Stox N Tax

Who Can Be an Independent Director in a Listed Entity: A Comprehensive Guide

Introduction

Independent directors form the backbone of corporate governance in listed entities, providing objective oversight and safeguarding stakeholder interests. Their role has gained increasing prominence as regulators worldwide emphasize the need for independent board supervision. This comprehensive guide explores the qualification criteria, eligibility requirements, and disqualification conditions for independent directors in listed entities in India, as prescribed by the Companies Act, 2013 and SEBI Listing Regulations.

Legal Framework Governing Independent Directors

The requirements for independent directors in India are primarily governed by:

  1. Companies Act, 2013: Section 149 and Schedule IV (Code for Independent Directors)
  2. SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015: Regulation 16(1)(b) and other related provisions

Basic Qualification Requirements

Academic and Professional Qualifications

While there are no specific academic qualifications mandated by law, independent directors should typically possess:

  1. Relevant Professional Qualifications: Degrees or certifications in areas like business management, law, finance, or industry-specific disciplines
  2. Professional Experience: Substantial experience in corporate management, governance, finance, or relevant industry expertise
  3. Specialized Knowledge: Familiarity with regulatory frameworks, risk management, and compliance requirements

Skills and Competencies

A well-rounded independent director should demonstrate:

  1. Financial Literacy: Ability to read and understand financial statements
  2. Business Acumen: Understanding of business models, strategic planning, and competitive dynamics
  3. Governance Knowledge: Familiarity with corporate governance principles and practices
  4. Risk Assessment Skills: Capability to identify and evaluate various business risks
  5. Ethical Judgment: Proven record of ethical decision-making and integrity
  6. Communication Skills: Ability to articulate views effectively and engage constructively with other board members

Eligibility Criteria Under Companies Act, 2013

Section 149(6) of the Companies Act, 2013 lays down specific eligibility criteria. An independent director must be a person:

  1. Of Integrity and Relevant Expertise: Possessing integrity, relevant expertise, and experience
  2. Without Specific Relationships with the Company:
    • Who is or was not a promoter of the company or its holding, subsidiary, or associate company
    • Who is not related to promoters or directors of the company, its holding, subsidiary, or associate company
  3. Without Pecuniary Relationships: Who has or had no pecuniary relationship (other than remuneration as director or transactions less than 10% of total income) with the company, its holding, subsidiary, or associate company, their promoters, or directors during the 2 (3 in case of listed company) immediately preceding financial years or during the current financial year
  4. Without Relative Having any interest: None of whose relatives
    • holds any security of or interest in the company, its holding, subsidiary or associate company during the 2 immediately preceding financial years or during the current financial year (except that relative can hold upto face value of ₹50 lakhs or 2% of paid-up capital of the company, its holding, subsidiary or associate company)
    • is indebted to the company, its holding, subsidiary or associate company or their promoters, or directors for an amount of ₹50 lakhs, at any time during the two (3 in case of listed company) immediately preceding financial years or during the current financial year
    • has given a guarantee or provided any security in connection with the indebtedness of any third person to the company, its holding, subsidiary or associate company or their promoters, or directors of such holding company, for an amount of ₹50 lakhs, at any time during the two (3 in case of listed company) immediately preceding financial years or during the current financial year
    • has any other pecuniary relationships or transactions with the company, its holding, subsidiary, or associate company, their promoters, or directors, amounting to 2% or more of its gross turnover or total income singly or in combination with the transactions referred above
  5. Without Management Connections: Who, neither himself nor through any relative or firm or association:
    • Holds or has held the position of 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 immediately preceding the financial year of appointment (except that relative can be employee other than KMP)
    • Is or has been an employee, proprietor, or partner of a firm of auditors, company secretaries, or cost auditors of the company or its holding, subsidiary, or associate company in any of the three financial years immediately preceding the financial year of appointment
    • Is or has been an employee, proprietor, or partner of a legal or consulting firm that has or had any transaction with the company, its holding, subsidiary, or associate company amounting to 10% or more of the gross turnover of such firm in any of the three financial years immediately preceding the financial year of appointment
  6. Without Substantial Shareholding: Who, along with relatives, holds less than 2% of the total voting power of the company
  7. Without any relation with Non Profit Organisation (NPO): Who shall not be a CEO or Director of any NPO that receives twenty-five per cent. or more of its receipts from the company, any of its promoters, directors or its holding, subsidiary or associate company or that holds two per cent. or more of the total voting power of the company
  8. Registration with Independent Directors Databank: Must register with the Indian Institute of Corporate Affairs (IICA) Independent Directors Databank and pass the proficiency test (unless exempted).

