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It is not uncommon for a financial Institution to foist on the Board of a Company, in exercise of its authority contained in the terms and conditions associated  generally with a borrowing arrangement contracted by the company. Whereas under the erstwhile provisions of Clause 49 of the Listing agreement with the Stock Exchanges, a  Nominee Director representing an Institution which has invested in or lent to the company was considered as an “Independent Director”, Section 149(6) of the Companies Act, 2013(hereinafter “the Act”) states unequivocally that a Nominee director would not be considered as an Independent Director in relation to the company. Further unlike its predecessor (Companies Act, 1956), the Act also contains, a definition for the term, which, albeit, is limited in scope for the purposes of section 149 only. In addition, the present Act empowers under the aegis of Section 161(3) the Board to appoint a Nominee director and such appointment shall not  necessitate regularization by the Shareholders of the company in compliance with the procedure laid down under Section 160 of the Act as in the case of persons appointed as Additional Directors, to fill up casual vacancies in the Board and the like.

In this exposition, we shall  throw  light on the above issues and also bring to the fore certain grey areas which need introspection.

Nominee Director - Not an Independent Director under the Act

The Explanation contained under Section 149(7) of the Act defines a  "Nominee Director" as under:

Quote

“For the purposes of this Section, “Nominee Director  ”means a director nominated by any financial Institution in pursuance of the provisions of any law for the time being in force, or of any agreement, or appointed by any Government , or any other person to represent its interests”.

Unquote

From the above, it is clear that a person appointed as a Nominee director on the Board has to have the following attributes:

a) He should be nominated by any financial Institution in pursuance of any law or in terms of an agreement entered into by the company

b) He could be appointed by the Government or by any other person.

c) The person so appointed shall represent the interests of the organization /Institution which he represents.

As stated above under the regime of the erstwhile listing agreement ,  the status of the Nominee director was that of an Independent director. This status stands negated under the Act in view of the express assertion contained under Section 149(6) of the Act. 

The JJ Irani Committee constituted by the Ministry of Company Affairs in its Report had expressed the view that Nominee directors appointed by any Institution or in pursuance of any agreement or Government appointees representing Government shareholding should not be deemed to be Independent directors. A view point was expressed that   nominees of Banks/Financial Institutions on the Boards of companies could be treated as “independent” .After detailed deliberation , the Committee came to the conclusion that such nominees represented specific interests and could not, therefore, be correctly termed as Independent directors.

The sentiments expressed by the Committee have found place in the form of an assertion in Section 149(6) to the effect that Nominee directors ought not to be considered as independent directors.

Paradox in the Act-Directors’ representing small shareholders are independent directors

Section 151 of the Act provides that in the case of a listed company   , there may be appointed a director to represent the interest of small shareholders. By definition “small shareholders” would mean shareholders holding shares of a nominal value not exceeding twenty thousand rupees or such other sum as may be prescribed.

Rule 7 of the companies (Appointment and Qualification of directors) Rules, 2014 lays down, inter alia,   the procedure to be adopted for the appointment of such a director.

Rule 7(4) stipulates that such director shall be considered as an Independent director subject to his being eligible for the appointment in terms of Section 149(6) and also subject to his giving a declaration of his independence in accordance with the provisions of Section 149(7).

From the above, it follows that  a  director elected by small shareholders would be deemed to be an independent director

A director appointed under Section 151 represents the constituency of small shareholders and it is incumbent upon him to protect the interest of his constituency.

It is interesting to note that while expressing the view that nominee directors should not be considered as independent directors, the JJ Irani committee had  opined that  as such nominee directors represented specific interests they should not be deemed to be independent. It is intriguing to note that despite the fact the small shareholders’ director too represents a specific interest group in the company, he is considered as an independent director by the law. This is an obvious contradiction which defies logic. When the responsibilities of both classes of directors are identical, they should both stand on the same pedestal. As the proverb goes, "what’s sauce for the Goose is sauce for the Gander" or what is good for a man is equally good for a woman ! Unfortunately the Law maker thinks otherwise .Until the law is suitably amended to set right the above contradiction, we shall have to live with the statute as it stands, albeit, with a pinch of salt.

