Independent Director in Name Only: Why India's Boards Keep Failing the Test and What SEBI Should Do

The independent director arrived in Indian company law as an import, and like most imports it was adopted without its context. In the jurisdictions it came from, boards answer to dispersed shareholders, and an independent director is independent of management. In India, three-quarters of listed companies are controlled by a promoter who appoints the management and the board. An independent director here is independent of the management the promoter appointed, selected by a committee the promoter's nominees dominate, approved at a general meeting the promoter's shares carry, and paid from fees the promoter's board sets. The law then asks this person to be the shareholders' check on the promoter.

The record

Every board that has failed in a way the public remembers was compliant on paper. Satyam had a board of distinguished independent directors when its chairman confessed in 2009 to inventing the cash. IL&FS had an audit committee of independent directors through the years in which it hid its debt. The lenders that collapsed in 2019 and 2020 had independent directors who had cleared the proficiency test, registered in the databank and attended every meeting. The technology companies whose independent directors resigned en masse in 2023 did so after the problems were public, not before. Each resignation letter said the same thing: the director was not given the information. The question nobody answers is why a director who was not given the information did not resign earlier, and the answer is that resigning costs something and staying does not.

Why the structure fails

1. Selection. The nomination committee is two-thirds independent, but the independent members were themselves chosen by the promoter, and the candidate list comes from the chairman. The 2022 requirement of a special resolution, and the 2023 fallback of a majority of public shareholders, applies at the general meeting — after the candidate has been chosen. Public shareholders can refuse a promoter's nominee. They cannot propose their own.
2. Payment. Sitting fees of up to ₹1 lakh a meeting and commission approved by the board are modest for a professional and material for a retiree, and a seat on five boards is an income. The director who asks the awkward question is not reappointed. No one needs to say so.
3. Information. Independent directors see what management sends them, when management sends it. There is no right to the company's systems, no independent staff and, outside the audit committee's limited powers, no budget to hire anyone.
4. Consequence. Section 149(12) limits an independent director's liability to what they knew or should have known. In practice, enforcement against independent directors after a fraud has been both rare and indiscriminate — the dissenter and the sleeper treated alike — which teaches the lesson that attention is risk.
5. Supply. The databank has lakhs of registrants; the pool from which boards actually recruit is a few hundred people known to the chairman's network, and the certification requirement has done nothing to widen it.

Public shareholders can refuse a promoter's nominee. They cannot propose their own.

Dev Patel

What SEBI should do

• Let minority shareholders nominate. Public shareholders holding a threshold — say five per cent in aggregate — should be able to nominate one independent director, elected by public shareholders alone. One seat chosen by the people the director is meant to protect would change the conversation at every meeting.
• Create a lead independent director with powers. Elected by the independent directors, with the power to convene a meeting of the board or of independent directors, to set agenda items, to require information from management within a stated period, and to engage advisers at the company's expense within a budget approved by shareholders.
• Pay through a formula, not a favour. Fix independent directors' remuneration by a schedule linked to company size, approved by public shareholders, so that no board can reward compliance or punish dissent through fees.
• Make resignation informative. A resigning independent director must already give reasons; SEBI should require the resignation letter to state whether the director had access to the information they sought, and should treat a pattern of resignations as a trigger for inspection.
• Enforce with discrimination. Publish a policy that independent directors who dissented, demanded information or resigned on a stated concern will not be proceeded against for the fraud they tried to surface, and that those who signed without asking will. The Ministry's guidance says something like this; SEBI's orders should show it.
• Cap the portfolio. Three listed boards, not seven. A director with seven boards is a director with none.

What will be said against this

That minority-nominated directors will be activists; that lead directors will create a board within a board; that formula pay will drive away talent; that caps will shrink an already small pool. Each objection assumes that the present arrangement works and needs protecting. The record says otherwise. The present arrangement produces boards that are fully compliant and entirely ineffective, and the people who defend it are, almost without exception, the people who appoint them.

Dev Patel writes on company law, FEMA and the compliance burden on growing businesses. Read The Counsel's report on the related party transaction amendments.

Opinion pieces reflect the views of their authors and not necessarily those of The Counsel. This article is for general information only and does not constitute legal advice. Readers should consult a qualified lawyer about their own circumstances.