Board Composition and Independent Directors

The maximum, under clause (b): fifteen directors. First proviso: a company may appoint more than fifteen after passing a special resolution. So the ceiling is not absolute; it requires the members' three-fourths approval to cross.

Second proviso: the woman director. Such class or classes of companies as may be prescribed shall have at least one woman director.

Section 149(2) gave companies existing on the commencement of the Act one year to comply with sub-section (1). It is spent as a transitional provision, but it is worth knowing that the Act phased these requirements in.

The resident director: section 149(3)

Every company shall have at least one director who stays in India for a total period of not less than one hundred and eighty-two days during the financial year.

The proviso, added by the Companies (Amendment) Act, 2017, provides that for a newly incorporated company the requirement applies proportionately at the end of the financial year in which it is incorporated. A company incorporated in January cannot have anybody in India for a hundred and eighty-two days of that financial year, so the requirement is scaled to the part-year.

Note the two features. It is every company, not merely a public or listed one. And it is stay, counted in days across the financial year, not domicile or citizenship.

How many independent directors: section 149(4) and (5)

Every listed public company shall have at least one-third of the total number of directors as independent directors, and the Central Government may prescribe the minimum number of independent directors in case of any class or classes of public companies.

The Explanation: any fraction contained in that one third shall be rounded off as one. So a Board of ten needs three and one third, which rounds to four, not three. Rounding is upward by the express words, and that is a favourite examination point.

Two limbs, and they are different. The one third applies of its own force to a listed public company. For other classes of public companies the number is what the Central Government prescribes, which is why an unlisted public company of sufficient size also carries independent directors.

Section 149(5) gave existing companies one year from commencement, or from notification of the relevant rules, to comply with sub-section (4).

Who is independent: section 149(6)

An independent director, in relation to a company, means a director other than a managing director, a whole-time director or a nominee director, who satisfies all the following.

(a) Integrity and expertise. Who, in the opinion of the Board, is a person of integrity and possesses relevant expertise and experience. This is the only limb resting on the Board's judgment; the rest are objective tests.

(b) Not a promoter, not related. Who is or was not a promoter of the company or its holding, subsidiary or associate company; and who is not related to promoters or directors in the company or its holding, subsidiary or associate company.

(c) No pecuniary relationship. Who has or had no pecuniary relationship, other than remuneration as such director or having transaction not exceeding ten per cent of his total income or such amount as may be prescribed, with the company, its holding, subsidiary or associate company, or their promoters or directors, during the two immediately preceding financial years or during the current financial year.

Note the words inserted in 2017. Before them any pecuniary relationship destroyed independence. Now a transaction not exceeding ten per cent of his total income is tolerated, which is a de minimis rule of the same family as the two per cent rules elsewhere in the Act.

(d) His relatives, four separate tests, all measured over the two immediately preceding financial years or the current one. None of whose relatives:

• (i) is holding any security of or interest in the company or its holding, subsidiary or associate company. Proviso: the relative may hold security or interest of face value not exceeding fifty lakh rupees or two per cent of the paid-up capital, or such higher sum as may be prescribed;
• (ii) is indebted to the company, its holding, subsidiary or associate company or their promoters or directors in excess of such amount as may be prescribed;
• (iii) has given a guarantee or provided any security in connection with the indebtedness of any third person to those companies or their promoters or the directors of such holding company, for such amount as may be prescribed; or
• (iv) has any other pecuniary transaction or relationship with the company or its subsidiary, holding or associate company amounting to two per cent or more of its gross turnover or total income, singly or in combination with the transactions in sub-clauses (i), (ii) or (iii).

(e) Neither himself nor any of his relatives, four more tests:

• (i) holds or has held the position of a key managerial personnel, or is or has been an employee of the company or its holding, subsidiary or associate company, in any of the three financial years immediately preceding the year in which he is proposed to be appointed. Proviso: where the relative is an employee, the restriction does not apply to his employment in those preceding three financial years;
• (ii) is or has been, in any of those three financial years, an employee, proprietor or partner of (A) a firm of auditors or company secretaries in practice or cost auditors of the company or its holding, subsidiary or associate company, or (B) any legal or consulting firm that has or had any transaction with those companies amounting to ten per cent or more of the gross turnover of that firm;
• (iii) holds together with his relatives two per cent or more of the total voting power of the company; or
• (iv) is a Chief Executive or director, by whatever name called, of any nonprofit organisation that receives twenty-five per cent or more of its receipts from the company, its promoters, directors or its holding, subsidiary or associate company, or that holds two per cent or more of the total voting power of the company.

