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The first information report (FIR) against Kumar Mangalam Birla, Chairman, Aditya Birla Group, has raised some questions. Apart from the usual debate on overreach on the part of the Central Bureau of Investigation (CBI), which has divided the legal community, it has put the spotlight on legal accountability of non-executive and independent directors on a board under the Companies Act.
Most legal experts, corporate lawyers, auditors, and some serving independent directors feel the move may make non-executive directors err on the side of caution and be selective in giving their concurrence to certain contentious decisions of the company.
Perhaps, the most famous case of prosecution and conviction of a non-executive chairman in corporate India was that of Keshub Mahindra of Mahindra Group, who had occupied the position at Union Carbide India, during the Bhopal gas tragedy.
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OFFICER IN DEFAULT WHAT THE LAW STATES |
| COMPANIES ACT, 1956 |
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Section 5: Meaning of officer who is in default Section 201: Avoidance of provisions relieving liability of officers and auditors of company |
| COMPANIES ACT, 2013 |
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Section 2(60): Officer who is in default Section 149(12): notwithstanding anything contained in this Act (i) an independent director (ii) a non-executive director not being promoter or key managerial personnel, shall 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
Source: Companies Act, 2013, & Companies Act, 1956 |
Accountability of non-ED
Legal experts point out that the term "non-executive directors" finds no reference under the Companies Act, 1956, anywhere. Though the Companies Act, 2013, also does not define "non-executive directors", the rules define an executive director as a whole-time director. "Non-executive director is understood to be a director who is not involved in the day-to-day affairs of the company, and receives his remuneration by way of sitting fees and/or commission," says Pallavi Bakhru, director, Grant Thornton Advisory Pvt Ltd.
In case of an offence committed by a company - apart from the company itself - the law makes relevant individuals accountable. This leads to a concept of officer in default, both in the 1956 Act, as well as under the 2013 Act. According to the 1956 Act, in Section 5, meaning of officer who is in default covers any person in whose accordance the board is accustomed to act.
"A person being non -ED maybe held only if it can be proved that the current board of directors acts in accordance with his directions or instructions," points out Kavish Sarawgi, director, Resurgent India, a corporate advisory firm.
Under Companies Act, 2013, section 149(12) states that non-executive directors or independent directors shall 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, provided he is not a promoter or KMP (key management personnel). Therefore, a non-ED cannot escape penalty, if he is a promoter or KMP, say auditors and corporate lawyers.
Section 197(13) provides that an insurance may be taken by a company on behalf of its MD, manager, CEO, CFO or CS for indemnifying any of them against any liability in respect of any negligence, default, misfeasance, breach of duty or breach of trust for which they may be guilty. As the section doesn't cover non-executive directors, promoter or KMP, they cannot be indemnified, point out experts.
In other words, if the independent director puts it on record - through minutes of the board meeting - that he did not concur with a certain decision of the board, he is not liable for prosecution. However, the burden of proof is on the director, point out legal experts.
Promoters and any KMP of a company - including non-executive directors who are part of the promoter group - are liable for prosecution whether or not they are involved in the day-to-day operations of a company.
Interestingly, the Ministry of Corporate Affairs had in March 2011 issued a circular instructing its officers to be cautious while initiating prosecution against independent directors, which included non-executive directors.
Divided legal fraternity
The Birla FIR issue has created a divide in the legal fraternity. According to H P Ranina, noted corporate lawyer and senior advocate, Supreme Court, the law does not say anything specifically about the role of non-executive chairman's accountability. "The question is whether you are aware of what is happening or not," he says.
Ranina points out that even if a person is a non-executive director, who is not in charge of day-to-day affairs, but has given his consent for something, he is liable. "In the case of Birla, he has admitted himself that he went to the PM with a representation," he adds.
However, another Supreme Court advocate, Gopal Jain, differs. "A non- executive director is not bound by the normal principles which apply to a person responsible for, and in charge of day-to-day affairs, that is, an executive director. So, I don't think you can take any penal or coercive action," says Jain.
Commenting on the Birla case, he says, the CBI hasn't even been able to prove any criminality before an FIR was filed.
"When a government decision is taken, there is always a presumption of legality, in this case, it seems to be the other way around," he says.
The shadow of this case will have a negative impact on independent directors as an institution, says Samir Barua, who is on the board of several companies including Axis Bank, ONGC and Torrent Power. "They will be extremely wary of getting involved, going forward" he adds.
Rajat Sethi, partner, S&R Associates, a Delhi-based legal firm, feels that this may even have implications in relation to availability of qualified persons willing to be appointed to such positions. Agrees Gopal Jain: "Absolutely, this is going to make people more wary. This defeats the entire purpose of having credible, independent persons come on board to improve governance." According to Ranina, who is on the board of 48 companies as an independent director, the normal practice is that non-executive directors and independent directors take a letter of compliance from the MD of the company saying that all rules have been complied with.
But there are also members on the board who are non-executive only on paper, but are fully clued into what's happening in the company, he points out. But there are many in corporate circles who feel this incident should not cow down the "independence" of independent directors. Says, Shriram Subramanian, Founder and Managing Director, InGovern Research Services, a proxy advisory firm, "I don't think directors should shy away from decisions and be careful. They have to use their judgment and act in a fair and correct manner. They should not be complicit in wrongdoings of the company."
Echoes Pallavi Bakhru of Grant Thornton Advisory: "The intention of the 2013 Act seems to be very clear that a non-executive director is expected to 'speak up' and 'blow the whistle' in case he is privy to any misconduct or default."
Perhaps independent directors will do good to remember the famous quote by Peter Spiderman Parker's uncle Ben: "With great power comes great responsibility"
