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Independent Directors and mandate of online proficiency test: Approbation or mere disdain?

07 January 2020

by Sudish Sharma Vidhi Madan

Introduction

With the objective of thriving good corporate governance, Ministry of Corporate Affairs (“MCA”) on October 22, 2019 notified the Companies (Creation and Maintenance of databank of Independent Directors) Rules, 2019 (“Databank Rules”) in exercise of the powers conferred upon it by Sections 150 and 469 of the Companies Act, 2013 (“CA 2013”). The Databank Rules endeavor to create and maintain an online databank of persons willing and eligible to be appointed as independent directors (“IDs”) which shall be placed on the website of the Indian Institute of Corporate Affairs (“IICA”). The provisions other than Rule 2 (dealing with definitions under the Databank Rules) and Rule 5 (dealing with panel of members of Indian Institute of Corporate Affairs) of the Databank Rules are effective from December 01, 2019.

Additionally, MCA amended Rule 8 of the Companies (Accounts) Rules, 2014 (“Accounts Rules”) and Rule 6 of Companies (Appointment and Qualifications of Directors) Rules, 2014 (“Appointment and Qualification Rules”). The aforesaid amendments to Accounts Rules and Appointment and Qualification Rules are effective from December 01, 2019.

Therefore, an attempt has been made to simplify the harmonious interpretation of the aforesaid notifications which thereby affects the process of appointments of IDs on the Board of Indian Companies and the process and requirements of the new database and test rules.

Analysing the aforesaid notifications and effect of creating an online databank

IDs are the most credible source on the board of the Company as they are expected to be under no influence from both inside and outside forces. However, considering the plethora of corporate scams coming to light, it became evident for MCA to improve the corporate governance regime by exercising conscious effort in making IDs aware of their independent practice on the board and to advance the corporate literacy by conducting online proficiency test within a period of one year from the date of inclusion of name in the databank.

As per Section 149(4) of CA 2013, every listed Company is under a mandate to appoint IDs on its board. The role of IDs broadly includes improving corporate credibility and governance standards, functioning as a watchdog, and playing a vital role in risk management of the Company. It be noted that when the CA, 2013 was notified, Section 150 of CA 2013 (which deals with the manner of selection of IDs) was kept inactive and reason for the same was the absence of a body or institution or association who can create and maintain the databank of IDs. However, this hurdle has now been removed as the authority and responsibility has been assigned to IICA. While the Central Government is in process of creating the database of IDs, any appointment or re-appointment made by the Companies is not affected by Section 150 of CA 2013 provided such appointments and re-appointments of IDs are made in terms of Section 149(6) of CA 2013 and provisions of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”).

However, the interpretation of the expression ‘an independent director may be selected from a databank’ stands changed now. The word ‘may’ was not interpreted in its literal meaning and therefore, the interpretation has now been affected by the amended Rule 6(1) of Appointment and Qualification Rules and Rule 3 and Rule 4 of Databank Rules. The effect of the creation of the databank can be understood on two broad classifications, i.e. effect on already appointed IDs and secondly on proposed appointments of IDs.

(a) Effect on already appointed IDs

Rule 6(1)(a) of Appointment and Qualifications Rules read with Rule 4 of Databank Rules clarifies the effect on already appointed IDs. Rule 6(1)(a) of Appointment and Qualifications Rules, states that every individual who has been appointed as an ID in a company as on December 01, 2019 shall within a period of three months from December 01, 2019 (i.e. within March 01, 2020) apply online to the institute for inclusion of his name in the data bank for a period of one year or five years or for his life-time and the effective date of applying online is from December 01, 2019. On the other hand, Rule 4 of Databank Rules states that the institute shall conduct an online proficiency self-assessment test covering companies law, securities law, basic accountancy, and such other areas relevant to the functioning of an individual acting as an ID as well as prepare a basic study material, online lessons, including audio-visuals for easy reference of individuals taking the online proficiency self-assessment test. Therefore, it can be said that any individual falling under Rule 6(1) of Appointment and Qualification Rules shall apply for inclusion of his name after passing an online proficiency test to be conducted by IICA and only on passing of such test his name shall be included in the database. The time limit for applying for inclusion of names shall be March 01, 2020.