(f) Who possesses such other qualifications as may be prescribed.

Note the three time windows. Clause (c) and clause (d) look back two financial years plus the current one; clause (e) looks back three financial years. Confusing the two is the commonest error in an answer on independence.

And note the definition of nominee director, in the Explanation to the section: a director nominated by any financial institution in pursuance of any law or agreement, or appointed by any Government or any other person to represent its interests. A nominee director is excluded from independence by the opening words of sub-section (6), because he sits for somebody.

The annual declaration: section 149(7)

Every independent director shall give a declaration that he meets the criteria of independence in sub-section (6):

• at the first meeting of the Board in which he participates as a director;
• thereafter at the first meeting of the Board in every financial year; and
• whenever there is any change in the circumstances which may affect his status as an independent director.

The pattern is the same as the disclosure of interest under section 184(1), and the two are worth learning together: on joining, every year, and on any change.

The Code: section 149(8) and Schedule IV

The company and independent directors shall abide by the provisions specified in Schedule IV.

Note "the company and". The Code binds both sides; several of its paragraphs are obligations of the company, not of the director.

Schedule IV has eight parts.

I. Guidelines of professional conduct. An independent director shall uphold ethical standards of integrity and probity; act objectively and constructively; exercise his responsibilities bona fide in the interest of the company; devote sufficient time and attention; not allow extraneous considerations to vitiate his independent judgment, whether he concurs in or dissents from the Board's collective judgment; not abuse his position for personal advantage or that of an associated person; refrain from any action that would lead to loss of his independence; immediately inform the Board if circumstances arise which make him lose his independence; and assist the company in implementing the best corporate governance practices.

II. Role and functions. To bring independent judgment on strategy, performance, risk management, resources, key appointments and standards of conduct; to bring an objective view in evaluating the Board and management; to scrutinise the performance of management against agreed goals; to satisfy themselves on the integrity of financial information and on financial controls and risk management systems; to safeguard the interests of all stakeholders, particularly the minority shareholders; to balance conflicting interests; to determine appropriate levels of remuneration of executive directors, key managerial personnel and senior management and to have a prime role in appointing and, where necessary, recommending the removal of them; and to moderate and arbitrate in conflicts between management and shareholder interest.

III. Duties. Thirteen of them, of which the ones that recur in examinations are: to undertake induction and refresh their knowledge; to take professional advice of outside experts at the expense of the company where necessary; to strive to attend all Board and committee meetings and the general meetings; where they have concerns, to ensure these are addressed by the Board and, if unresolved, insist that they are recorded in the minutes; not to unfairly obstruct an otherwise proper Board; to pay sufficient attention to related party transactions and assure themselves these are in the company's interest; to ensure an adequate and functional vigil mechanism and that whistleblowers are not prejudiced; to report concerns about unethical behaviour, actual or suspected fraud or violation of the code of conduct; to act within their authority; and not to disclose confidential information including unpublished price sensitive information unless expressly approved by the Board or required by law.

The right to have a dissent recorded in the minutes is the practical heart of the Code, because it is how an independent director protects both the company and himself.

IV. Manner of appointment. The appointment process shall be independent of the company management; the appointment shall be approved at the meeting of the shareholders; the explanatory statement shall state that in the Board's opinion the appointee fulfils the conditions specified and is independent of the management; the appointment shall be formalised through a letter of appointment setting out the term, the Board's expectations and committees, the fiduciary duties and accompanying liabilities, any directors' and officers' insurance, the Code of Business Ethics, the list of things a director should not do, and the remuneration; and the terms and conditions shall be open for inspection at the registered office by any member during normal business hours and posted on the company's website.

V. Re-appointment. On the basis of the report of performance evaluation.

VI. Resignation or removal. In the same manner as sections 168 and 169; a director who resigns or is removed shall be replaced within three months; and the replacement requirement does not apply where the company still meets the independent director requirement without filling the vacancy.

VII. Separate meetings. The independent directors shall hold at least one meeting in a financial year without the attendance of non-independent directors and members of management, which shall review the performance of the non-independent directors and of the Board as a whole, review the performance of the Chairperson taking into account the views of executive and non-executive directors, and assess the quality, quantity and timeliness of the flow of information between management and the Board.

VIII. Evaluation mechanism. Performance evaluation of independent directors is done by the entire Board excluding the director being evaluated, and on the basis of that report it is determined whether to extend or continue the term.

A note added in 2017 disapplies several of these paragraphs to a Government company where the concerned Ministry or Department specifies the requirements and the company complies with them.

