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Role of Directors in Corporate Governance

The new Companies Act, 2013 makes a laudable contribution towards stipulation and elucidation of the duties and responsibilities of the directors of a company, more so of public limited companies.[i] It removed the deficiencies of the old Companies Act, 1956 and improves the growth and prosperity of the corporate world in India. It increased the ambit of director's duties and responsibilities and explicitly clarifies (for providing a greater certainty to the directors with regards to their responsibilities and conduct) them and thus, ensures a better corporate governance and management.

The functioning of the corporate governance is concerned mainly with the Board of Directors. Directors are appointed by the shareholders, who sets the overall policy for the company and they appoint some persons to be the managing director/ executive director/ whole time director by the prior approval of shareholders.

In Indian States Bank Ltd. v Sardar Singh[ii], it was held that the management of the companies should be in proper hands and hence, the appointment of directors is strictly regulated by the said Act. The success of the company depends upon the competence of its directors.

The board's chief function is to monitor management on behalf of the shareholders. Thus, directors and shareholders are influenced by each other and for quality governance, there must be an interface between them. The directors have to maintain a balance between the conflicting interests of shareholders, promoters, customers and directors. Therefore, they are the heart and soul of a company.

Section 2(34) of Indian Companies Act, 2013 defines director as “a person appointed to the board of a company”.[iii] This definition not only included de jure directors but also de facto and shadow directors. A director is defined by the role he performs and his duties, rather than by title. Thus, a director (in the eyes of law) could also be a person who controls the management, direction, conduct or affairs of the company.

As per the Companies Act, 2013, Section 2(10) “Board of Directors” or “Board”, in relation to a company, means the collective body of the directors of the company.[iv] A director can be a full time working director i.e. managing or whole time director. These directors look after the day to day affairs of the company and are collectively known as ‘management' directors.

A company also have non-executive directors who attend the board meetings and have no link with company's daily activities. As per Clause 49 of the listing agreement, there are independent directors also who are non-executive and they don't have a material relationship with the company other than sitting in the board. There is another category of directors known as shadow directors who are not officially appointed as directors but in accordance with whose directions, the directors of a company are accustomed to act.[v] Thus, directors are the key managerial persons of the company and plays a crucial role in corporate governance.

The Board of Director- Roles and Responsibilities
The Board of Directors key function is to ensure the company's prosperity whilst meeting the appropriate interests of the shareholders. However, the authority of the board is subject to the limitations imposed by the Memorandum of Association, Articles of Association of the company and the relevant provisions of the Companies Act, 2013.[vi] When it comes to public listed companies, securities are traded publically and various other provisions like SEBI regulations and guidelines in the listing agreement deserve consideration.

While private limited companies are closely held and run by the directors. Annual general meetings in such companies are actually conducted as there are certain directions which can only be given by a discussion in AGM. Rest day to day affairs of the company are taken care of by the directors according to the provision of Companies Act, 2013 as it is not possible for AGM to direct company in every matter.

Let us examine the role and responsibilities of Board of Directors in terms of Companies Act, 2013 and other legal provisions. Company is a legal personality and BOD's are its body and mind.

The Board of Directors focuses on four key areas:

  1. by establishing vision, mission and values;
  2. by setting strategy and structure;
  3. by delegating authority and responsibility to management; and,
  4. by exercising accountability to shareholders and be responsible to relevant stakeholders. [vii]

As per Section 166 of the Companies Act, 2013 the duties of the director are:

  1. They should act in accordance with the Articles of a company.
     
  2. A director of the company shall act in good faith in order to promote the objects of the company for the benefits of its members as a whole. It was also held in Bank of Poona Ltd. v Narayandas that the good faith would require that all the endeavours of the directors must be directed to the benefit of the company. [viii]
     
  3. A due and reasonable care, skill and diligence shall be exercised which performing duties of a director. The Supreme Court in the case of Official Liquidator v. P.A. Tendolkar, held that a director could be held liable for dereliction of duties if his negligence is of such character as to enable frauds to be committed and losses thereby incurred by the company.[ix]
     
  4. A director should never involve into a situation which directly or indirectly collides with the interests of the company. In Walchandnagar Industries v Ratan chand, it was held that the director's other duties would include duty to disclose interest to the company and to ensure that his personal interest as an agent of the company do not conflict with company's principal interest. [x]
     
  5. A director shall not attempt to achieve an undue gain for himself or his relatives and if he is found guilty of making such undue advantage then he has to pay a sum equal to that gain to the company. It was held in the case of Guinness plc v. Saunders that director in question is bound to hand over the benefits , if any, that he might have secured under the transaction and he cannot ask for set off for any claim that he may have against the company. [xi]
     
  6. A director shall not assign his office and any assignment so made is void.[xii]
For better governance, the board should function as follows- the directors must be totally committed to the company, should meet regularly and steer discussions properly. They should set up their priorities and then acted upon them. They must have the courage to look to any deteriorating situation related to stock market, finance and especially moral issues. They should not exercise the powers for their own or in a fiduciary capacity but for a proper purpose, for which they are given to them by the shareholders.