Does the Nominee Director retire by   rotation

Having grudgingly accepted the position that a Nominee director is not an Independent Director , the next question that comes up is that, given the fact that he is also a non-executive director, does the nominee director retire by rotation in the manner contemplated under Section 152(6) of the Act?

It is pertinent to note that there is nothing in the definition of a Nominee director as   given by the Explanation under Section 149(7) which suggests that he shall   not be liable to retire by rotation.

As we are aware, a Nominee director can be appointed  by a financial Institution either in pursuance of a statutory provision under any law for the time being in force or by an agreement or he may be appointed by any Government or by any other person to represent their interests.

Section 161(3) of the Act provides that subject to the Articles of a company, the Board may appoint any person as a Director nominated by any Institution pursuant to any law for the time being in force, or of any agreement or by the central Government or the State Government by virtue of its shareholding in a Government company.

Where such nominees have been   appointed pursuant to any statutory provision applicable to the financial Institution nominating the person   , reference has to be made to the   relevant statute for determining their status. Under clause ( c ) of   Section 19A(3)  of the Unit Trust of India Act, 1963, a Nominee is not liable to retire by rotation and he shall not be taken into consideration in computing the number of Directors who are liable to retire by rotation.

Section 19A(3) of the Unit Trust of India Act, 1963,provides as under:

Quote

Any director appointed as aforesaid shall-

a) hold office during the pleasure of the Trust and may be removed or substituted by any person by order in writing by the Trust.

b)not incur any obligation or liability by reason of his being a director or for anything done or omitted to be done in good faith in the discharge of his duties as a director or anything in relation thereto

c) not be liable to retire by rotation and shall not be taken into consideration for computing the number of directors liable to retire by rotation.

Unquote

There exist similar provisions in Section 30A of the Industrial Development Bank of India Act  , in Section 27 of the State Finance Act, under Section 6A of the Life Insurance corporation Act, Section 35A of the state Bank of India Act, 1955,section 38A of the State Bank of India (Subsidiary Banks) Act, 1959 and Section 10A of the Banking companies(Acquisition and Transfer of Undertakings )Act, 1970.Those appointed  under statutory provisions such as the above, shall not be liable to retire by rotation under Section 152(6) and they shall continue to remain Directors as per the will and pleasure of the Institutions  nominating them despite not enjoying  the status of Independent directors. The authority conferred under the aforesaid legislations would have an overriding effect over the provisions in the Act  , thus making it possible for the person appointed as Nominee to continue in office at the will and pleasure of the Institution nominating him and be excluded from being considered for re-appointment by the process of rotation. He will also not be taken into consideration for the purpose of determining the two-thirds and one-third limits as provided in Section 152 (6) of the Act.

The   above position also applied under the provisions of section 255 of the 1956 Act which corresponds to section 152 of the 2013 Act.

Appointment of Nominee Director under an arrangement or agreement with the company

It would be interesting to examine the legal position of  a Nominee Director who is foisted on the Board of a company in terms of any agreement between the company and a particular stake holder which may be a Holding company also. Does the Nominee so appointed   qualify as one who is not liable to retire by rotation .Further does he continue to be in office at the will and pleasure of the concerned stake holder. A pre-requisite to such an appointment would be the existence of enabling provisions in the company’s Articles to facilitate such an appointment. .It is pertinent to note that Section 161(3) in the Act begins with the words  ”Subject to the Articles of a company”. The above opening words make it clear that the Articles should facilitate the appointment of a Nominee director in all circumstances, be it through the force of a specific legislation or by agreement. In James v EVE(1873)LR 6 HL 335 it was held that if the company’s articles provide for the appointment of directors by recommendation of shareholders at the general meeting, a contract by which the company purports to confer the rights on any other person to make appointments to the Board in any other way is invalid.

It is also possible that the nomination agreement among the members may also be embodied in the articles. The person empowered to make nominations in terms of the agreement can exercise such authority as long as he is in the saddle and continues to hold authority under the agreement. The related issue that  , however, arises in such a case is whether the nominee would have to be taken into consideration as one liable to retire by rotation. In East Indian Produce Co. Ltd v Naresh Acharya Bhaduri(1988)64 Com Cases 259, 278(cal) , there existed a clause in an agreement between sellers who were shareholders of the company and the purchasers of the shares of the company from the sellers which provided , inter alia, that  the sellers shall cause at least 4 directors to resign and to get nominees of the purchasers to be appointed to the board of the company. The Court held that   the clause did not affect the provisions of   Sections 255 and 256 of the 1956 Act governing rotation of directors.

