PNB fraud may become a test case for judging roles of independent directors

The NCLAT, in its recent order, upheld the plea by the Ministry of Corporate Affairs to freeze personal assets of independent directors associated with companies being investigated in the PNB scam.

Independent directors are in a tizzy. This follows the recent National Company Law Appellate Tribunal (NCLAT) order upholding the plea by the Ministry of Corporate Affairs to freeze personal assets of independent directors associated with companies that are being investigated for their involvement in the Punjab National Bank scam. 

Legal experts say the power to freeze personal assets of directors during the course of an enquiry or investigation in the operation of the company is available under Sections 221 and 242 (1) of the Companies Act, 2013. However, the power to do so is not absolute, but based on facts in each case, they add. “The power to order the freezing of assets of director or managers or officers, fastening personal liability against them should be exercised with restraint and only when sufficient evidence would be available against them,” says Atul Pandey, partner, Khaitan & Co.

The NCLAT order has left many independent directors in a pensive mood. “This is a very serious and unfortunate development,” says Arun Duggal, an experienced banker, who is on the board of several companies. Duggal is of the view that an independent director should be held liable only if it is proven that the wrongdoing is with his or her connivance, and he has personally benefited from it. 

What galls many directors is in most cases, agencies that conduct investigation paint all members of the board of the company with the same brush. A common complaint is that the agencies often fail to distinguish the role of the independent director from those who have an operational role in the company.

“I have looked upon the role of independent directors as positive, value adding and constructive. These attributes transform as business performance deteriorates or melts precipitously,” says Shailesh Haribhakti, an independent director with more than 35 years of experience. It is in these circumstances that the call has to be taken on the extent of involvement of independent directors in the operations of the company and the claim on their personal assets, he adds. 

Shriram Subramanian, founder and managing director, InGovern Research Services, too feels that freezing of assets without proving whether the independent director is complicit in the fraud is akin to holding a person guilty without trial.

There are, however, some who feel independent directors cannot alienate themselves from company issues. “Their principal responsibility is to protect the interests of the general shareholders which they must uphold at all costs which unfortunately did not happen in the UB, JP Associates, Fortis or Nirav Modi case,” says M P Shorawala, a Supreme Court advocate.

Legal experts say one after-effect of the NCLAT order will be that independent directors going forward will become more diligent while associating themselves with a company. 

“After such judgment, independent directors have to be extra cautious and must be able to prove that they have always acted in a bonafide way and in the best interest of the company,” says Sumit Naib, director, Nangia Advisors.

Raising appropriate red flags at the right time would help them in avoiding unwanted situations and their consequences to a great extent, he adds. 

Duggal fears that this may make it harder to attract high-quality independent directors to serve on the boards of smaller companies. “The Companies Act should be amended to offer adequate protection to honest and competent independent directors so that they can help safeguard the interests of stakeholders if a company gets into distress,” he says. That is when they are needed most, he adds. Many independent directors feel that industry bodies, like CII and Ficci, should sensitise different arms of the government and the investigating agencies on the role of independent directors in a company.

TURNING ON THE HEAT

February, 2018

• Following the PNB scam, an interim NCLT order allows the government to attach 64 properties belonging to individuals and companies associated with Nirav Modi and Mehul Choksi

April, 2018

• Former independent directors on the board of these companies approach the tribunal to seek removal of their names from the earlier order
• A division bench of the NCLT vacated its earlier order on the restriction on the personal assets of former directors

July, 2018

• The National Company Law Appellate Tribunal upheld the Ministry of Corporate Affairs' (MCA) plea for revocation of the NCLT order. It allowed the freezing of assets of independent directors till completion of the ongoing investigation

CHANGING ROLE OF INDEPENDENT DIRECTORS

• The Expert Committee on Company Law, constituted by the MCA, had this to say on the role of independent directors: 

“Independent directors should be able to bring an element of objectivity to Board process in the general interests of 

the company and thereby to the benefit of minority interests and smaller shareholders”

• In light of the Nirav Modi debacle, the MCA has been mulling stricter regulations for curbing malpractice among independent directors