Nominee directors of IL&FS cannot be absolved of accountability: Experts

In the midst of the blame game over the performance of the sacked board of the beleaguered infrastructure finance behemoth, IL&FS, eyebrows are being raised on the role of the nominee directors.

None of the six nominee directors— who represent the five shareholders in IL&FS — are named as respondents in the government’s appeal before the National Company Law Tribunal (NCLT). Further, the nominee directors are not subject to the ongoing investigation by the Serious Fraud Investigation Office (SFIO) in the affairs of the company.

So, why were the nominee directors let off the hook, when the erstwhile board was considered incompetent and sacked through a court order?

“We have carved out a very special niche for nominee directors in our governance framework. Their special role is to represent the institution they are employed by,” explains chartered accountant Shailesh Haribhakti. 

Perhaps the view taken by the government was that the nominee directors were only following directions, he adds.

Most legal experts, including some proxy advisory firms, feel as the board of directors has a collective responsibility — to that extent, the nominee directors are equally accountable for the IL&FS’ current failures.

According to the Companies Act, 2013, a nominee director has the same rights as other directors on the board. This gives him/her the right to cast vote at a board meeting in favour of or against a proposed resolution. As regards obligations, nominee directors are required to comply with Section 166 of the Companies Act. They have fiduciary duties toward the company and its shareholders.

Legal experts point out that from an operational and commercial perspective, nominee directors — and the shareholders who nominate them — are usually not involved in the day-to-day management of a company.

Their role is largely that of one providing oversight and protecting the interests of the shareholder who nominates them, adds another company law expert.

“From a legal perspective, the Companies Act, and the jurisprudence that has come up around it recognises that nominee directors should be given more protection against the liabilities that other directors are sometimes faced with,” says a corporate lawyer.

Param Pandya, research fellow at Vidhi Legal for Legal Policy, points out that Section 149(12) of the Companies Act, 2013, requires that nominee directors,  who are non-executive directors, shall be held liable for any act or omission by the company which occurred with his knowledge, attributable through the board process, and with his connivance or where he had not acted diligently.

“This is a higher threshold compared to that of pinning liability against an executive director, who is in charge of the day-to-day affairs of the company,” says Pandya.

However, despite this ‘safe harbour’, nominee directors still have the same obligations toward the company and its shareholders that other directors do. For instance, in situations where a company has misrepresented its financials to its investors or shareholders, even nominee directors could be exposed to liability, unless they are able to show that they exercised due diligence and care in their duties, say legal experts.

“Generally, charges should be brought only based on actual evidence of wrongdoing by an individual, not merely on account of his/her status as a director,” says Harsh Pais, partner, Trilegal.

Hetal Dalal, chief operating officer, Institutional Investors Advisory Services (Iias), says that in the IL&FS case, while the nominee directors are equally responsible for the current failures of the company, these shareholders have to be on board to take ownership of the few painful decisions that are likely to be taken to turn around its operations. 

Legal experts say action by the government against the nominee directors of IL&FS cannot be ruled out at a later stage. 

“The government could seek to prosecute nominee directors for failing to fulfil their statutory duties toward IL&FS and its shareholders under Section 166 of the Companies Act – for which the punishment is a fine that may extend up to Rs 500,000,” note a company law expert.

Haribhakti is of the view that as more active board participation and engagement become the norm, the role of nominees will evolve to the role of an independent director. “I hope this happens sooner rather than later,” he says.

Shriram Subramanian, founder and managing director, InGovern Research, is of the view that the IL&FS crisis could trigger a review of the performance of the nominee directors in public sector companies. "The boards of several public sector enterprises have been complacent, and in some cases, even incompetent. There could be a case for the government to supersede some of these boards," he adds.