’t like what the independent directors are doing, why should the courts interfere? To put it bluntly, as far as the law is concerned, “the best interest of the company” has now come to mean the best interest of the majority shareholder. RIP Corporate Governance.
At the end, this is what it comes down to. You want independent directors to control the people who hire them and pay their bills. Independent Directors are treated with kid gloves for so long as they are able to toe the line and keep their mouths firmly shut but should they disagree with the will of the majority, the courts are quick to concur in their ejection. What you get then is the worst kind of hypocrisy. You know independent directors can’t discharge their statutory function: you just want them to pay lip service to it so that you can continue to have yourself a corporate world which really has no business but the business of getting on with doing what the majority shareholder wants whatever it takes with no one to ask questions or apply the brakes. When you get hit in the face with a fubar, you always have the fall guys to spit venom at even though you know they were incapable of doing anything. It’s a farce.