Independent directors - are they decision-makers?

The Companies Act provides immunity to independent directors only in exceptional cases; the recent SC decision on Jaypee is a wake-up call

The Supreme Court (SC) in its November 22 order restrained all directors, including independent directors (IDs), of Jaiprakash Associates (JAL) from alienating their personal properties or assets in any manner. It said if they did so, they would be liable for criminal prosecution and contempt of court. The SC also directed the properties and assets of their immediate and dependent family members not be transferred in any manner. The order has raised debate on whether IDs should be held liable for operational issues. 

The case relates to the insolvency proceedings against Jaypee Infratech (JIL), which defaulted on a loan of Rs 526.11 crore from IDBI Bank, and also failed to deliver homes to 32,000 people who had purchased flats. To seek clarity on the legal issues and protection of their interest, the homebuyers approached the SC. In September, to protect the latter’s interest, the SC ordered JAL, parent of JIL, to deposit Rs 2,000 crore. The promoter’s holding in JAL is a little more than 39 per cent. JAL holds a little more than 76 per cent in JIL. 

The role of the board of directors and their accountability are established in law. The board is responsible for managing the company. It delegates power and authority to the chief executive officer (CEO) for day-to-day operations and operational issues. Therefore, the board cannot abdicate its responsibility of overseeing the executive management. The board and directors are accountable to shareholders and other stakeholders for all decisions.  

The Companies Act provides immunity to IDs. It stipulates that an ID be held liable only in respect of such acts of omission or commission by a company which had occurred with his knowledge, attributable through board processes and with his consent or connivance, or where he had not acted diligently. The provision is very broad and, therefore, immunity is available only in exceptional cases. For example, an ID cannot be held responsible if the company is found guilty of bribing a government official, provided the proposal to bribe government officials was not included in the board agenda and discussed there. 

However, an ID cannot claim immunity for omission or commission if the matter was included in the board agenda and discussed in the meeting because he/she is expected to study the agenda and minutes of board meeting diligently. It is deemed an item that is included in the agenda or minutes of board meetings is within the knowledge of every director. It is immaterial whether the director attended the meeting or not. 

In the absence of dissent recorded properly, it will be deemed that an ID consented to the decision of the company. If a director fails to get an issue which should be discussed in the board, included in the agenda or fails to seek required information on issues before the board, it may be construed that he/she has not applied due-diligence. In providing immunity to IDs, the law does not make a difference between decisions on operating issues and those related to strategic issues. 

In practice, it is often difficult to distinguish between operating and strategic decisions. The business model flows from the strategy and operating decisions, except those taken at a lower level of the management, flows from the business model. Take the example of real estate. Although the significant delay in delivering apartments to homebuyers by realty companies is attributed to the slowdown in the housing sector, it is not exactly true.  

The primary reasons are a faulty business model, greed to expand the business without evaluating the risk of delay in obtaining regulatory approval and possible downturn, weak cash management and a long practice of ignoring customer interest because of a weak regulatory environment. Therefore, a significant delay in delivery does not arise from operational decisions. Rather, it arises from both operational and strategic decisions. It is futile to try to classify top management decisions into operational and strategic decisions. 

Directors, including IDs, should be held accountable for every decision of the board or the ones usually reserved for the board but taken at the executive level without effective checks and balances, due to a board’s ineffectiveness. The SC’s decision is a wake-up call.

The author is adjunct professor, Institute of Management Technology, Ghaziabad)

Mail id: asish.bhattacharyya@gmail.com

Twitter handle: @AsishB50