Is the Holding Company’s right to appoint majority of directors consistent with Section 152 of the Act which corresponds to Section 255 of the 1956 Act

Section 4 of the 1956 Act as also Section 2(87) of the 2013 Act which corresponds to the above Section confers on the Holding Company the right to control the composition of the Board of the Subsidiary by which process the latter becomes a subsidiary even without the Holding company exercising control over more than half of the voting power in the company. The question that comes up in such a case is whether the provisions of Section 2(87) in the new Act are compatible with Section 152(6) of the Act which corresponds to Section 255 in the predecessor Act and whether in such a case the provisions of Section 152(6) are violated.

MCA vide its circular No 14 of 1974 dated August ,28, 1974 has stated , inter alia, that  .any amendment in a company’s Articles which has the effect of conferring on another company the right to control the composition of the Board would be hit by the provisions of Sections 255, 256 and 257 of the Act. Section 257 is a mandatory provision and a person’s right cannot be taken away by virtue of any contract to the contrary by the members passing a special resolution or under the Articles. Such an   Article or special resolution would be invalid  under Section 9 of the Act.

Despite the above circular, the Delhi HC has held in Oriental Industrial Investment Corporation Ltd v Union of India(1981)51 Comp Cas 487(Cal.)  that control over the composition of the Board of another company does not contravene the provisions of Section 255, 256 and 257 of the 1956 Act because Section 255 excludes from its purview cases which have been otherwise expressly provided in the Act and Section4(2) of the 1956 Act is an express provision for the appointment of directors on the Board of the subsidiary by a holding company.

Similar views have been expressed by the Kerala HC in Velayudhan(M)v Registrar of Companies(1980)(50 Comp Cas 33).

From the above discussion it emerges that a person appointed as a Nominee on the Board of a subsidiary would not be taken into consideration for determination of the number of directors liable to retire by rotation nor would he be liable to retire by rotation as long as he continues as a Nominee of the holding company in the subsidiary.

Position under the 2013 Act- Appointment of Nominee Director

Section 161(3) of the Act provides as under:

Quote

Subject to the articles of a company, the Board may appoint any person as a director nominated by any institution in pursuance of the provisions of any law for the time being in force or of any agreement or by the Central Government  or the state Government by virtue of its shareholding in a Government company.”

Unquote .

From the above it follows that where the Articles of the company contain enabling  provisions, the Board can appoint as a Nominee director who is being nominated by any Institution or person or by the Govt. as envisaged in the Section.

It is pertinent to note that Section 152(2) states as under:

Quote

“Save as otherwise expressly provided in this Act,(Emphasis supplied)  every director shall be appointed by the company in general Meeting.” .

Unquote

Meaning of the expression” Save as otherwise expressly provided in this Act”

The import of the expression “Save as otherwise expressly provided in this Act” has been brought out as under in Wharton’s Law Lexicon:

“Section 10 of the Maintenance of Internal Security Act   opens with the words ”Save as otherwise expressly provided in this Act”. These words mean that the Section would apply only to cases not expressly provided for in the Act ,that is to say, it would not apply to cases “otherwise expressly provided” in the Act.( Sambhu Nath Sarkar v State of West Bengal(AIR 1973 SC 1425 (1973) “.

The general Rule laid down by Section 152(2) is that every director shall be appointed by the company in general Meeting subject to exceptions as expressly provided in the Act. Section 161 sets out the situations under which the Board is empowered subject to the company’s Articles , to appoint directors .These are :

a)Appointment of any person who has not failed to be appointed in General Meeting as Additional Director.

b)appointment of a person who does not hold any alternate directorship for any other director in the company, to act as an Alternate director for a director during his absence for a period of not less than three months from India.

c)to appoint any person as a director nominated by any Institution/ by any agreement as a Nominee director

d)in the case of a public company to fill up a casual vacancy in the office of any director who has been appointed in general meeting and whose office stands vacated before the expiry of his term in the normal course.

As an additional director holds office under law only up to the date of the next annual general meeting, his appointment has to be regularized in the manner set out in Section 160.