What an independent director may be paid: section 149(9)

Notwithstanding anything in any other provision of the Act, but subject to sections 197 and 198, an independent director:

• shall not be entitled to any stock option; and
• may receive remuneration by way of fee under section 197(5), reimbursement of expenses for participation in Board and other meetings, and profit related commission as may be approved by the members.

The bar on stock options is deliberate. A director holding options has a personal stake in the share price, and a personal stake in the share price is exactly the kind of interest independence is meant to exclude.

The proviso, added in 2020, allows an independent director to receive remuneration in accordance with Schedule V, exclusive of sitting fees under section 197(5), where the company has no profits or its profits are inadequate. Without it a loss-making company could not pay its independent directors at all.

Tenure: section 149(10) and (11)

Section 149(10). Subject to section 152, an independent director shall hold office for a term up to five consecutive years on the Board, but shall be eligible for reappointment on passing of a special resolution and disclosure of such appointment in the Board's report.

Section 149(11). No independent director shall hold office for more than two consecutive terms, but he shall be eligible for appointment after the expiration of three years of ceasing to become an independent director.

The proviso closes the obvious evasion: during those three years he shall not be appointed in or be associated with the company in any other capacity, either directly or indirectly. So he cannot spend the cooling-off period as a consultant.

The Explanation provides that any tenure of an independent director on the date of commencement of the Act shall not be counted as a term under sub-sections (10) and (11). The clock started fresh in 2014.

So the maximum is ten years, then three years out. Five plus five, with a special resolution for the second term.

Liability: section 149(12)

Notwithstanding anything contained in this Act, (i) an independent director; (ii) a non-executive director not being promoter or key managerial personnel, shall be held liable, only in respect of such acts of omission or commission by a company which had occurred with his knowledge, attributable through Board processes, and with his consent or connivance or where he had not acted diligently.

Take the test apart, because it is four conditions and an answer should show all four.

• the act or omission occurred with his knowledge;
• that knowledge is attributable through Board processes, so through papers, agendas and minutes rather than gossip;
• and it was with his consent or connivance;
• or he had not acted diligently.

Notice who else is protected. Not only independent directors, but any non-executive director who is not a promoter and not a key managerial personnel. That is the protection a nominee director relies on, since he is not independent.

And notice that diligence is a separate route to liability. A director who knew nothing because he never read the papers cannot say he did not consent; he did not act diligently.

Retirement by rotation: section 149(13)

The provisions of sub-sections (6) and (7) of section 152 in respect of retirement of directors by rotation shall not be applicable to appointment of independent directors.

This follows from the fixed term. An independent director appointed for five consecutive years cannot also be liable to retire by rotation at the third annual general meeting; the two schemes would contradict each other. He is also therefore not counted in working out the two thirds liable to retire by rotation.

The databank: section 150

Section 150(1). Subject to section 149(6), an independent director may be selected from a data bank containing the names, addresses and qualifications of persons who are eligible and willing to act as independent directors, maintained by any body, institute or association notified by the Central Government having expertise in creating and maintaining such a databank, and put on their website for the use of companies making the appointment.

The proviso keeps the responsibility where it belongs: the duty of exercising due diligence before selecting a person from the databank lies with the company making the appointment. The databank is a list, not a certificate.

Section 150(2). The appointment shall be approved by the company in general meeting as provided in section 152(2), and the explanatory statement annexed to the notice shall indicate the justification for choosing the appointee.

Section 150(3) and (4). The databank shall be created and maintained in accordance with prescribed rules, and the Central Government may prescribe the manner and procedure of selection.

The small shareholders' director: section 151

A listed company may have one director elected by such small shareholders in such manner and with such terms and conditions as may be prescribed.

"Small shareholders" means a shareholder holding shares of nominal value of not more than twenty thousand rupees, or such other sum as may be prescribed.

Note the word "may". Unlike the one third independent directors, this is not compulsory on the face of the section; it is an enabling provision, and the manner of election is left to the rules.

A worked example

Konkan Cements Limited is a listed public company with a Board of eleven directors: a managing director, two whole-time directors, a nominee director of a financial institution, and seven others.

How many independent directors? One third of eleven is three and two thirds. By the Explanation to section 149(4), any fraction is rounded off as one, so the company needs four independent directors.

Can the nominee director count? No. Section 149(6) opens with "a director other than managing director or a whole-time director or a nominee director", and by the Explanation he is a director nominated by a financial institution in pursuance of any law or agreement. He is outside the definition.