The Supreme Court in Eclairs Group Ltd and Glengary Overseas Ltd v JKX specified that “the proper purpose rule is not concerned with excess of power by doing an act which is beyond the scope of the instrument creating it as a matter of construction or implication. It is concerned with abuse of power, by doing acts which are within its scope but done for an improper purpose”.[xiii]

The directors must always look for the best interests of the company and should work honestly and in good faith and if there is a conflict between their own interests and company's then they must go in favour of the company's interest. The Board has a great responsibility of recruiting the CEO of the company based on the market reports. They have to ensure that processes are in place in order to maintain the integrity of the company and should also look upon the company's compliance with all legal requirements.

Role of Independent Directors

The revised clause 49 of the listing agreement states that if a company has executive chairman then the Board requires to have at least 50 percent of independent directors and if a company has non- executive chairman then the independent directors required are one-third of the board.

An independent director is a non-executive director who maintains integrity, sense of accountability, tracks various activities of the company from failures to achievements, plans strategically, degree of commitment and possess sense of devotion. Neither they possess any financial relationship with the company (except the sitting charges) nor can own shares in the company.

Some of the most significant duties and functions of independent directors as per Schedule IV of the Companies Act, 2013 are:

  1. Help in bringing an independent and equitable judgement to the board;
  2. Safeguard the interests of all stakeholders, particularly the minority shareholder;
  3. balance the conflicting interest of the stakeholders;
  4. Strive to attend all the meetings of the Board;
  5. Report concerns about unethical behaviour, actual or suspected fraud or violation of the company‘s code of conduct or ethics policy.[xiv]
     
Independent directors plays a major role in improving the corporate credibility of the company and in risk management. They also play a great role in various committees set up by the company to ensure good governance. They should makeup at least two-thirds of the directors in the audit committees of listed companies to oversee the financial reporting process and disclosure of the company's financial information, ensure compliance with listing and other legal requirements, disclosure of related party transactions and qualification in the draft audit report, among other things. [xv]

Independent directors are responsible for formulating business strategies on behalf of the shareholders and have to make sure that all business activities are compatible with all legal provisions. These directors have power to challenge the decision of management directors and this protects the interests of shareholders and other stakeholders also.

Role of Board Committees

The committees are incorporated into the company to improve the corporate governance.

The Board (of the company) shall comprise of following committees:

  1. Audit committee:
    Section 292A of the Companies Act, 1956 states that every public limited company (whether listed or unlisted) having a paid-up capital of at least Rs.10 crore should constitute a committee of the board to be known as Audit Committee.[xvi]

    The meetings of this committee should happen at least two to three times a year and preferably before the date of each Board meeting. The act provides that the Audit Committee shall consist of a minimum of three directors with independent directors forming a majority.[xvii] The functions of the Audit committee shall include- the recommendation for appointment, remuneration and terms of appointment of auditors of the company; review and monitor of the auditor's independence and performance and effectiveness of audit process; examination of the financial statement and the auditor's report thereon; Approval of any subsequent modification of transaction of the company with related parties; Scrutiny of inter-corporate loans and investments; Valuation of undertakings or assets of the company, wherever it is necessary; Evaluation of internal financial controls and risk management systems; Monitoring the end use of funds raised through public offers and related matters.[xviii]

    The committee can also call for the comments of the auditors about the internal control systems and the review of the financial statement before the submission to the Board.[xix] Satyam scandal is one of the biggest example of lacuna in internal auditing process. The auditors work didn't yield any good result and they signed the financial statements without any prior examination and hence were held responsible for fraud.
     
