As a corporate governance measure, the Companies Act, 2013 (the “Act”) has introduced provisions to ensure that the board of directors is actually independent, considering that it is the body making decisions for the management and affairs of the company. Directors are required to exercise due and reasonable care, skill and diligence, independent judgment and to act in good faith to promote the objects of the company and in the best interests of the company.

Yet, decades after the Enron scandal (USA) showed the world what would happen if the boards looked the other way, little has truly changed. Legal mandates alone cannot suffice to ensure that a board of directors is actually independent in practice. The scandal reminds us of a board of directors that failed to protect the interests of the corporation. Many referred to the board of directors as a rubber stamp board. The term ‘rubber stamp board’ is not widely used across the globe; however, the phenomenon it describes can be witnessed in corporate entities across jurisdictions.

Rubber stamp board is a board of directors that participate in the decision making of the company passively. They may approve board resolutions without actively engaging in fruitful discussions, which is fundamental to protect the interest of the company’s affairs. In short, they fail to make informed decisions. Enron scandal was examined to determine the factors to label a board of director as rubber stamp board. The two factors are (a) a high percentage approval record for any board resolution, and (b) approving resolutions that are judged as poor decisions on an ex-ante basis.

Attempts to ensure independence of board of directors before the Companies Act, 2013.

In 1998, the Confederation of Indian Industry task force issued the report titled Desirable

Corporate Governance: A Code, which discussed, the role and importance of independent directors in ensuring greater objectivity and accountability at the board level. Thereafter, in 2000, Securities Exchange Board of India (SEBI) introduced Clause 49 of the SEBI Listing Obligations and Disclosure Regulation, which prescribed, inter alia, requirements relating to the composition of the board and the presence of independent directors, with the objective of enhancing transparency, accountability and the quality of decision-making within the boardroom. Section 292A of the Companies Act, 1956, required certain public companies to constitute an Audit Committee which was supposed to strengthen the institutional framework for board oversight and laid the foundation for subsequent reforms concerning board accountability and independence. A major turning point came with the Satyam scandal in 2009, which raised questions regarding the effectiveness of board of directors in detecting and preventing corporate misconduct. Thereafter, in 2013, the Companies Act introduced provisions to ensure that the board of directors is actually independent.

The Companies Act vis-à-vis Board of Directors.

To make the board of directors genuinely independent, there is a statutory mandate for a minimum number of directors on the Board of a company under the Act. Further, it formally recognised the concept of an ‘independent director’ under Section 149(6) of the Act and mandates the appointment of independent directors in specified classes of companies. The Act further sought to strengthen their role through provisions relating to their duties, liabilities, appointment, tenure, remuneration and participation in key board committees.

Section 166 of the Act requires directors to exercise due and reasonable care, skill and diligence. Section 149 of the Act describes the eligibility of an independent director to ensure that the independent director shall have no pecuniary interest or related with either the founder/promoter of the Company or the Company. Schedule IV to the Companies Act, 2013 requires independent directors to bring an objective and independent view to board deliberations, remain adequately informed, and ensure that sufficient deliberation takes place before decisions are taken.

Section 177 and 178 of the Act provides for the Audit Committee and Nomination and Remuneration Committee, respectively, which are intended to provide an additional layer of oversight over matters such as financial reporting, related-party transactions, appointments and performance evaluation.

The law regulates the formation of board of directors, composition including appointment of an independent director, meetings, preparation of minutes and board’s reports, duties they are expected to perform. However, it is pertinent to note that to regulate the quality of discussion before approving any board resolution, the willingness to dissent, or the independence of a director’s judgment is a tough nut to crack.

If a Board is actually independent?

Despite all the statutory and regulatory compliances followed, the board may fail to be classified as independent. An independent director may technically be independent under Section 149(6), while still being influenced by their appointment, reappointment, professional relationships or the prevailing culture of the board.

Particularly in promoter-run or family-run companies, constitution of a board of directors is more for the sake of compliance with law, and less for managing the affairs of the company. Founders desire neither to give away the control of the company nor to give away decision making power. Board of Directors hardly applies brain and make an informed decision; even they enjoy the minimalist approach. Instead of being loyal to the interests of the company, the directors show their loyalty to the founder/promoter or the management of the company. As evident from the Enron case, the directors appointed to the board had expertise, skills and experience and yet continued approving resolutions while failing to dissent, engage in quality discussions. Independence of the board for compliance’s sake and independence as a behavioural one are different things, and the gap between them is where rubber-stamping lives. Whether a board is actually independent and effective depends largely on the conduct and culture within the boardroom.

Conclusion

Compliance with the law alone fails to certify a board as an independent board. The following shall be followed, otherwise, the board would become a rubber stamp board.

In order to make the board genuinely independent, in addition to the statutory and regulatory compliances, the directors should indulge in healthy scepticism rather than being gullible while approving any board resolution. The directors should obtain adequate information and time to decide on any business agenda. The directors should prepare notes, ask questions and have healthy discussions before any decision is taken. The minutes of the meetings should be prepared in detail including the questions asked and discussed. Further, the directors should be encouraged to buy a substantial portion of the securities of the company, as that serves as an incentive to engage in informed decision making and more significantly, monitor the decisions taken. A director serving on several boards will rush the decision-making process and hence, the number of directorships permitted under the Act should be reduced from 20. Furthermore, the number of directors should also be proportionate to the size of the corporate entity.