Appointment and Removal of Independent Directors: Need for Reform?

The removal this week by three Tata
group companies of Mr. Nusli Wadia as an independent director from each of them
has reinvigorated some of the debate surrounding board independence from a
conceptual standpoint. This has provided critics of board independence with
more fodder. In the past, there was anecdotal evidence that whenever there were
disagreements between managements or promoters on the one hand and independent
directors on the other, either the term of the independent director would not
be renewed upon expiry or such director simply resigned from the board. To my
knowledge, this the first time an independent director has been removed by
shareholders on account of a disagreement, in this case with the promoters.
Hence, the occasion is somewhat momentous and may require some regulatory
Retaliating to his removal, Mr.
Wadia has argues that independent directors carry onerous duties and
responsibilities without any protection whatsoever. Moreover, he
that the promoters of the respective Tata group companies ought to
have abstained from the extraordinary general meetings called for his removal,
and that the majority for his removal should have been a higher threshold of
75% rather than a simple majority. Here, the episode reveals some significant
chinks the regulatory armour surrounding independent directors.
In an earlier paper in 2011 titled
Evolution and Effectiveness of
Independent Directors in Indian Corporate Governance
”, I had sought to
identify some of the problems relating to board independence, which have now
manifested in the Tata group. The first concern is that independent directors
are appointed like any other directors. I had noted:
[The law] does not
contain any specific procedure for nomination and appointment of independent
directors. That process occurs in the same manner as it does for any other
director. It therefore requires us to explore the provisions of the Indian
Companies Act to examine how directors are appointed and the various factors
that play out in that regard.
In India, the
appointment of each director is to be voted on individually at a shareholders’
meeting by way of a separate resolution. Each director’s appointment is to be
approved by a majority of shareholders present and voting on such resolution.
Hence, controlling shareholders, by virtue of being able to muster a majority
of shareholders present and voting on such resolution can control the
appointment of every single director and thereby determine the constitution of
the entire board. Similarly, controlling shareholders can influence the renewal
(or otherwise) of the term of directorship. More importantly, shareholders
possess significant powers to effect the removal of a director: all that is
required is a simple majority of shareholders present and voting at a
shareholders’ meeting. The only protection available to directors subject to
removal is that they are entitled to the benefit of the principles of natural
justice, with the ability to make a representation and explain their own case
to the shareholders before the meeting decides the fate of such directors. The removal
can be for any reason, and there is no requirement to establish “cause,”
thereby making it a potential weapon in the hands of controlling shareholders
to wield against directors (particularly those directors that the controlling
shareholders see as errant to their own perceptions regarding the business and
management of the company).
The absence of a
specific procedure for nomination and appointment of independent directors
makes it vulnerable to capture by the controlling shareholders. Assuming that
one of the purposes of the independent directors is to protect the interest of
the minority shareholders from the actions of the controlling shareholders,
such a purpose can hardly be achieved given the current matrix of director
appointment, renewal and removal. The absolute dominance of controlling
shareholders in this process creates a level of allegiance that independent
directors owe towards controlling shareholders. If controlling shareholders
cease to be pleased with the efforts of an independent director, such a director
can be certain that his or her term will not be renewed, even if such director
is spared the more disastrous consequence of being removed from the board.
In the case of Mr. Wadia, he had to
face the “most disastrous consequence” noted above, which makes this episode
somewhat exceptional.
Of course, since the publication of
the above paper in 2011, there have been significant corporate governance
reforms in India culminating in the Companies Act, 2013 and the SEBI (Listing
Obligations and Disclosure Requirements) Regulations, 2013 (“LODR
Regulations”). The roles and responsibilities of independent directors have
been delineated more clearly. However, when it comes to their appointment and
removal, there is only one significant change, which is that the requirement of
a Nomination And Remuneration Committee has now become mandatory under section
178 of the Companies Act, 2013. This formalizes the process for appointment of
directors, including independent directors, as it is required to determine
qualifications, positive attributes and independence of a director. It allows
for a great deal of transparency and minimizes the influence of management and
promoters in the nomination of independent directors. However, as I have argued
in the above paper, any system of nomination committee is acutely insufficient
to address the problems facing board independence in countries like India:
… Even if an independent
nomination committee were to nominate candidates without the influence of the
controlling shareholders or management, those candidates would ultimately have
to be voted at a shareholders’ meeting, where the controlling shareholders
would wield significant influence. … The nomination committee tackles the first
process, but it does not touch upon the second. Controlling shareholders will
continue to have the ability to sway the shareholder decision on whether the
candidate nominated by the nomination committee should be appointed on not.
