Corporate Governance and Role of Independent Director
Background
The Corporate Governance is the system of rules and process which governed the company through its board of directors and management to protect the interest of stakeholders. The concept of Corporate Governance is not new but evolved from time to time especially after the corporate world faces many financial crises due to mismanagement of companies including financial frauds by promoters ‘directors of the company.
In order to protect the interest of corporate entities and investors, the legal foundation was laid down in many jurisdictions including in India. Therefore, in year 2013 the concept of Independent Director was introduced under Companies Act, 2013 (“Companies Act”) and Securities and Exchange Board of India Act.
Legal framework of Independent Directors
Every director is appointed in accordance with the procedure as set-out under the Companies Act including an Independent Director. The appointment, role and responsibilities and liabilities of each director is defined from Section 149 to Section 172 of the Companies Act 2013 (“Companies Act”). The specific provisions of Independent Directors are under Section 149 of the Companies Act.
SEBI has further regulated this concept under the SEBI (LODR) Regulations, 2015, particularly for listed entities and defined the Independent Directors under Regulation 16(1)(b) r/w Section 149(6) of the Companies Act 2013 as a person, other than Managing Director or Whole Time Director or Nominee Director, who in the opinion of Board of Directors is a person of integrity and possess relevant expertise and experience and who is or was not a promoter of a company or its holding subsidiary or associate company and not related to promoter or director of the company.
Difference Between Independent Directors and Other Directors
Independent Director is a non-executive director and fundamentally differ from executive and promoter directors as such promoters directors are involved in day to day management and decision-making process of corporate , whereas Independent Directors function is in accordance with the law and have a supervisory and advisory position at the board level to watch the process of decision making of promoters directors and advise such promoter directors or management as might be needed for corporate governance point of view.
This distinction has been judicially recognised in SMS Pharmaceuticals Ltd. v. Neeta Bhalla( AIR 2005 SUPREME COURT 3512),where the Supreme Court held that liability of directors cannot arise solely from designation. The Court ruled that only those directors who are “in charge of and responsible for the conduct of business” can be proceeded against, thereby excluding Independent Directors unless specific responsibility is pleaded and proved.
Appointment Mechanism of Independent Directors
The mechanism for appointment of Independent Directors is similar to appointment of any other directors. The Board of Directors recommend the name of director based on the recommendation of the Nomination and Remuneration Committee, supported by declarations of independence and disclosures of interest and shareholders in a general meeting appointed such persons as the director.
Judicially, the significance of this appointment mechanism was highlighted in Pooja Ravinder Devidasani v. State of Maharashtra ((2014) 16 SCC 1), where the Supreme Court held that a non-executive director, appointed without managerial control, cannot be presumed to oversee company affairs. The Court observed that the statutory mode of appointment itself negates any automatic assumption of operational responsibility.
Role of Independent Directors in the Company and Board
The main purpose of appointment of Independent Directors is to protect, inter-alia, the interest of minority shareholders and to supervise the compliance of corporate governance of the company in accordance with provisions as set out in the Companies Act and SEBI LODR Regulations. Therefore, Independent Directors are expected to bring objective judgment, oversee financial integrity, and protect minority shareholders’ interests.
Various courts/ tribunal have clarified that this role does not make them custodians of every corporate action. In B. Ramalinga Raju vs. SEBI(AIR 2018 SC 3491), the Supreme Court held that Independent Directors cannot be expected to detect accounting fraud unless circumstances clearly indicate manipulation or red flags. Reasonable reliance on audited financial statements was held to be permissible.
Limitations of Independent Directors in Corporate Governance
Independent Directors depend largely on information provided by management and professionals and do not possess investigative powers. The Supreme Court in Shiv Kumar Jatia v. State of NCT of Delhi ((2019) 17 SCC 193) recognised this limitation and held that directors cannot be held criminally liable for negligence unless there is direct involvement or gross negligence with mens rea. The Court explicitly rejected the notion that directors are expected to foresee or prevent every mishap.
