Tag Archives: Independent directors

Post-Merger Corporate Governance

Corporate governance is an important aspect for the success and growth of any organisation. A well-structured corporate governance regime becomes even more important post a merger (strategic or otherwise). It might prove to be especially beneficial in the smooth transition and functioning of the business of the merged entity, especially during the early stages after the merger. At the same time, a weak corporate governance structure may be detrimental to the success of the merged entity.

In a merger, the merging entities commonly come together to work and operate as a single merged entity. This would mean the integration of different cultures, mindsets, viewpoints, work ethics, principles, etc. Therefore, post-merger corporate governance becomes important so that all discussions between the key stakeholders of the merged entity are seamlessly documented leaving zero scope for potential conflict in the future. This would also help the key stakeholders to run the business of the merged entity without having to worry about internal conflicts, mismanagement, etc. Also, depending on the end goal or the objectives of the merging entities, there has to be a clear understanding on the type of merger to be undertaken. Refer to our previous post on M & A: Different structures and a comparative to know more about different structures of M&A.

What is Corporate Governance?

Before moving on to the different aspects of corporate governance to be considered post a merger, let us try to understand the meaning of the term ‘corporate governance’. With respect to early-stage unlisted entities, corporate governance generally refers to the internal rules and policies of the organisation, the relationship between the shareholders, the roles and responsibilities of the directors and the top management and the decision-making structure, including the financial and operational decision making. In a nutshell, it includes all aspects which govern the organisation and basis which business is conducted and an organisation is run, both with respect to internal stakeholders, as well as external stakeholders.

Significance of Post-Merger Corporate Governance

Merger of entities, more often than not, would mean the integration of different cultures, mindsets, viewpoints, work ethics, principles, etc. Even though the end goal would be the same, that is, the success and growth of the merged entity, perspectives on the means to achieve the end goal may differ from person to person. However, since the merging entities would no longer be separate entities, it is important that the means to achieve the end goal is also aligned. Thus, while corporate governance is very important for every organisation, it gains even more significance post a merger.

There has to be a clear understanding on the structure of the corporate governance post-merger, which could primarily be recorded discussions and step plans to achieve the objectives of the merger. For example, if the main objective of a merger is market expansion of the business, it would be good to have a clear step plan detailing out the potential markets, key people to target the same, timelines and other operational parameters which could eventually determine achievement of results as agreed amongst the key stakeholders. If a merger involves employee movement, a clear plan for the transitioning of employees, in terms of location, identification, compensation plan, positive interactions across teams and often (in new age companies) regular counselling on challenges faced may prove to be tremendously beneficial in the long run.

Also, post the merger, it is always better to have each and every discussion documented. Such discussions (including the informal discussions) should also be conducted at the board level, which would help in ensuring that the important stakeholders are part of these discussions. The objective is not to increase bureaucracy but to ensure that the operations are seamless. This might not seem to be important especially during the initial stages after a merger. However, the importance of documenting every discussion comes into play when, at some point, the difference of opinion arises. In order to avoid tense and awkward situations at that point of time, if every decision or discussion in relation to the business and operations is documented and is taken with the knowledge of all the key stakeholders, it would to a large extent help in solving the issue at hand in a much more efficient and faster manner.

A merger would, in most circumstances, result in a change in the board composition and management. The board of the merged entity will play an important role in effective management and quick transition. The composition of the board (and the committees of the board) is usually determined prior to the closing of the transaction and is documented in the transaction documents. The composition of the board (and the committees of the board) will have to be properly thought through and well planned. Every member of the board/committee needs to understand their respective roles. It is important to ensure that there is equal representation for all the key stakeholders. The members of the board/committees have to be diverse, experienced and should have a clear understanding of the goals of the merger. Also, it is important to conduct review meetings to ensure that the goals or targets are being met and if not, analyse on the reasons and improve on the same. The board/committee meetings may be conducted on a regular basis.

It may be a good option to appoint an independent director to the board. This will help in situations where there is a difference of opinion between the various members of the board since the independent director will be a neutral party and would be able to give unbiased opinions. The independent directors bring objectivity and an independent opinion to the decisions made by the directors. They can also help in bringing more transparency to the proceedings of the board and also ensure that the interests of the shareholders are given due regard. However, an independent director can play a major role in ensuring good corporate governance only as long as he/she functions independently. His/her decisions should not be influenced by the other board members. Refer to our previous post on Independent Directors to know more about independent directors and their independence.

Conclusion

Even though there is no specific statute or law governing corporate governance as a whole in case of unlisted companies, there are various provisions under the Companies Act, 2013, SEBI guidelines, etc. which indirectly strives to have a good corporate governance system like provisions for appointment of independent directors and their roles and duties, appointment of audit committees, role of directors, etc.

To achieve the goals and objectives of the merged organisation and for a smooth transition, a well-structured corporate governance is vital.

 

Author: Paul Albert, Associate at NovoJuris Legal

REMUNERATION TO INDEPENDENT DIRECTOR

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:

  1. 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.
  2. 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.
  3. 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.
  4. 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.
  5. 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.
  6. 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)

Independent Directors- Are they Independent in their Judgements?