  2. Nomination and Remuneration Committee:
    the Objective of this committee is to lay down a framework in relation to the remuneration and appointment of directors, Key Managerial Personnel and senior management personnel.[xx] This committee consists of three or more non-executive directors out of which not less than one-half shall be independent directors.[xxi] The functions of this committee are- it should identify persons who are qualified to become directors and recommend their appointment to the Board. [xxii]

    It shall formulate the criteria for determining the qualifications of a director and recommend a policy to the Board regarding the remuneration for directors and other employees.[xxiii] The committee while formulating the policy for remuneration should take care that it is reasonable and motivate directors of the quality required to run the company.[xxiv]
     
  3. Stakeholders' relationship committee:
    This committee shall be constituted if BOD of the company consists of more than one shareholders, debenture-holders, deposit-holders or any other security holder during the financial year. The said committee shall consist of a chairperson who shall be the non-executive director and such other persons as may be decided by the Board.[xxv] The objective of this committee is to solve the grievances of security holders of a company.

As per the SEBI regulations, the committee shall meet at least once in year. The key to a good governance is to conduct business in such a manner that the stakeholder's rights and interests are protected and the transparency is maintained to ensure that the trust and confidence of the stakeholder in the company remains unharmed. Thus, this committee plays a great role in achieving the objective of good corporate governance.

Structure, Size and Composition of Board of Directors

According to Section 149 of the Companies Act, 2013, every company must have a minimum number of three directors in case of a public company, two in case of a private company and one in case of a one-person company; and a maximum of fifteen directors (the number of maximum directors can be increased by passing a special resolution). The Central government may prescribe the class of companies who are required to have at least one women director. Every public listed company shall have at least one-third of the total number of directors as independent directors. [xxvi]

Under LODR (Listing obligation and disclosure requirement), for listed companies, the members of the board shall have an optimum combination of executive and non-executive directors and at least one women director.[xxvii] At least fifty percent of the board of directors must be non-executive directors. The size of the board should not be too small or big as small size allows for real strategic decisions, are more cohesive and productive and monitor the firm more effectively while larger board results in diverse experience and viewpoints. They involve high coordination cost and thus less effective in monitoring.

Diversity in case of large boards includes nationality, gender, technical expertise, academic qualifications and age. Gender diversity is the relevant aspect of board diversity and companies should have women in the board. The board would be considered effective by its size, demographics and diversity.

Powers of Board of Directors

As per Section 179 (1) of the Companies Act:
“the Board of Directors of a company shall be entitled to exercise all such powers, and to do all such acts and things, as the company is authorised to exercise and do unless barred by the restriction on their power by the memorandum or articles or by the provisions of the Companies Act.” [xxviii]

It is not in dispute that directors while exercising their powers do not act as agents for the majority of the members, so the resolution passed by the majority of members cannot supersede director's power.

The powers of management are confined with the directors and they alone can exercise these powers. The only way to overrule the BOD's of a company is by altering the articles of association and refusing to re-elect the directors, whose actions they disapprove.[xxix] The shareholders also can't take away the powers which are granted to them by the Articles.

Thus, the relationship between Board of Directors and the shareholders is not of subordination but more of a federation. The powers granted to directors includes the right to ask the shareholders if money is unpaid on their share, power to issue debentures, power to invest the funds of the company, to grant loans or provide security in respect of loans, to approve financial statement, amalgamations and mergers, to diversify the business of the company and the power to authorize buy back.[xxx] Although, the directors can delegate these powers (by a resolution passed at the meeting) to any committee of directors but still the principal powers vests with the Board of directors themselves.

Apart from this, BoD has powers to fill up casual vacancies in the office of directors (Section 161), power to constitute audit committee (Section 177), to make donation to political parties (Section 182), power to accord sanctions for specified contracts (Section 459), power to receive notice of disclosure of director's interest (Section 184), power to appoint or employ a person as Managing Director or Manager (Section 152 (2)), power to make a declaration of solvency, where it is proposed to wind up the company voluntarily (305), power to approve the text of advertising for inviting public deposits (Section 73). Some of the powers can only be exercised by the resolution passed at the meeting by the consent of directors as per Section 180.

Comparison with a foreign jurisdiction (US)

US is seen to be liberal while deciding the role of the Directors as a brief note whereas India has a detailed role in respective laws.[xxxi] The primary source of rules and regulations in India is the Companies Act and SEBI regulations while in the US, it is state corporate laws and federal securities laws. In the United States, at the federal level, the SEC (Securities and Exchange Commission) has the power to regulate and enforce the securities act while in India, MCA (Ministry of Corporate Affairs) is the apex body and SEBI is the statutory body which oversees corporate governance.

At the state level, there is no statutory body. In the US, state corporation laws are indifferent to maximum or minimum board size and thus, number of directors vary from one company to another while in India, every public company shall have minimum of three directors and private company to have at least two directors.

