The Case for Conflict of Interest Norms for Appointment of Independent Directors

[By Prannv Dhawan]

This Blog is part of a series of posts as a collaboration titled “KAIZEN” between the Centre for Business and Commercial Laws (CBCL), NLIU Bhopal and Law School Policy Review (LSPR). To view this blog on LSPR, please click here.

Prannv Dhawan is a third-year student of National Law School of India University, Bengaluru. He is the founding editor of the Law School Policy Review.

The debate on corporate governance reforms in Indian context invariably focus on questions of concentration of unchecked economic power in the hands of controlling shareholders and promoters. Hence, the institution of independent directors has been time and again heralded as a panacea for all that ails the institutional landscape of corporate governance. The independent directors are considered to play the role of ‘trustees’ who safeguard the core interests and values of the corporations like accountability, managerial efficiency and protection of minority shareholders against unscrupulous impulses of dominant promotors who are more likely to ignore concerns like wealth expropriation and entrenchment. Notwithstanding the debate about institutional independence of independent directors in predominantly promotor-controlled board structures and appointment processes, the promise behind this trusteeship position merits vibrant debate in light of a significant contemporary event.

The appointment of former Chief Vigilance Commissioner and Chairperson of Central Board of Direct Taxes, KV Chowdhury as a non-executive additional director in the Reliance Industries Limited Board  in October last year raised eyebrows in various quarters. The relevance of these concerns becomes even more pronounced when considered in the light of the fact that Reliance Industries Limited (RIL) has been facing investigation in black money and round-tripping of funds related matter from the Income Tax authorities since 2011 while KV Chowdhury has been at the helm of investigation in various capacities since August 2010. These investigations involved allegations of holding over ₹ 2100 crores in foreign banks through an illegal network of international subsidiaries and off-shoots of the RIL. In the context of public outcry against ‘black money’ stashed abroad, the Supreme Court had mandated the setting up of a Special Investigation Team in which KV Chowdhury served as an advisor. Even his tenure as the chief anti-corruption watchdog (the CVC), was mired in controversy involving allegations by accountability activists as well as erstwhile CBI Chief regarding the Rafale aircraft procurement investigation that would have had implications on the business interest of Anil Ambani led Reliance Defence.

This controversial post-retirement appointment of the chief of the independent, statutory apex vigilance institution to the board of the largest private sector corporation in India should raise concerns for not just the independence and impartiality of the vigilance institution but also the character of Indian corporate sector in particular and private capitalist institutions in general. This is because the apprehension of conflict of interest by a reasonable person is very clear from the various aforementioned facts. The test of apparent bias that stands on two legs of impact public confidence as well as conclusion of a fair minded and informed observer about the possibility of compromise has been an important consideration for decision making in public law. Considering the incorporation of these principles from common law  {AWG Group Ltd v. Morrison [2006] 1 WLR 1163; R v. Bow Street Metr} in Indian legal system Ranjit Thakur v, Union of India (1987) 4 SCC 611, their violation should be considered seriously. This is important because this corporate appointment decision does not only impact corporate governance but has serious implications on the independence, impartiality, efficacy and public confidence of an important statutory institution like the CVC.

The administration and decision-making over a high-profile investigation that could have made minority shareholders and general public vulnerable to economic losses and liability makes KV Chowdhury’s appointment suspect, especially as it was proposed and actualised by the board controlled by RIL Chairman and Managing Director. Instead of acting as a check on unethical practices and illicit activities operating in a surreptitious manner through managerial functionaries, the appointment of this particular independent director sends a very negative moral message about the principles that govern the operations of India’s most powerful corporation. It is no wonder that the public outcry against this appointment seriously questions the business ethics of the corporation, as well as the moral conscience of the appointee. Hence, this sets a bad precedent for both an important government functionary who is supposed to comply with highest standards of probity and impartiality as well as the post of independent directors who should be a trustee of company’s ethics.

It reveals the structural constraints for the position of independent directors who are supposed to be gatekeepers of corporate governance. It is important to note that in the promotor-controller corporate structure, where the appointments of independent directors are essentially based on the decisions of controlling shareholders and there exists a lacunae in ensuring effective say of non-controlling in appointment and removal process. A 2014 Organization of Economic Cooperation and Development study on Improving Corporate Governance in India highlights the undue influence of controlling shareholders in the appointment and removal of independent directors, proposing that taking cue from Israel and Italy, “controlling shareholders not be allowed to vote in the election of independent directors so as to ensure the latters’ independence”. So, even as the lacunae with regard to the interests of minority shareholders have been deliberated in the academic and policy discourse, the peculiar lack of disqualification criteria based on the principles of conflict of interest is unfortunate.

It is notable that the section 164 of the Companies Act 2013 mentions the disqualification criteria for appointment of directors and it does not disqualify individuals who have a conflict of interest. The section 150 (4) provides for the government to notify rules, regulations and procedures of appointment of independent director from a databank. On the 1st of December, the Companies (Appointment and Qualification of Directors) Fifth Amendment Rules, 2019 came into force and even they do not mention this in the qualification criteria. Even though these rules provide for proper application process along with renewal procedures that almost resemble bureaucratic appointments, the omission of the basic tenet of fair decision making is very significant. This is especially pertinent because the government is, albeit peculiarly, leading the process of selection test and qualification procedure for independent directors of corporate entities. Hence, it should be incumbent on the government to prevent conflict of interest on part of its own officials, especially those in charge of important investigative and statutory duties. Notably, the section 12 of Competition Act, 2002 restricts the chairperson and the members of the statutory anti-trust regulator, the Competition Commission of India from any employment with any corporation which has been a party to a proceeding before it.

The extant legal framework is riddled with uncertainties and incongruity and there is a dire need to evolve effective safeguards for the protection of independent directors in the interest of good corporate governance. Even the Supreme Court in Pooja Ravinder Devidasani v State of Maharashtra & Ors has acknowledged the role of independent director as the custodian of corporate governance. Appreciating the ethical core of their role and lack of remuneration based incentives, experts like John Armour, Luca Enriques, Henry Hansmann, and Reinier Kraakman have termed the independent directors as a wide-spectrum prophylactic. Hence, there is urgent need for reform in the appointment process and institutional role of independent directors.

Ultimately, it needs to be understood and appreciated by the dominant promoters, executives and shareholders that at a time when public trust in corporate entities and business elite is plummeting and the regulatory gaze of the State is moving towards criminalization, it is important to engender public trust and confidence. This trust can only be engendered through robustly pursuing a corporate agenda that embraces modern-day decision making and appointment practices. Certainly, appointing an ex-regulator and investigator to a pecuniary position after retirement sends a very negative message to the public and makes the company’s past actions that are under investigation more suspicious. It must also be borne in mind that this violates not just the modern-day progressive conception of corporate social responsibility but also the traditional considerations of a good-faith based free market operation. The trailblazer of free market capitalism, Prof Milton Freidman had written in 1962 that “there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”


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