(b) Effect on proposed assignments

Rule 6(1) (b) of Appointment and Qualification Rules states that anyone who intends to get appointed as an ID in a Company, shall before such appointment apply online to the institute for inclusion of his name in the data bank for a period of one year or five years or for his life-time, till he continues to hold the office of an independent director in any company. Rule 6(1)(b) of Appointment and Qualification Rules obligates the individual who is proposed to be appointed as an ID to qualify the online proficiency test to be conducted by IICA with effect from December 01, 2019.

Therefore, the interpretation of the word ‘may’ in Section 150(1) of CA 2013 has now been broadly interpreted to state that any ID whether already appointed or is proposed to be appointed has to undergo the process of passing online proficiency test for inclusion of his or her name into database of IDs. Further, IICA has also been empowered to reject the applications received for inclusion of names in the database or remove any name already included on case to case basis.

Positive and negative aspects of conducting online proficiency test

Rule 6 of Appointment and Qualification Rules requires IDs to qualify the online proficiency test with atleast 60% marks. This is a novel step by the MCA and is in line with the amended CA 2013. This will remove years of slack and frequent allegations of corruption, nepotism and directors who act like mute spectators in corporate boardrooms. It is not just domain knowledge that will be put to test, but also various aspects of Companies’ law, Securities law, basic accountancy and such other areas relevant to the functioning of an individual acting as ID. The rules made are stringent as it was noticed that in many cases political appointees with standard financial background were also getting rehabilitated in several Companies as IDs. This method may help in bringing professionalism, alertness and more accountability leaving aside a usual passive role. Furthermore, the entire process is done in a financially efficient way that will make the crème de la crème of the industry available to various companies and business organizations.

However, there lies some ambiguity and visible gaps in the process of conducting this entire mechanism of online proficiency test.

Firstly, it is not clear whether the existing IDs will have to vacate their office if they do not qualify online proficiency test or if they do not get themselves enrolled in the databank.

Secondly, the enrolment can be for one year, five years or for lifetime. However, the qualification requirement of passing the online proficiency test is only once in a lifetime. It is therefore, presumed that prospective IDs will update their knowledge of rapidly changing laws on their own and only under the apprehension of qualifying the online proficiency test.

Thirdly, a uniform test may not achieve its intended purpose and could shrink the pool. A board needs multiple skills depending on the business they are in and the requirements vary from business to business. Having a standardized test would only take away from the pool of available IDs and limiting the options available to a business organization.

Lastly, there is a procedural and administrative impediment concerning the fast track implementation of the aforesaid notifications. At present, neither the Institute, databank, educational material nor test system seem to be fully ready for the new requirement of ticking the box for qualifying the online proficiency test for IDs.

Conclusion

The initiative of MCA in bringing this requirement of online proficiency test for IDs can be praised as a step in the right direction. It has been observed that the number of IDs required in the industry is ever increasing. Their obligations and potential liabilities are also enormous and continue to increase. A singular database would make it easier for corporates to compare and select the right individual as per their requirements as it would give them atleast an objective scale in the form of the standardized test to compare them. This initiative of MCA is not expected to be costly and the fees payable to the Institute for the enrolment is also reasonable. Therefore, it can be said that the effort and costs would pay off in terms of knowledge possessed by the IDs along with the increased opportunities for the individuals.

However, there are some ambiguities that need to be clarified. Even though enough time has been given for the transition, this would still make it difficult for many prospective IDs to comply with the requirement. If the rules are taken literally and narrowly, it is possible that many IDs would become disqualified and some may vacate their office. Clearly, some clarification and relaxation both in terms of time and requirement of enrolment is needed. The office of IDs also needs a holistic relook so that the cream of the IDs does not quietly leave the scene being underpaid, underpowered, under-respected and over-obligated.

[The authors are Executive Partner and Associate, respectively, in Corporate Advisory team, Lakshmikumaran & Sridharan, Gurgaon]