The Alternate director’s tenure automatically comes to an end upon the return to India of the original director.

The person who holds office to fill up a casual vacancy will hold office till the conclusion of the term of the person whose void he has filled up.

Where the person has been appointed by the Board as a Nominee director in terms of either a statutory provision or an agreement, there does not exist in the Statute any provision by which the appointment has to be regularized in the manner provided in section 160 nor is it necessary to obtain the approval of the shareholders after the appointment has been made by the board.

Again the Act is silent on the point whether the nominee director is liable to retire by rotation. There is also no express provision in the statute which stipulates the tenure of his appointment.

In as much as the Act is silent on the issues stated above, one has to take a view that once the person has been appointed by the Board as Nominee director , there is no requirement to seek approval of the shareholders. It   would also not be appropriate to subject the Nominee to the process of retirement   by  rotation . He will also be in office as per the will and pleasure of the Institution appointing him. If the appointment is by virtue of an agreement  , the term may be specified in the agreement .in the absence of any such stipulation, his appointment shall be for an indeterminate period.

Need for structuring Board as per Section 152(6) consequent upon appointment of Independent director

As a Nominee director does not retire by rotation nor is he an Independent director  ,consequent upon his appointment the company should ensure that the Board  continues to remain structured  in the manner contemplated under subsection(6).Furthermore, listed and other companies which are under obligation to appoint Independent directors under Section 149 should ensure that they continue to have the required number of Independent directors  even after a Nominee has been foisted on the Board.

Does the Nomination and Remuneration Committee have any role to play in the appointment of the Nominee Director 

Under Section 178 those companies which meet with the criteria laid down in Rule 6 of the companies (Meetings of Board and its powers)Rules, 2014 have to constitute a Nomination and Remuneration Committee.

Section 178(2) provides that it is incumbent on the Committee to , inter alia, identify persons who are qualified to become directors and recommend to the Board their appointment. Thus the recommendation by the Committee is a pre-requisite to the appointment of any person as a director by the Board. Where it comes to the nominee director, the committee has no role really to play , given the fact that the candidate has been appointed by the Institution under a Statute or an agreement .All that the Committee should do by way of procedure to simply take note of the appointment and inform the Board accordingly.

Viewed against the above perspective, it must be stated that the provisions of Section 178 are not in sync with Section 161(3).

Board’s Role and appointment of Nominee Director

As the Nominee automatically stands appointed through the authority of the Institution, the Board’s role too is only cosmetic in this matter. The Board will have to only ensure that the incumbent provides his for the appointment under Section 152(5) which should be filed with the Registrar in Form  DIR-12 within thirty days from the date of appointment. The Nominee should also furnish a declaration that he is not disqualified to become a director on the lines laid down under Section 152(4).

The Board will have to record in the Minutes the fact that the incumbent has been nominated as director at the behest of an Institution in terms of a statutory provision or agreement  appointment  and direct the company Secretary to ensure that necessary formalities in connection with the appointment of the director.

Intimation to Stock Exchanges

In case of a listed company, pursuant to the requirements of Regulation 30 of the SEBI (Listing Obligations Disclosure Requirements) (LODR)Regulations 2015, the company must inform the stock exchanges as soon as it gets information about the appointment of a Nominee director .It should be clarified also that such appointment has been by the specific Institution in terms of the agreement entered into by the company with it. The intimation should also indicate the tenure of the appointment if any tenure has been stated by the nominating institution.

Conclusion

In the above exposition we have tried to bring to the fore the issues that emerge from the appointment of a nominee Director. The Statute as it stands is bereft of any clarity on the point as to whether a Nominee is liable to retire by rotation or whether his appointment is subject to regularization by members  thus allowing scope for myriad interpretations and speculative conjectures on these issues. Further the role of the Nomination Committee and the Board also stands marginalized substantially in view of the provisions contained in Section 161(3). Besides, we have to live with the inherent contradiction that while a Nominee is not an Independent director, a director for small shareholders is one. As is often said, no law can ever be perfect given that it is a creation of man. Our wish list would be endless for an ever elusive law. Hence, we have to accept the reality of the Statute stoically and learn to grapple with its nuances.


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Category Corporate Law, Other Articles by - Ramaswami Kalidas 



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