Independent Directors (ID) bring objectivity and an independent opinion to the decisions made by the directors of the company. IDs play a supervisory role and take into account the interests of shareholders, creditors, employees and other stakeholders in general. While IDs generally do not take part in the day-to-day functioning, their acumen should be such that they ask the right set of questions to ensure that the decisions made by the directors are in the best interest of the company, so that concentration of power or special influence can be adequately balanced and in the best interest of the company. IDs will have to take an active interest in the decision-making process not only in the meeting of the Board but also generally take steps to ensure that the interests of all stakeholders are protected.

Kumar Mangalam Birla committee report opines that “Independent Directors are directors who apart from receiving director’s remuneration do not have any other material pecuniary relationship or transaction with the company, its promoters, its management, or its subsidiary, which in the judgment of the Board may affect their independence of judgment”.

Appointment of IDs is mandatory to all public listed companies and unlisted public companies who have (i) share capital more than Rs. 10 crores (ii) turnover of more than Rs.100 crores (iii) total outstanding loans, debentures, deposits is more than Rs 50 crores. In case of private limited companies, where institutional investors or venture capital investors have investments, they usually opt for an independent director to be on the Board.

The Companies Act, 2013 entrusted the governance to the Board of Directors and the Audit Committee for detection and prevention of fraud. The directorship is a fiduciary position and each person on the Board are exposed to many liabilities, not only under Companies Act but under various other legislation. Considering the fact that the IDs being nonexecutives on Board, they themselves cannot play an effective role even though they have a full commitment to ethical practices. Therefore, the executive directors shall have to be proactive and transparent in decision making and it is expected that IDs are informed about all facts, activities, and ongoings, beyond a structured/mandatory sharing of financials and mandatory board meeting agenda items.

IDs once appointed shall be equally responsible for wrongdoings in the Company. Therefore, before taking any directorship, the IDs may pose certain questions to the Company as provided herein below:

(i) Check on conflict of interest, whether such IDs has any pecuniary relationship with the Company directly or indirectly; (ii) The expectations of the Board from ID; (iii) Board Process on decision making, flow of information to its directors etc; (iv) Compliance status under various statutes as may be applicable to the company; (v) Risk and controls in relation to business and measures taken to mitigate such risks; (vi) Adaptability of the promoters towards suggestions of the Board. The expectation is that the executives shall run the show and non-executive board shall act as advisors; (vii) Check on whether the directors have the Directors and Officers Liability insurance policy.

A prima facie question that usually arises prior to taking an ID position is the liabilities. You can access our handbook on Directors here: https://drive.google.com/file//0BytybNhvfzRcb0JfRUFGQVpmaDQ/view?usp=sharing Eligibility Criteria to be an Independent Director

Independent Director shall be a person:`

  • who is not an executive director or nominee director;
  • who shall possess appropriate skills, experience, and knowledge in one or more fields of finance, law, management, sales, marketing, administration, research, corporate governance, technical operations or other disciplines related to the company’s business.
  • who is or was not a promoter of the Company or its holding, subsidiary company or associate company and shall not be related to any of these persons;
  • who including his relatives has or had no pecuniary relationship with the company, its holding, subsidiary or associate company, or their promoters, or directors, in last two preceding financial years or during the current financial year;
  • who holds together with his relatives two percent. or more of the total voting power of the company;
  • who, neither himself nor any of his relatives—
    • 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 preceding the financial year;
    • is or has been an employee or proprietor or a partner, in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed, to:
      • a firm of auditors or company secretaries in practice or cost auditors of the company or its holding, subsidiary or associate company; or
      • any legal or a consulting firm that has or had any transaction with the company, its holding, subsidiary or associate company amounting to ten percent. or more of the gross turnover of such firm;
  • holds together with his relatives two per cent. or more of the total voting power of the company; or
  • is a Chief Executive or director, by whatever name called, of any non-profit organization that receives twenty-five percent. or more of its receipts from the company, any of its promoters, directors or its holding, subsidiary or associate company or that holds two percent. or more of the total voting power of the company; or

Are they really Independent in their Judgements?

Most of the Companies in India are family run business, where a majority of the decisions are taken by the promoters (without consulting any other non-executive directors). Further, these promoters hold a majority of the shares in the company, thereby the interest of these promoters are influenced in every such decision. Though, under law the shareholders appoint the independent director, but the process of selection of the independent director, is the existing directors who nominate the independent candidates for the post of the independent non-executive director, that too in consultation with the promoters and the shareholders accepts the nomination on the basis of the recommendation of the Board.

So, the very appointment is dependent on the recommendation being provided by the promoters, it would be hard to explain that the IDs do in fact exercise complete independence.

Despite many fallouts in the real world on the transparency of board’s decisions in their presence, IDs are the only hope to uplift the discipline/ transparency, provided their independence is not being compromised and decisions are taken professionally. If they are no more independent then their appointment in a company will have limited benefit as IDs. (of course, their business acumen and domain expertise is always of value).

Even if one or two of them are independent of their judgment and takes a fair and prudent view, they may be compromised by the decision of the majority. So, in some sense, are the independent directors actually dependents? This is a very strong question and we believe that the way the legislation is proposing for appointment and remuneration of the independent directors, should be re-evaluated.

Author: Ashwin Bhat, is a Junior Partner at NovoJuris Legal