Additional Requirements Under SEBI Listing Regulations

SEBI Listing Regulations add further conditions:

  1. Without Specific Relationships with the Company: Independent Director shall not be member of the promoter group of the listed entity
  2. Without being employee: Independent Director himself and his relative should also not hold or has held the position of a KMP or is or has been an employee of the listed entity or its holding, subsidiary or associate company or any company belonging to the promoter group of the listed entity, in any of the 3 financial years immediately preceding the financial year in which he is proposed to be appointed
  3. Age Limit: Independent directors must be at least 21 years of age
  4. Without CEO Experience in Related Companies: Who is not a non-independent director of another company on the board of which any non-independent director of the company is an independent director (if the non independent director of the Company is independent director of another Company, that Company’s non independent director cannot be independent director in the Company)
  5. Professional Service Restrictions: Must not be a material supplier, service provider, customer, lessor, or lessee of the listed entity
  6. Maximum Board Positions: Can serve as an independent director in a maximum of 7 listed entities (3 if serving as a whole-time director/ MD in any listed entity).

Appointment Process in Listed Entities

The appointment process for independent directors involves:

  1. Nomination Committee Evaluation: The Nomination and Remuneration Committee evaluates potential candidates based on skills, expertise, and diversity requirements
  2. Board Recommendation: The board recommends appointment to shareholders
  3. Shareholder Approval: Appointment must be approved by shareholders through an Special resolution
  4. Disclosure Requirements: Detailed disclosures about the director’s skills, expertise, and independence must be made to shareholders
  5. Intimation to Stock Exchange(s): Inform the stock exchange(s) about the appointment of Independent Director.
  6. Entry in Structured Digital Database (SDD): Make the addition in the list of designated person in SDD.
  7. Inform the Designated Depository: It is mandatory to inform the Designated Depository on the same day.
  8. Issue Appointment Letter: It is necessary to issue the letter of appointment to the Independent Director.
  9. Updation on website of the Company: Update the details of the new independent director on the website of the Company.
  10. Disclosures: Take the necessary disclosures from the new Independent Director.

Do check if the new Independent Director is registered with Independent Directors’ Databank before the appointment and also if he/ she is required to pass the self assessment test.

Tenure and Term Limits

  1. Maximum Term: Independent directors can serve up to two consecutive terms of up to 5 years each. Independent Director can be appointed for less than 5 years but it will be treated as 1 term. Hence, he/ she will be required to demit office after 2 terms even if total number of years of his appointment in 2 terms is less than 10 years.
  2. Cooling-Off Period: After 2 consecutive terms, a minimum 3 year cooling-off period is required before being eligible for reappointment
  3. Aggregate Tenure Limit: The maximum aggregate tenure of an independent director is 10 years in a listed entity
  4. Special Resolution for Extended Tenure: If an independent director has completed a five-year term, they can be appointed for one more term of up to five years only through a special resolution

Other Requirements

Listed Entities are required to comply with following as well:

  1. Independent Director Databank: Mandatory registration of Independent Directors with the databank maintained by the Indian Institute of Corporate Affairs (IICA)
  2. Proficiency Test: Requirement to pass an online proficiency self-assessment test conducted by the IICA (unless exempted)
  3. Enhanced Disclosure: Detailed disclosures about skills, expertise, and competencies in the annual report
  4. Separate Meeting: Independent directors must hold at least one meeting annually without the presence of non-independent directors
  5. D&O Insurance: Top 1000 listed entities are now required to undertake Directors and Officers (D&O) insurance for independent directors
  6. Succession Planning: Boards must now have a succession plan for independent directors
  7. Terms & Conditions of appointment: Terms & conditions of appointment of Independent Director shall be available on the website of the Company.

