In India, over the years, there have been changes in the corporate governance structure, especially with the passing of the Companies Act 2013. Special focus is being given to the independent directors (ID) and it is now applicable to both public and private entities. Although the major discussion has targeted the statistical data of the listed companies, more and more discussions have paid attention to the independent directors of the private companies. From this blog, it is the writer’s intention to seek to understand what independent directors are, why they are needed, for what uses they can be employed in private companies and the advantages and disadvantages that come with having them in organizations.
Understanding Independent Directors
An independent director as per the act of Companies Act 2013 is a non-executive director who has no relation or connection with the company, its promoter or its management. An independent director is appointed in order to bring independent judgment to bear on the board’s proceedings, particularly in matters regarding shareholders.
Management is monitored by independent directors who offer caution to actual or probable misuse of the company’s power. For this reason, their detached view ensures that the decisions being made accommodate both the concerns of the company and the wider issues of governance and accountability.
Applicability of Independent Directors in Private Companies
Section 149 of the Companies Act, 2013 provides for the appointment of independent directors. Section 149(6) of the Act provides for criteria for Independent Directors and the qualities and restrictions that must be satisfied to comprise an independent director. But where independent directors apply is questionable in this case of private companies.
Legal Requirements for Independent Directors in Private Companies
As per sections 149(1) and 152 of the Companies Act 2013, private companies are not required to appoint an independent director, except for some conditions. Section 149 of the Act contains the principal rules concerning the appointment of independent directors, which are mainly aimed at public companies. However, there are some exceptions where private companies are also required to have independent directors:
- Public Interest or Listed Private Companies: The above provisions of the Act will apply in case a private company is listed on the stock exchange or has made a public offer. Large companies need to have independent directors for them to meet the corporate governance requirements.
- Large Private Companies: Every independent director in a private company subordinate to the Companies Act must meet specific criteria: the company must have a turnover of more than ₹ 200 crores or paid-up capital of ₹ 10 crores. While this is not a strict provision for all private firms, enlightenment: Large private companies should ensure that they have independent directors as it is known to boost transparency, corporate governance, and investors.
Importance of Independent Directors in Private Companies
Enhancing Governance Practices
An independent director’s main responsibility is to introduce good practices of corporate governance. Independent directors are free from any bias and bias to the company and its operations in approach to the board of directors’ function and decisions. In many private companies, the management and ownership are aligned, so outsiders hold independent director positions to make decisions that are for the benefit of the company and its shareholders.
Accountability and Transparency
Independent directors played an important role of enhancing accountability at the board level for checking the actions of the executive directors and on other legal and regulatory frameworks. They also enhance the credibility of the company since the outside stake holders such as investors, creditors and regulators are assured that the Company is being run in an ethical manner.
Risk Management
Independent directors are capable of lending a helping hand on matters to do with risk management. From their perspective, they seek to assist in the evaluation of risks associated with business management decisions and to help the company mobilize adequately for market challenges. They also assist in the establishment of good internal controls in relation to business risks.
Availability of Specialization and Connections
Most of the independent directors usually possess large experience and connections to many companies. Such professionals can afford the management strategic advice on business issues, investment options, amalgamation, acquisitions as well as market trends. The insight and experience they have can assist the company to diversify its operations to new areas or solve functional issues.
Who Should Be Appointed as an Independent Director?
Laws regulating the eligibility of independent directors are highly laid down. Under the Companies Act 2013, the individual must meet the following qualifications:
- No Material Interest: The director must not hold any shares in the company or have any related stake or material or financial interest in the company’s promoters or in any subsidiary of the company.
- Independent Judgment: The director should be able to be responsible for the decision making of corporations and other matters on his or her own.
- Professional Expertise: Recommendation regarding boards of directors has been made that independent directors of a company must have had at least three years of experience within their field of operation either in legal, finance, management or any specialized field.
- Non-Executive Role: An independent director cannot be associated with the executive of the company in any way or control the functioning of the company.
- No Relationships with the Company: He or she should not have any affiliation with the company’s affairs so as to have an unbiased view.
Appointment Process of Independent Directors
For private companies that choose to appoint independent directors, the process follows a formal procedure, which typically includes the following steps:
Board Nomination and Selection
As we already know, the election of directors to the board of a listed company must be done in compliance with the provisions of the Companies Act, 2013, more particularly the requirements spelling out the qualifications which the candidates for the election must possess. Usually, this selection depends on the competency of the candidate and his/her ability not to be affiliated with the company.
Letter of Appointment and Engagement
After the recruitment process of an ideal candidate for an independent director is done, an appointment letter is prepared for him. It establishes their duties and responsibilities when appointed, their pay structure and other expectations that the company has in him or her. Out of the provision in this agreement, the assignment of duties and responsibilities of the independent director is clarified.
Formal Resolution and Filing with ROC
The appointment of an independent director is documented by means of a resolution of the board of directors. After the passage of the resolution, it has to present the various forms to the Registrar of Companies (ROC) to make the appointment formal.
Induction and Orientation
Independent directors are then appointed after which the undertake a training exercise, which serves to introduce them to activities of the company, including its financial responses and governance frameworks. This assist them in making good choices as well as engage well when it comes to board debates.
Challenges in Appointing Independent Directors
While the inclusion of independent directors offers several benefits, private companies face certain challenges in implementing this practice:
- Cost Considerations: Directors that are independent are usually paid a fee for their time as well as service they offer. For the small private companies, especially start-ups, cost related to appoint independent directors may prove very expensive.
- Sufficient Qualifications Available: Sourcing for independent directors that meet the required experience profile, skills and independence is not easy. Also the laws may hinder small private enterprises from engaging qualified individuals in that they lack enough capital to meet those requirements.
- Cultural Resistance: Most often, there may be resistance within a particular culture within a number of private business entities, particularly those that are family-held. The management may fear that the external people who are involved in its operations will interfere with key decisions especially where ownership lies in the family domain.
- Legal compliance and following up on the regulations: Private companies must ensure they meet provisions of the Companies Act, 2013, on the appointment of independent directors. Noncompliance is punishable by fines or sanctions; meanwhile, the company’s reputation suffers a major blow.
Conclusion
Private limited companies may not be legally required to have independent directors, but their integration provides numerous benefits for governance, transparency, and risk management. Such directors work in the organization’s best interests, assist in enhancing the quality of decisions made within an organization, and protect shareholders. With the changing business environment, it is apparent that the firms that engage independent directors will have improved corporate governance standards and reliable investors and market favour so that they can remain competitive in the market.
Despite these difficulties, its advantage of having independent directors surpasses all the difficulties or hurdles faced by companies relating to it. Large and growing private firms should embrace integration of independent directors into the boards as this will help in shaping the fate of the companies by making them adhere to accountability and transparency principles; this will assist in their growth.