Protection and Rights of Independent Directors Under Law
Section 149(12) of the Companies Act, 2013 limits the liability of Independent Directors. Unless the Independent Director acts, either omitting or committing, with their knowledge, consent, connivance, attributable through Board processes or lacks due diligence, he or she cannot be held liable. This provision has been judicially reinforced in Rallis India Ltd. v. Poduru Vidya Bhushan ((2011) 13 SCC 88), where proceedings against Independent Directors were quashed for lack of specific allegations. The Court held that mechanical prosecution defeats the legislative intent of Section 149(12) and discourages competent professionals from joining boards.
Independent Directors have the right to seek information, record dissent, access professional advice, and hold exclusive meetings without management. In Sunil Bharti Mittal v. CBI((2015)4 SCC 609), the Supreme Court observed that the presence of Independent Directors on boards is to ensure checks and balances. Courts have treated recorded dissent as evidence of independence and due diligence, often shielding directors from allegations of connivance.
Liabilities and Duties of Independent Directors
Civil liability may arise from breach of fiduciary duty, while criminal liability requires proof of active involvement or culpable negligence. In Gunmala Sales Pvt. Ltd. v. Anu Mehta((2015) 1 SCC 103), the Supreme Court reiterated that criminal proceedings against directors must disclose specific role attribution, and vague allegations are insufficient. This principle has been repeatedly applied to protect Independent Directors from frivolous prosecutions.
In Harshendra Kumar D. v. Rebatilata Koley (AIR 2011 SUPREME COURT 1090), the Supreme Court quashed criminal proceedings against a non-executive director on the ground that statutory records showed cessation of directorship before the alleged offence. The Court held that documentary compliance records can be relied upon to prevent abuse of criminal process, reinforcing the importance of compliance documentation for Independent Directors.
Schedule IV of the Companies Act prescribes duties such as safeguarding stakeholder interests, ensuring integrity of financial information, and acting in good faith. In N. Narayanan v. SEBI (AIR 2013 SC 3191), the Supreme Court clarified that directors are expected to exercise due care and diligence, but the standard is that of a reasonable director, not an infallible one. The Court held that liability arises only where failure is deliberate or reckless.
In case of proceedings against Independent Directors under the Insolvency and Bankruptcy Code, 2016 (“IBC”), The National Company Law Tribunal (“NCLT”), Mumbai Bench, in Anuradha Kapur v. Dinkar T. Venkatasubramanian(Company Petition No 1555 of 2017) has ruled that independent directors and non-executive directors cannot automatically escape liability for alleged fraudulent transactions under Section 66 of IBC. The NCLT observed that merely holding the position of an independent or non-executive director does not exempt a person from scrutiny if there is evidence suggesting their awareness of irregularities in the company’s affairs. In SEBI v. Gaurav Varshney ((2016) 14 SCC 430), the Supreme Court cautioned regulators against indiscriminate prosecution of non-executive directors, reiterating that statutory safeguards must be respected before initiating action
Authorities Before Which Independent Directors Are Answerable
It may be noted that in case of Non-Application of Independent Director while approving any Board Resolutions he or she maybe answerable before Courts and Tribunals including SEBI.
Independent Directors are required to raise concerns internally, approach SEBI, record dissent, or seek judicial remedies. Courts have recognised that Independent Directors who actively object or report irregularities demonstrate good faith. In B. Ramalinga Raju. v. SEBI(AIR 2018 SC 3491), the Supreme Court acknowledged that Independent Directors who raised concerns internally could not be equated with executive wrongdoers.
Conclusion
There is no doubt “Judicial interpretation” of Independent Directors’ roles reflects a consistent effort to balance corporate accountability with statutory protection as courts in many cases have firmly rejected the doctrine of automatic or vicarious liability for Independent Directors. Despite the judicial interpretation, the position of Independent Directors is not a privilege but a great responsibility. Ignorance of responsibility in discharging their duties invites criminal liability including heavy penalty impose on them by the tribunals/ courts. Hence, Independent Directors must remain vigilant, record dissent, and exercise meaningful oversight and should not be “Silent Spectators”, being a friend of promoters or directors.
-By ISHTIAQ ALI
Managing Partner of Orbit Law Services
The author has more than 4 decades of experience in recovery of debts both as the inhouse lawyer of public financial institution as well as he is a practising lawyer specialized in banking and finance. In case of any clarifications, please feel free to contact the author at ishtiaq.ali@orbitlaw.co.in
Research and Assistance: Roshan Gaud, Senior Associate, Tejas Singh, Trainee Associate
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