A situation arising from a conflict of interest of directors on a board, especially when family relationships are involved, is like the proverbial elephant in the room. Everyone in the room knows it is there, but they don't see it.
The Companies Act, 2013, has changed the dynamics in the boardroom by spelling out the role of independent directors, while taking a stringent view of how businesses deal with related party transactions. At a time when businesses are becoming more collaborative, it has become all the more important for the board to have a process in place to report and resolve such conflict of interest situations.
Legal experts point out that a conflict of interest arises when there is a conflict between self-interest of a director and the interests of the company. The company law deals with this matter by regulating related party contracts and by requiring 'interested' directors to disclose their interest and recuse from resolutions or discussions that involve a conflict of interest. Independent directors have a higher threshold of eligibility in order to ensure that they act in the best interests of the company and the shareholders. Generally speaking, family relationships may affect 'independence' if the relative holds a key position in a company or a firm that regularly transacts with the company.
"Under law, 'independence' is not affected if the relative holds a key position in a competitor entity. Both under the Companies Act and Sebi's Listing Agreement, it is possible for a director to be an independent director of a company, though his or her spouse is a director of a competitor company," says Akila Agarwal, partner, Shardul Amarchand Mangaldas & Co.
'Disclosure of interest' does not extend to relatives under the company law. It is limited to self-interest of the director in question. There is no disclosure requirement if a relative holds a key position in a competitor entity. This does not make the director an 'interested' director, and he is not prevented from participating in the affairs of the board. Moreover, according to a recent directive by the Ministry of Corporate Affairs, directors in a private limited company can participate in resolutions even if they are interested, points out Lalit Kumar, partner in law firm, J Sagar Associates. Many legal experts and management consultants regard these as a technical gap in regulations.
In such situations, experts say judgment of the directors plays a crucial role in identifying and resolving the conflict. "You cannot mandate everything by law. An individual has to exercise his or her independent judgement in such situations," says Sangeeta Talwar, an independent director on the board of half-a-dozen companies.
Arun Duggal, chairman, ICRA, and an independent director in several companies, says conflict of interest situations in a board are something that has always been there. "Identifying and resolving potential conflict of interest situation depends to a large extent on the judgement of independent directors and promoter directors," he says.
The issue has become accentuated due to the change in the dynamics in the operation of a board brought about by the new company law provisions, says Amit Tandon, managing director, Institutional Investors Advisory Services. "We are sitting on a cusp as roles and responsibilities of directors are changing," says Tandon.
Kavil Ramachandran, who heads the Thomas Schmidheiny Centre for Family Enterprise at Hyderabad-based Indian School of Business, feels there is a huge variance across company boards when it comes to putting in safeguards to alert or detect conflict of interest situations. "Many of the large companies do ensure that such conflicts are avoided, but tend to compromise when it comes to matters related to their family members," says Ramachandran.
Independent directors and legal experts say the quality of the board and its governance culture play a key role in resolving such situations. However, there is no substitute to putting in place a process to detect and resolve such conflicts. "Apart from self-declarations by members of the board, regular review by external auditors could throw up instances of related party transactions. Company secretary and CFOs play a key role in the discovery of such conflict situations," says A Subba Rao, CFO, RPG Group. It all depends on the will of the board to see the elephant in the room.
CHECKS & BALANCES
Companies Act, 2013 requires each director of the board to disclose the nature of the interest in any contract or arrangement. Therefore, if there is any contract proposed to be entered with the relative of any director, the director concerned is required to make disclosure with respect to the said contract or arrangement
A conflicted director on the board does not participate and vote on resolutions in which he is interested
If there is any related party transaction with the relative of a director then such director is not allowed during discussions on the related party transaction
- The law prohibits the appointment of any person as an independent director who is related to promoter or other directors of the company, whose relatives have or had any pecuniary relationship or transaction with the company, its holding company, subsidiary or an associate company