A candidate. Mrs Deshpande is proposed. She was a partner in the firm of cost auditors of the company's subsidiary two financial years ago. Clause (e)(ii)(A) disqualifies a person who was a partner of a firm of cost auditors of the company or its holding, subsidiary or associate company in any of the three financial years immediately preceding the year of appointment. Two years ago falls within three, so she cannot be appointed this year.

Another. Mr Rao's son holds shares in the company of face value forty lakh rupees. Clause (d)(i) bars a relative holding any security or interest, but the proviso permits a holding of face value not exceeding fifty lakh rupees or two per cent of the paid-up capital. Forty lakh is within it, so the holding does not disqualify him. Had it been sixty lakh, it would.

A third. Mr Fernandes receives professional fees from the company amounting to six per cent of his total income. Clause (c) bars a pecuniary relationship other than remuneration as such director or a transaction not exceeding ten per cent of his total income. Six per cent is within the tolerance, so he is not disqualified.

A fourth. Ms Iyer is the Chief Executive of a charitable trust that receives thirty per cent of its receipts from the company's promoters. Clause (e)(iv) disqualifies a Chief Executive or director of a nonprofit organisation receiving twenty-five per cent or more of its receipts from the company, its promoters, directors or its holding, subsidiary or associate company. She cannot be appointed.

Appointment. The four appointments are approved by the members in general meeting under section 150(2), and the explanatory statement gives the justification for choosing each appointee and states, as Schedule IV paragraph IV(3) requires, that in the Board's opinion each fulfils the statutory conditions and is independent of the management. Each receives a letter of appointment setting out the term, the committees, the fiduciary duties and liabilities, the remuneration and the code of ethics, and the terms are open to inspection at the registered office and posted on the website.

The annual declaration. At the first Board meeting each attends, and at the first meeting of every financial year, each gives the declaration under section 149(7) that he or she meets the criteria in sub-section (6). When Mr Rao's son later increases his holding to sixty lakh rupees, Mr Rao must give a fresh declaration, because there is a change in the circumstances affecting his status, and in truth he must inform the Board immediately under Schedule IV paragraph I(8) and cease to be independent.

Remuneration. The company proposes to grant each independent director stock options. Section 149(9) forbids it. They may receive sitting fees under section 197(5), reimbursement of expenses for participation in meetings, and profit related commission approved by the members. In a year of inadequate profits, the proviso allows remuneration in accordance with Schedule V, exclusive of sitting fees.

Tenure. Each is appointed for five consecutive years. At the end, reappointment for a second five year term is possible on a special resolution, with the appointment disclosed in the Board's report, and the reappointment is to be on the basis of the report of performance evaluation under Schedule IV paragraph V. After two consecutive terms, ten years in all, each must wait three years, during which he may not be associated with the company in any other capacity, directly or indirectly.

Retirement by rotation. At the annual general meeting the company works out which directors retire by rotation. The four independent directors are left out of the calculation entirely, because section 149(13) disapplies section 152(6) and (7) to them.

A resignation. One independent director resigns in March. Under Schedule IV paragraph VI(2) the company must replace him within three months, unless, under paragraph VI(3), the Board still satisfies the independent director requirement without filling the vacancy. Here it would fall to three of eleven, below the required four, so the vacancy must be filled.

A loss. A contract approved by the Board turns out to have been procured by the managing director's fraud. The independent directors had the papers, raised no question and did not read them. Under section 149(12) they are liable only for acts occurring with their knowledge, attributable through Board processes, and with their consent or connivance, or where they had not acted diligently. They did not consent or connive, but on these facts the question is whether they acted diligently, and a director who did not read the Board papers on a transaction of that size has difficulty saying he did.

The separate meeting. Once in the financial year the independent directors meet without the non-independent directors and management, to review the performance of the non-independent directors and the Board as a whole, review the Chairperson's performance, and assess the flow of information from management to the Board: Schedule IV paragraph VII.

A small shareholders' director. Being listed, the company may have one director elected by shareholders holding shares of nominal value of not more than twenty thousand rupees, in the prescribed manner: section 151. It is not obliged to.

Distinctions that carry marks

What this does NOT mean

It does not mean fifteen is an absolute ceiling. More than fifteen directors may be appointed after passing a special resolution.

It does not mean the one third is rounded down. The Explanation to section 149(4) says any fraction shall be rounded off as one, so three and a third becomes four.

It does not mean any pecuniary relationship destroys independence. Since 2017, remuneration as a director and a transaction not exceeding ten per cent of his total income are excepted by clause (c).

It does not mean an independent director cannot be paid at all in a loss-making year. The proviso to section 149(9) allows remuneration in accordance with Schedule V, exclusive of sitting fees.

