Under the Companies Act, every company should have a board of directors, the minimum number of directors being three in case of a public limited company and at least two in case of a private limited company. One-third of the directors should be independent. However, Sebi rules say that in case of listed companies, one-half of the directors should be independent if the chairman is an executive chairman.
An instance has come to light where a company exists without a board of directors for quite some time. On August 4, 2014, Mint reported that UB Engineering (a listed company) is without a board after a string of resignations. UB Engineering is a Vijay Mallya-owned company. The company is in distress and its managing director was charged with service tax evasion. The only board member now is the managing director.
My presumption is that the promoter is unable to induce any individual to join the board as an independent director. Those days are gone when a friend of the promoter or a senior executive of the company would join the board of directors of the company without due diligence.
We do not know the reasons for the resignation of directors, including executive directors. Presumably, they resigned because they do not want to get punished for wrong doings of the company. In the coming days, we may find more companies without a board of directors, or a board without independent directors.
Professionals would be hesitant to join the board of directors of a troubled company. Companies get into trouble because of inappropriate strategies or due to factors beyond their control, for example due to a policy change by the government, or economic slowdown. Whatever be the reason, managers of a troubled company expect good days will come back soon and are tempted to sail through bad times by accounting manipulation, non-compliance with law and often by using employees' money (e.g. provident fund) or government money (e.g. service tax collected from customers) in business. In a promoter-managed or a promoter-driven company, where promoter is the anchor investor, the temptation to survive by hook or by crook, is much higher.
The Companies Act 2013 has provided for stringent penalties for offences under the Companies Act. Moreover, directors might be liable for offences punishable under other laws. Some of the penalties involve imprisonment.
The Companies Act 2013 has defined 'officer who is in default' and who is punishable for offences committed by the company. The following persons are treated as officer in default: whole-time director, key managerial personnel (KMP) (CEO, CFO, company secretary and whole-time director), specified directors (if there is no KMP) and all directors (if there is no KMP, or there are no specified directors). The Companies Act generally provides immunity to independent directors. However, an independent director is punishable for a company's offence, if he had knowledge of the contravention through the board process and he did not object to the contravention. Similarly, if the director failed to act diligently, he may attract penal provisions even if he is not an offender.
The Companies Act has increased the responsibilities of directors manifold, some of which are onerous and some of which are ambiguous. For example, the board of directors is duty-bound to act diligently and in good faith in the best interest of the company, its employees, the shareholders, and the community and for the protection of environment.
The Companies Act 2013 does not explain whether the board of directors has a duty of loyalty to all the employees, including those employed through contractors, or to permanent employees only.
Similarly, it is not clear as to the boundary of the community for whose best interest the board of directors should function. One of the roles of independent directors is to balance the conflicting interest of stakeholders. Stakeholder is not defined in the companies Act.
SEBI has gone a step ahead and formulated revised clause 49, which will be effective from October 1, 2014. Both the Companies Act 2013 and a revised clause 49 aim to improve corporate governance and protect the interest of stakeholders. However, the purpose would be defeated if individuals with right capabilities and high integrity and commitment do not join the board of directors.
The duties of independent directors should not be made too onerous. This will result in bad directors replacing good directors, particularly in companies where corporate governance is weak or which are in trouble.
Professor and Head, School of Corporate Governance and Public Policy, Indian Institute of Corporate Affairs; Advisor (Advanced Studies), Institute of Cost Accountants of India; Chairman, Riverside Management Academy Private Limited