Compliance and Disclosure Requirements

Independent directors must comply with:

  1. Initial Disclosure: Provide a declaration of independence, DIR-2, MBP-1, list of relatives, disclosure of interest of relatives, DIR-8, declaration to be taken from Designated Person and Form A under SEBI (PIT) Regulations, 2015, at the time of appointment.
  2. Annual Declaration: Submit an annual declaration confirming continued independence, MBP-1, list of relatives, disclosure of interest of relatives, DIR-8, affirmation of compliance of code of conduct and declaration to be taken from Designated Person under PIT Regulations.
  3. Committee Participation: Actively participate in committee meetings as required.
  4. Attendance Requirements: Meet minimum attendance requirements for board and committee meetings.
  5. Separate meeting of Independent Directors: They shall strive to participate in the separate meeting of Independent Directors conducted without the participation of non independent directors.

Compensation for Independent Directors

Compensation typically includes:

  1. Sitting Fees: For attending board and committee meetings
  2. Commission: Based on company profits (subject to statutory limits)
  3. Reimbursement: For travel and other expenses incurred for attending meetings
  4. Stock Options: Prohibited under Companies Act, 2013 as well as SEBI Listing Regulations.
  5. D&O Insurance: Coverage for potential liabilities arising from board service

FAQs

Q1: Can a former employee of a company become its independent director?

A: Yes, but only after a cooling period of three financial years from cessation of employment.

Q2: Can a person be an independent director in multiple companies simultaneously?

A: Yes, but with limits – a maximum of seven listed entities, reduced to three if serving as a whole-time director in any listed entity.

Q3: Is there an age limit for independent directors?

A: While there is a minimum age requirement of 21 years under SEBI regulations, there is no maximum age limit under the Companies Act. However, some companies may have their own age limits specified in their articles of association.

Q4: Can foreign nationals serve as independent directors in Indian listed companies?

A: Yes, foreign nationals can serve as independent directors subject to compliance with relevant FEMA regulations and obtaining a Director Identification Number (DIN).

Q5: Is registration with the Independent Directors Databank mandatory?

A: Yes, all individuals intending to be appointed or already serving as independent directors must register with the Independent Directors Databank maintained by the IICA.

Q6: Can independent directors hold shares in the company?

A: Yes, independent directors can hold shares, but their shareholding, along with their relatives, must be less than 2% of the total voting power of the company.

Q7: What happens if an independent director fails the proficiency test?

A: If an independent director fails to pass the proficiency test within two years of registration in the databank, they would need to re-register and attempt the test again. However, certain experienced professionals are exempted from this requirement.

Q8: Can independent directors receive stock options?

A: No, independent directors cannot receive stock options. They can only receive sitting fees and profit-related commission within prescribed limits.

Q9: What are the consequences if an independent director loses independence during their tenure?

A: If an independent director ceases to meet the independence criteria during their tenure, they must inform the board immediately. The board would then need to reconsider their position, potentially reclassifying them as a non-independent director.

Q10: Can independent directors be held liable for company decisions?

A: Independent directors can be held liable for acts of omission or commission that occurred with their knowledge, attributable through board processes, and with their consent or connivance, or where they did not act diligently.

Conclusion

The role of an independent director in a listed entity carries significant responsibilities and requires a unique combination of qualifications, experience, and personal attributes. The regulatory framework in India has evolved significantly to ensure that independent directors remain truly independent and capable of providing objective oversight.

Aspiring independent directors should focus on developing relevant skills, understanding governance best practices, and maintaining a reputation for integrity and independent judgment. Companies, on their part, should implement robust selection processes to identify directors who can contribute meaningfully to board deliberations and enhance corporate governance standards.

Call to Action

For Aspiring Independent Directors:

  1. Enhance Your Qualifications: Invest in director certification programs and governance training
  2. Build Your Network: Connect with board members, governance professionals, and industry leaders
  3. Register with the Databank: Complete your registration with the Independent Directors Databank
  4. Develop Specialized Expertise: Focus on building knowledge in areas like ESG, digital transformation, or risk management
  5. Start Small: Consider board positions in smaller companies or non-profits to gain experience

For Listed Entities:

  1. Review Selection Criteria: Ensure your director selection process identifies truly independent candidates
  2. Provide Proper Onboarding: Implement comprehensive induction programs for new independent directors
  3. Ensure Information Access: Create systems that provide independent directors with adequate information
  4. Evaluate Board Performance: Regularly assess the effectiveness of independent directors
  5. Maintain Proper Documentation: Keep detailed records of independent director appointments and declarations

Whether you’re an aspiring independent director or a corporate leader responsible for board composition, understanding the evolving requirements for independent directors is essential for effective corporate governance in today’s complex business environment.

Leave a comment

Timeline of events