Who is an Independent Director? Why should a company consider having an independent director on board? In this article, we will discuss both these questions
Introduction
It is common knowledge that companies have a board of directors who are the top management and they consist of directors who decide the vision and the direction of the company. Why You Need Independent Directors On Your Board
However, it is not very commonly known that there are different types of directors in a board of directors. Three kinds to be more specific. There are executive directors, non-executive directors and independent directors.
Executive directors are directors who are involved in the day to day operations of the company. They have roles and responsibilities and duties to perform apart from participating in board meetings.
Then there are non-executive directors who do not participate in the operations and only have voting rights on certain matters that are the responsibility of the board of directors. They are usually shareholders or representatives of shareholders.
And then there is a third peculiar category called independent directors. These are directors who are neither shareholders, nor representatives of shareholders, nor part of the management but have been honorarily invited onto the board due to some qualification or experience they possess that the management and the body of shareholders deem valuable to the top management of the company.
In this article, we shall specifically discuss the concept of independent directors and the role they can play in the success of a company.
Who Is An Independent Director?
It is common for any company to have directors but it is rare to have independent directors though they are crucial.
Well, you could be confused regarding why your company should have such an independent director? In that case, you can get the answers to your questions cleared from our explanation here.
Business decisions taken by board members of a company often have far-reaching consequences. Independence, in this scenario, becomes a cornerstone of accountability, transparency and fairness. Independent Directors like the word suggests, are ‘independent’ and therefore, not motivated by profits, sales or any other association with the company.
They act as professionals giving advice on matters while taking board-decisions and are assumed to base their advice on their acumen of the legal, financial and business world. In this post, we cast light on the need for independent directors while also highlighting the role played by them in any business organization.
Independent Directors are directors who apart from receiving director’s remuneration do not have any other material pecuniary relationship or transaction with the company, its promoters, its management, or its subsidiary, which in the judgment of the Board may affect their independence of judgment.
Section 149 of the Companies Act also mentions that the Independent Director must be a person of integrity, should not be a promoter himself or with his relatives of any holding or subsidiary company.
Further, he must not have been an employee or auditor or legal consultant in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed.
Moreover, an Independent Director should possess appropriate skills, experience and knowledge in one or more fields of finance, law, management, sales, marketing, administration, research, corporate governance, technical operations or other disciplines related to the company’s business.
Benefits Of Appointing An Independent Director
Although it is public companies that are under an obligation to appoint an independent director, here is why you should consider having an independent director on your board:
- They bring focus and perspective to the company: If we think about one of the world’s greatest industrial disasters, the Bhopal Gas Tragedy, the board of Dow Chemicals collectively had decided to stop funding for a maintenance valve that would have checked the poisonous gas from escaping. Had there been one conscious independent director voicing his opinion, the outcome could have been very different. Independent Directors, given their experience in business, add a fresh perspective that other routine directors may not possess.
- Expertise & Impartiality: The Rule 5 of the Companies (Appointment of Director) Rules, 2014 clearly lays down that Independent Directors must have experience in the areas of sales, governance, finance, law, taxation, company’s technical operations etc. There are no parallel stipulations for any other director appointed by the company. Thus, given their skills and knowledge in core areas and lack of alignment with material causes or financial pursuits, the company stands to gain.
- Bridge in clearing deadlocks: If two or more board members disagree on a particular policy, it is often the independent director who is uniquely positioned (due to lack of familiarity, pecuniary gains or material relationships) to act as a neutral party, arbitrating internal conflicts between board members or stakeholders.
- Limitations on remuneration & stakes: Because of a mandate that independent directors cannot be offered any equity or stake in the company, independent directors can only be given the sitting fee for attending meetings which can be a maximum of 1 lac rupees. Further, a maximum of 1% of the company’s net profits can be paid as remuneration to its independent directors. In case there is no managing director or whole-time director or manager, then a maximum of 3% of net profit can be paid. Thus, the basis of payment to the independent directors is the net profit of the company. The company is however not obligated to remunerate its independent directors.
To put it succinctly, an independent director, barring remuneration, doesn’t have any other material or pecuniary relationship or transaction with the company.
Moreover, they get expertise, perspective, and impartiality to the decision-making process. They also make for great arbitrators during a disagreement between two or more directors of the firm.
Conclusion:-
Structuring a company is as important as the funding, the vision and the business plan. Without the former, the latter three are most likely to be misused and wasted, ultimately ending in the demise of the company.
Having a sound business structure is likely to attract investment and boost shareholder morale and confidence in the company. So it is always important to have an expert or a professional consultant guide you when you are structuring your company.
If you have any other queries with regards to corporate law and regulations, get in touch with us and we will ensure that you receive the right kind of guidance from our team of experts.
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