The role of Independent Director features prominently in Corporate Governance Codes. In India, the Companies Act 2013 (the Act) and SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015 have completely revamped the country’s corporate governance code.
Corporate governance generally places a fair amount of emphasis on the independence of a Board and the corporate governance models in India have drawn large references from the recommendations of the Cadbury Committee (1992) of the UK and the Sarbanes-Oxley Act of 2002 of the USA.
A director is independent only if the Board affirmatively determines that he or she has no material relationship with the company that adversely affects his or her ability to be independent from management in connection with the performance of duties as a Board member and committee member. This assessment is fact specific and when assessing the materiality of such relationship, the Board should consider the source of the director’s compensation including any consulting, advisory or other compensatory fees. This includes consideration of whether the director receives compensation from any person or entity that would impair his ability to make independent judgments about the company’s management decisions.
Please see our recent post on the independence of Independent Directors here.
It is pertinent to note that only listed companies and public companies having a paid-up share capital of ten crore rupees or more or having turnover of one hundred crore rupees or more, or having in aggregate, outstanding loans, debentures, and deposits, exceeding fifty crore rupees have to mandatorily appoint at least two Independent Directors (or such higher number as mentioned specifically under Rule 4 of the Companies (Appointment and Qualification of Directors) Rules 2014]. Private companies are exempted from appointing Independent Directors. However, private companies may appoint them if the Board is of the opinion that there is a requirement of an Independent Director or if any investment agreement mandates such appointment.
Independent Directors devote their valuable time to addressing the strategic issues in the course of the Board and Committee meetings and use their expertise while guiding the management of the Company from time to time. Independent directors, who are truly independent, can be an effective barricade against corporate frauds. However, active oversight and prudent judgment may suffer when remuneration comes into the picture, as it is an important factor which needs consideration. The extent of remunerating Independent Directors determines their retention and motivation to discharge their duties without cloudy judgments.
As per the Companies Act 2013, “remuneration” means any money or its equivalent is given or passed to any person for services rendered by him and includes perquisites as defined under the Income-Tax Act, 1961. Now, let us examine the various remuneration models of Independent Directors in India.
The remuneration of an Independent Director is restricted to the following emoluments:
- Sitting Fee: Sitting fee to an Independent Director may be paid for attending meetings of the Board or committees thereof, such sum as may be decided by the Board of directors of and shall not exceed INR 1,00,000 per meeting of the Board or committee thereof.The sitting fee to be paid to Independent Directors shall not be less than the sitting fee payable to other directors.
- Commission: The Act allows a company to pay remuneration to its Independent Directors either by way of a monthly payment or a specified percentage of the net profits of the company or a combination of both. Further, it states that where the company has either a managing director or whole-time director or manager, then a maximum of 1% of its net profits can be paid as remuneration to its Independent Directors. In case there is no managing director or whole-time director or manager, then a maximum of 3% of net profit can be paid. Thus, the basis of payment to the Independent Directors is the net profit of the Company. The Company is however not obligated to remunerate its Independent Directors. Hence the Company may pay profit related commission to the Independent Directors with prior approval of the members. Given this, the commission should be profit-linked only and not revenue based. The Act does not eliminate profit-related commission which could create a conflict of interest since the commission is linked to the company’s performance.
- Consulting Fee: The remuneration of Independent Directors has been restricted to sitting fees, reimbursement of expenses for participation in the board and other meetings, and profit-related commission. Therefore, it can be noted that Consulting Fee is not allowed to be paid to Independent Directors.
- ESOP: The Act and SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015 prohibit the issuance of stock options to Independent Directors, in a bid to address the concern that it might be causing a conflict of interest and will affect their independence. An alternative option could have been to place restrictions either on the total amount of issue of stock options or put a time limit on exercising stock options, rather than having a complete prohibition.
- Sweat Equity: The Company may opt to remunerate its Independent Director by way of issuing sweat equity shares. However, such issuance shall be in accordance with the procedure prescribed under the Act. The total percentage of voting power of such independent director together with his relatives shall not exceed more than two percent.
- Refund of excess remuneration paid: If the Independent Director draws or receives, directly or indirectly, by way of fee/remuneration any such sums in excess of the limit as prescribed or without the prior sanction, where it is required, such remuneration shall be refunded to the Company within two years or such lesser period as may be allowed by the company and until such sum is refunded, hold it in a trust for the Company. The Company shall not waive the recovery of any sum refundable to it unless approved by the Company by special resolution within two years from the date the sum becomes refundable.
Thus, to sum up, apart from the restriction on stock options, the remuneration of independent directors has been limited to sitting fees, reimbursement of expenses for participation in the board and other committee meetings, profit-related commission, and issuance of sweat equity shares as may be approved by the shareholders.
Additionally, the SEBI (Listing Obligation Disclosure Requirement) Regulation 2015 requires every listed public company to publish its criteria for payment of remuneration to Independent Directors in its Annual Report. Alternatively, this may be published on the company’s website and reference may be drawn thereto in its annual report. Section 197 of the Companies Act, 2013 and Regulation 17(6)(a) of SEBI (Listing Obligation Disclosure Requirement) Regulation 2015 states that the prior approval of the shareholders of the company is required for making payment to its Independent Directors, as recommended by the Board of the Company.
Authors: Ms. Ifla.A (Associate at NovoJuris Legal)