India: An Alternate Mechanism For The Appointment, Re-Appointment And Removal Of Independent Directors In Listed Companies

The independent directors ("IDs") act as a bridge between the management and the shareholders of the Company and hold the key responsibility of safeguarding the interest of the stakeholders, including the minority shareholders. The Companies Act, 2013 ("CA 2013") has laid down the criteria for IDs for all types of companies whereas SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 ("LODR Regulations") laid down additional criteria for IDs in the listed companies. Over a period of time, there have been no significant amendments in the provisions of IDs in CA 2013, however, SEBI has been proactively strengthening the provisions related to IDs for listed companies to ensure that corporate governance is upheld in the listed companies.

Regulatory framework for appointment, re-appointment, and removal of IDs

The appointment and re-appointment of IDs are prescribed under section 149 of the CA 2013, wherein an individual can be appointed as an ID of a company for a term up to 5 consecutive years by passing an ordinary resolution (i.e., at least 50% approval) in the general meeting and he/she would be further eligible for re-appointment as an ID by passing a special resolution (i.e., at least 75% approval) in the general meeting. While the tenure of IDs under LODR Regulations is in line with CA 2013, the appointment or re-appointment of IDs in listed entities is subject to the approval of shareholders in the form of a special resolution only. Therefore, the listed companies would need to seek a special resolution (and not an ordinary resolution) in case of the appointment of IDs.

In order to further strengthen the process of appointment, re-appointment or removal of IDs in listed companies, SEBI vide its notification, i.e., SEBI (LODR) (Sixth Amendment) Regulations, 2022 ("2022 amendment") introduced the alternative mechanism for the appointment of IDs in the listed entities wherein, if a resolution for the appointment of IDs fails to pass by 75% approval from the shareholders, then the listed companies would need to follow the alternate mechanism (given below) for ensuring the decision for appointment of IDs are made in fair and sensible manner:

(a) Whether the votes cast by all the shareholders in favor of the resolution is more than the votes cast against the resolution (i.e., more than 50% approval from all shareholders) and;

(b) Whether the votes cast by the public shareholders in favor of the resolution are more than the votes, if any, cast by them against the resolution (i.e., at least 50% approval from public shareholders).

When both the above-mentioned conditions of the alternate mechanism are fulfilled, the appointment of IDs would be deemed to be approved by the shareholders.

The process for removing an ID would depend on whether they were initially appointed by passing a special resolution, or by an alternate mechanism. If the IDs were appointed through a special resolution, the same procedure would need to be followed for the removal. For the IDs appointed through an alternate mechanism (stated above) then such IDs can only be removed through the alternate mechanism.

The intention of the market regulators behind the implementation of the alternate mechanism is to limit the influence of the promoter(s) on the process of appointment of IDs by virtue of their shareholding. Although the introduction of an alternate mechanism in regulation 25(2A) is limited in its applicability under the following two instances:

Not applicable in case of re-appointment of IDs:

The text of Regulation 25(2A) is, "The appointment, re-appointment or removal of an independent director of a listed entity, shall be subject to the approval of shareholders by way of a special resolution."

The proviso to regulation 25(2A) which implements the alternate mechanism is applicable only in the case of the appointment of IDs. The opening of sub-regulation 2A of regulation 25 talks about "appointment" as well as "re-appointment" of IDs, however, the proviso of regulation 25(2A) only laid down the emphasis only on the appointment of IDs. In general parlance, the word "appointment" includes "re-appointment" and therefore, there was a margin of ambiguity with the interpretation of sub-regulation 2A, where it may be construed that the entire sub-regulation (i.e., alternate mechanism) will be applicable in both the case, i.e., "appointment" and "re-appointment".

If that was the case, then an alternate mechanism (i.e., ordinary resolution) in case of re-appointment of IDs would lead to a violation of the correspondence section under the CA 2013, wherein it requires special resolution for re-appointment of IDs. Therefore, the alternate mechanism is not applicable in case of re-appointment of IDs. The same was clarified by SEBI in its agenda papers for the board meeting held on September 30, 2022. Further, with the amendment in the LODR Regulations dated January 17, 2023, SEBI has clarified that the provisions laid down under regulation 17 (1C) are applicable in case of both appointment and re-appointment of Directors after inserting the word "or Re-appointment". In light of this, one might infer that the appointment does not include re-appointment in LODR Regulations.

Not applicable in case of an individual has attained the age of 75 years:

As per Regulation 17(1A), no listed company shall appoint a person or continue the directorship of any person as a non-executive director (including IDs) who has attained the age of 75 years unless a special resolution is passed to that effect. The listed companies generally come up with a single resolution for the appointment of IDs and specific approval for age of IDs of 75 years or above. In such instances, the alternate mechanism would be a failure as it requires a 'majority of minor' approval for appointment on one hand, and the special resolution would be needed in case of appointment of an individual above 75 years of age on the other hand.

Even if the listed companies propose two separate resolutions (i) for appointment of IDs and (ii) specific approval for the aspect of 75 years of age; then it would be the hypothetical situation to say where one is not in favour of the first resolution (appointment) but support the second resolution (an aspect of 75 years age). Therefore, the alternate mechanism does not appear to hold good in the case of the appointment of individuals who have attained the age of 75 years as IDs.

In a nutshell, there has been inconsistency in the provisions of CA 2013 and SEBI LODR regulations, when it comes to appointment, re-appointment and removal of IDs. While there is the provision of an alternate mechanism for the appointment and removal of IDs in SEBI LODR, the correspondence provision is not available in SEBI LODR regulations. Similarly, the re-appointment of IDs requires a special resolution under CA 2013 and therefore, SEBI will not be in a position to implement an alternate mechanism for re-appointment. However, to remove this ambiguity SEBI has already given the recommendation to MCA to consider amendments in the CA 2013 so as to incorporate the alternative mechanism for the purpose of re-appointment of Independent Directors, at least for listed entities.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.