It does not mean section 149(12) protects only independent directors. It also protects a non-executive director who is not a promoter or key managerial personnel.

It does not mean a company must have a small shareholders' director. Section 151 says a listed company may have one.

Quick revision

• 149(1): Board of individuals; minimum three public, two private, one OPC; maximum fifteen, exceeded by special resolution; prescribed classes must have at least one woman director.
• 149(3): at least one director staying in India not less than one hundred and eighty-two days in the financial year, proportionately for a newly incorporated company.
• 149(4): every listed public company, at least one third independent directors, fractions rounded off as one; the Central Government may prescribe the number for other classes of public companies.
• 149(6): independent director is a director other than a managing, whole-time or nominee director, who is (a) in the Board's opinion of integrity with relevant expertise; (b) not a promoter and not related to promoters or directors; (c) without pecuniary relationship save director's remuneration or a transaction within ten per cent of his total income, over the two preceding years and the current year; (d) none of whose relatives holds security beyond fifty lakh rupees or two per cent, is indebted beyond the prescribed amount, has guaranteed a third person's debt beyond the prescribed amount, or has other pecuniary dealings of two per cent or more of turnover or income; (e) neither he nor his relatives being KMP or employee in the preceding three financial years (relative's employment excepted), employee, proprietor or partner of the auditors, company secretaries or cost auditors or of a legal or consulting firm with ten per cent or more of its turnover from the company, holding with relatives two per cent or more voting power, or heading a nonprofit taking twenty-five per cent or more of its receipts from the company or holding two per cent of its voting power; and (f) such other prescribed qualifications.
• 149(7): declaration of independence at the first meeting he attends, at the first meeting of every financial year, and on any change of circumstances.
• 149(8) and Schedule IV: the Code for Independent Directors, binding the company and the directors: professional conduct, role and functions, thirteen duties, manner of appointment by shareholders' approval and a letter of appointment, re-appointment on performance evaluation, resignation or removal under sections 168 and 169 with replacement in three months, one separate meeting a financial year without management, and evaluation by the entire Board excluding the director evaluated.
• 149(9): no stock options; sitting fees under section 197(5), reimbursement of expenses and profit related commission approved by members; Schedule V remuneration where profits are absent or inadequate.
• 149(10) and (11): five consecutive years, reappointment by special resolution with disclosure in the Board's report; not more than two consecutive terms; three years before reappointment, during which no association with the company in any capacity; tenure before the Act not counted.
• 149(12): an independent director, and a non-executive director who is not a promoter or KMP, is liable only for acts of the company occurring with his knowledge attributable through Board processes and with his consent or connivance, or where he had not acted diligently.
• 149(13): retirement by rotation does not apply to independent directors.
• 150: selection from a databank notified by the Central Government, due diligence remaining with the appointing company; appointment approved in general meeting with the justification in the explanatory statement.
• 151: a listed company may have one director elected by small shareholders, that is, holders of shares of nominal value not more than twenty thousand rupees.

Test yourself

1. A listed public company has a Board of eight. How many independent directors must it have? One third of eight is two and two thirds. By the Explanation to section 149(4) any fraction is rounded off as one, so the company must have three independent directors.

2. Who cannot be an independent director by the opening words of section 149(6)? A managing director, a whole-time director and a nominee director, the last being a director nominated by a financial institution under any law or agreement or appointed by any Government or other person to represent its interests.

3. How long may an independent director serve? Up to five consecutive years in a term, renewable by special resolution with disclosure in the Board's report, but not more than two consecutive terms; after that he is eligible only after three years of ceasing to be an independent director, during which he must not be associated with the company in any other capacity, directly or indirectly: section 149(10) and (11).

4. State the limits on an independent director's liability. Under section 149(12) an independent director, and a non-executive director who is not a promoter or key managerial personnel, is liable only in respect of acts of omission or commission by the company which occurred with his knowledge, attributable through Board processes, and with his consent or connivance, or where he had not acted diligently.

5. What must the explanatory statement say when an independent director is appointed? Under section 150(2) it must indicate the justification for choosing the appointee, and under Schedule IV paragraph IV(3) it must state that in the Board's opinion the proposed director fulfils the conditions specified in the Act and the rules and is independent of the management.

6. What must the separate meeting of independent directors do? It is held at least once in a financial year without the attendance of non-independent directors and members of management, and it must review the performance of the non-independent directors and of the Board as a whole, review the performance of the Chairperson taking into account the views of executive and non-executive directors, and assess the quality, quantity and timeliness of the flow of information between management and the Board: Schedule IV paragraph VII.