Hence, nomination committees are compelled to function in the shadow of an
ultimate shareholder decision (with controlling shareholder influence). For
this reason, nomination committees are unlikely to pick a candidate who does
not have the tacit acceptance of a controlling shareholder. It would be an
embarrassment after all if the person nominated by the nomination committee
fails to muster enough votes at a shareholders’ meeting due to opposition from
the controlling shareholders. …
Given that the present episode
reveals inadequacies in the current board independence structure, it is
imperative to consider potential reforms to the process. As I had noted:
independent directors in India are elected by shareholders through the
“straight voting” system, whereby a majority of the shareholders
present and voting for a resolution can determine whether or not a candidate
for independent directorship is appointed. It is the straight voting system
that confers dominance on controlling shareholders in the appointment of
independent directors, as minority shareholders do not have any say at all. My
proposal deals with the enhancement of minority shareholder involvement in
independent director elections. This would make independent directors
accountable to the shareholder body as a whole (including the minority
shareholders) as opposed to the sole allegiance to controlling shareholders as
currently practiced in India.
shareholder participation can be introduced through two principal methods: (i)
cumulative voting by shareholders; and (ii) election of independent directors by
a “majority of the minority.” …
a. Cumulative
Cumulative voting
will ensure that minority shareholders will have the ability to elect such
number of independent directors as is proportionate to their shareholding in the
company, thereby reducing the dominance of controlling shareholders in the
process. In this structure, each shareholder gets to exercise such number of
votes determined as the product of the number of shares held by the shareholder
and the number of independent directors to be elected. A shareholder can
exercise all votes in favor of a single candidate or can split the votes among
different candidates. In case all votes are cast in favor of a single
candidate, then that candidate may have a chance of being elected depending on
the total number of candidates that are in the fray. …
The advantage of
cumulative voting is that it allows both controlling shareholders as well as
minority shareholders to elect independent directors depending on the
proportion of their respective shareholding.
b. Voting by
‘majority of the minority’
In this schema,
only the minority shareholders are entitled to vote for the election of
independent directors. Each independent director will be elected so long as the
candidate enjoys majority support within the constituency comprising the
minority shareholders. In this approach, neither the controlling shareholder
nor the management can influence the appointment as they have no role at all.
The controlling shareholders will not be permitted to vote in independent
director elections under this proposal. Furthermore, this is useful where the
number of independent directors to be appointed is small whereby the system of
cumulative voting would render itself ineffective. This will result in true
representation of minority shareholders on corporate boards and instill
accountability in the minds of the independent directors towards minority
Of course, it is not sufficient if the
regulatory process fixes issues relating to the appointment of independent
directors: it must also address the question of removal which surfaced in the
case of Mr. Wadia. As I had argued:
The procedure for
renewal of the term of independent directors ought to be the same as that for a
fresh appointment, i.e., through selection by an independent nomination
committee and election through minority shareholder participation. As far as
removal is concerned, there are some key issues to be borne in mind. There is
no benefit in having a carefully considered election process for independent
director if that can be undone in one stroke by a straightforward removal
process. For example, if independent directors can be removed by a simple
majority of shareholders, then the controlling shareholders can reverse the
effect of appointing independent directors by removing them through exercise of
their influence. In order to obviate such a reversal, along with minority shareholder
participation in independent director elections, it is necessary to impose
stringent removal requirements. Either independent directors can be removed by
shareholders only for “cause” or they can be removed with a
supermajority that requires a higher threshold (of say 3/4 or 2/3 majority of
shareholders voting for the resolution). This would ensure that independent
directors are capable of being removed only in extreme circumstances, and not
simply because such directors no longer enjoy the trust of the controlling
shareholders. Such a requirement is essential to ensure that independent directors
remain outside the influence of controlling shareholders.
While some may argue against the
theoretical nature of the debate or implying that such excessive reforms are
unnecessary, the episode involving Mr. Wadia has demonstrated that these issues
are real. It would to foolhardy to brush these issues aside. Other such as
Professor Bala Balasubramanian too have long argued for “majority of the
minority” voting in case of specific transactions, including in
case of appointment of independent directors
. Even an OECD document titled
Corporate Governance in India
” highlights the undue influence of
controlling shareholders in the appointment and removal of independent
directors, finding that “jurisdictions, like Italy and Israel, have provisions
for the appointment of independent directors by minority shareholders, which
ensures more independence”, thereby suggesting that “controlling shareholders
not be allowed to vote in the election of independent directors so as to ensure
the latters’ independence”.
Granted the recent round of reforms
surrounding corporate law and governance have given more teeth to independent
directors, but the current episode exposes the continued vulnerability of
individuals who occupy that office. The legislators and regulators ought to
take cognizance of these glaring loopholes, and address them in the appropriate

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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