In the US, the NYSE (New York Stock Exchange) listing standards require that the majority of the listed company's director to be independent. While in India, as per Companies Act, every listed company should have at least one-third of the total number of directors as independent directors. In the US, there are no specific provisions which defines the term of directors while in India, non-executive directors i.e. independent directors shall not serve for more than 5 years. In the US, the public companies are required to disclose their board leadership structure whether the same person serves as the CEO or the head of the board.

In India, companies act along with clause 49 is silent on this. Generally listed companies disclose their corporate governance structure under board composition section which is a part of annual report.[xxxii] In the US, there is no quota for women on boards but they promote gender diversity while in India, a company board must consist of at least one female director.

The US corporate governance has three committees i.e. audit, nominating and compensation. On the other hand, India has audit, shareholders and remuneration committee. Compensation committee in US and remuneration committee in India both have similar agendas that is to monitor the remuneration to the executives of the company. Similar to US (directly derived from state), India also possess the inherent powers of delegation which is not dependent upon shareholders. Thus, we can say that, in both countries, the difference is the approach of the regulators and support of the stakeholders in implementing the same.

Conclusion
In the eyes of law, company is an artificial person which has no physical existence and no body or soul. Therefore, directors are the persons who act on behalf of it. They are appointed by the shareholders of the company to set the overall policy for the corporation. The BOD assists in corporate governance by advising the executive management and by taking strategic decisions. The role and responsibilities of the board of directors vary depending on the nature of the position and the business entity they works.

The board committees are comprised of specialized group of people who focus on specific work areas to make good corporate governance. In India, the role and responsibilities of board of directors depends upon the regulations in the Articles of the company and the Companies Act. When it comes to listed public company, the various guidelines and provisions of SEBI deserves consideration. While in US, State corporate laws and Federal Securities laws are the source of r

End-Notes:
  1. Shodhganga: A Reservoir Of Indian Theses @ INFLIBNET (Sg.inflibnet.ac.in, 2020) accessed 1 December 2020
  2. AIR 1934 ALL 855.
  3. Indian Companies Act, 2013, Section 2 (34).
  4. Indian Companies Act, 2013, Section 2 (10).
  5. Court Says 'Shadow' Directors Can Be Subject To Directors' Fiduciary Duties' (Helix Law, 2020)accessed 1 December 2020.
  6. Board Of Directors | Roles | Duties & Responsibilities' (Accountlearning.com, 2020) accessed 2 December 2020.
  7. Ibid.
  8. AIR 1961 Bom 252 at 253.
  9. {1973} 43 Com cases 382.
  10. AIR 1953 Bom 285.
  11. {1990} 1 All ER 652 HL.
  12. Indian Companies Act, 2013, Section 166.
  13. [2015] UKSC 71.
  14. Indian Companies Act, 2013, Schedule IV.
  15. Who Are Independent Directors And What Role They Play - The Economic Times' (The Economic Times, 2020) accessed 5 December 2020
  16. Companies Rules, 2014, Chapter XII, Rule 6.
  17. The Companies Act, 2013, Section 177 (2).
  18. The Companies Act, 2013, Section 177 (4).
  19. The Companies Act, 2013, Section 177 (5).
  20. Taxguru LLP, 'Nomination And Remuneration Committee' (TaxGuru, 2020) accessed 3 December 2020.
  21. The Companies Act, 2013, Section 178 (1).
  22. The Companies Act, 2013, Section 178 (2).
  23. The Companies Act, 2013, Section 178 (3
  24. The Companies Act, 2013, Section 178 (4).
  25. The Companies Act, 2013, Section 178 (5).
  26. The Companies Act, 2013, Section 149 (4).
  27. ‘Board of directors- Composition' (toppr, 2020) https://www.toppr.com/guides/business-law-cs/elements-of-company-law-ii/board-of-directors-composition/ accessed 1 December 2020.
  28. Indian Companies Act, 2013, Section 179 (1).
  29. Sumaira Jan and Mohi-ud-din Sangmi, 'The Role Of Board Of Directors In Corporate Governance' (2016) 2 Imperial Journal of Interdisciplinary research accessed 1 December 2020.
  30. The Companies Act, 2013, Section 179 (3).
  31. (Iicjlaw.com, 2020) accessed 4 December 2020.
  32. '(PDF) Corporate Board Structure In The United States And India: A Comparative View' (ResearchGate, 2020). accessed 3 December 2020.
Written By: Khyati Goyal - Qualifications: Pursuing B.B.A-L.L.B (3rd year) - O.P. Jindal Global University Email : [email protected], Ph no.: 8630581123

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