Amit Tandon: Directors as change agents

For that to happen, the law should offer protection to independent directors so that they can safeguard the interests of minority investors and the company, not just act as advisors to the controlling shareholder

Owning shares entitles you to dividends and voting rights. Secured lending in the extreme entitles you to seize the assets of the company to make your money whole. Recent developments at Yahoo Inc pose a question: If a minority equity holder in the US is able to nominate directors to the Board (or initiate the nomination, in this case) to influence the future direction of the firm, why are lenders in India not doing the same?

A quick recap on the events at Yahoo.

Starboard Value, an investment advisor, recently wrote to the shareholders of Yahoo Inc seeking the election of its nine nominees to the company's Board. In its letter, Starboard stated that "Yahoo is deeply undervalued and opportunities exist within the control of management and the Board to unlock significant value for the benefit of all shareholders". It went on to state that the Board and management team of Yahoo had repeatedly failed shareholders, that they were extremely disappointed with the oversight provided by the Board and believed that it lacked the leadership, objectivity, and perspective needed to make decisions in the best interests of shareholders.

Starboard, the largest shareholder in Yahoo, owns 1.7 per cent of the equity valued at $570 million. It invests in "deeply undervalued companies and engages with managements and boards to identify and execute on opportunities to unlock value".

Yahoo's problems are not new. Back in 2012, the company had hired Marissa Mayer as chief executive officer to help it sort through the issues. Starboard believes that declining profitability of the core business has been at the root of Yahoo's problems and it should jettison that. Starboard began its dialogue with Mayer, notched it up to the chairman, extended it to the Board and finally, to all the shareholders. At first, it engaged with the Yahoo Board and management privately, but with the passage of time, this dialogue became very public.

Yahoo, in its defence, cited the growth of over $1 billion in its new business and that it returned $9.1 billion to shareholders. It has appointed two new directors to its Board and called for bids to sell its core business.

Fed up with the slow progress, Starboard has increased pressure on Yahoo by setting the stage for a proxy battle in June. In its letter seeking the election of nine of its nominees to the Yahoo Board, Starboard pointed out that it had sifted through a hundred candidates before narrowing the list down to nine, and provided the detailed biography of each candidate.

Time will tell if Yahoo will survive and whether the decision to sell its core business is correct. But what is noteworthy is enhancing value through control over the Board and finding more than 100 people, who could possibly sit at the high table. The US has a long history of directors being hauled to court; Indian laws relating to class action suits, though proposed, are yet to be notified. Yet perversely, only the well-managed companies are able to find directors. At the first whiff of crisis, banks and institutions withdraw their nominees. Why is it that those whom you would trust, step off the Board?

To begin with, the regulations offer limited protection to directors. Section 149 of the Companies Act offers limited protection to non-executive and independent directors, with no protection from arrest, and puts the onus on such directors to prove in court that the acts in question were executed without their knowledge and further, that they couldn't have prevented the same even if they had exercised due diligence. In reality, this translates into individual directors being caught up in legal proceedings for years to prove their innocence. This is deleterious, particularly for banks that are trying to recover money and want to appoint a nominee on the board. This explains the foot-dragging by banks in taking charge of companies that owe them large sums of money and replacing the directors en masse. The liabilities of non-compliance pass on to these new directors. Foreign Exchange Management Act violations, Customs duty, past provident fund not paid, factory not in compliance with safety regulations… the list is long and covers a range of day-to-day actions, which a director can never control.

Under the Companies Act, 2013, the definition of the term "officer who is in default", as currently worded, exposes non-executive and independent directors to liabilities for offences under the Act, which cannot be the intention, as the day-to-day affairs of the company are managed by the executive management and key managerial personnel. The definition of "officer in default" under Section 2(60) of the Act needs to be amended by excluding applicability of the definition to nominee directors of all banks, in cases under CDR and SDR. The exemption needs to be granted with a retrospective date. Further, nominee directors should be provided immunity from prosecution under all laws along the lines of those enjoyed by nominee directors of the State Bank of India (under the State Bank of India Act) and state financial corporations (under the State Financial Corporations Act).

This is not new. The Ministry of Corporate Affairs had granted some exemptions in its Master Circular dated July 29, 2011, regarding the prosecution of directors along these lines under the Companies Act, 1956.

Two other observations: Yahoo, the largest shareholder, holds just 1.7 per cent of the equity and hopes to accomplish so much. In India, just to affect a change on the Board you need a minimum 10 per cent shareholding. Unless this 10 per cent threshold is lowered and cumulative voting is brought about, controlling the company through the Board will be impossible. Cumulative voting is permissible and GSK Consumer Health allows this.

Finally, these dynamics in India are different because the owner is usually also the manager. This means that the independent directors invariably see themselves more as advisors to the controlling shareholder rather than those who protect the interests of the minority investor or even the company. This needs to change for real change to happen.

The author works with Institutional Investor Advisory Services of India Limited. The views are personal