Independent directors - inherently weak institution

Tata Steel, Tata Motors and Tata Chemicals will hold extra-ordinary general meetings (EGM) in December 2016 to remove, at the request of Tata Sons, Nusli Wadia and Cyrus Mistry from the board of directors (here after ‘Board’). Nusli Wadia is an independent director and Cyrus Mistry was removed as the chairmen of Tata Sons on October 24, 2016. Removal of an independent director through the formal process of passing a resolution is unprecedented.

The Companies Act 2013 provides that shareholders may remove a director before the expiry of his term by passing an ordinary resolution in a general meeting. The concerned director has the right to make representation before the shareholders.

Tata Sons’ move to remove an independent director shows the weakness of the institution of independent directors. The most important role of independent directors is to protect the interest of non-controlling shareholders (also called minority shareholders). They are expected to protect minority shareholders from strategies and other decisions of the management that are detrimental to the interest of the company. Therefore, situations might arise in which independent directors do not support the proposals placed before the Board. In that situation, the controlling shareholder can easily get rid of the dissenting independent directors. Removal of all the dissenting independent directors together gives a signal to the market that something is wrong in the company. Therefore, the controlling shareholder, to subdue dissenting voices, would remove that independent director who assumes the leadership role. Usually a polite request to resign works, as independent directors lack the motivation to take the role of a crusader. If that does not work, the controlling shareholder, like Tata Sons, can make the Board to call an EGM and remove the dissenting independent directors. Removal requires simple majority of all those who vote on the resolution. If, the controlling shareholder holds more than 50 percent of voting right, resolution would certainly be passed. Even if the controlling shareholder has less than 50 percent voting right, the resolution is likely to be passed, as non-institutional shareholders lack enthusiasm for voting in general meetings. Only if the institutional shareholding is substantially high, as in the case of Tata Steel (institutional shareholding 42% against promoter’s holding of 32%), institutions’ voting is key in passing the resolution. Rationally, an institutional shareholder should vote in the interest of the company rather than siding with the controlling shareholder blindly unless its internal governance is weak. However, if consensus cannot be reached among institutional shareholders to vote against the resolution, the probability of passing the resolution remains high.

Tata Sons alleges that Nusli Wadia was ‘galvanizing other independent directors against Tata Sons’. This is a curious allegation. Every independent director is a leader and develops his/her own perspective of the situation and develops his own views on how to address an issue. It is natural that in a separate meeting of independent directors, every independent director will try to build a consensus around his view/solution, which he/she considers the best alternative. In the meeting, independent directors listen to each other and may change their views. But it is not necessary that a consensus will be reached. If the view of a particular independent director does not fit into the scheme of the controlling shareholder, he may always be accused of ‘galvanizing other independent directors against the controlling shareholder’, because of his/her efforts to build consensus around his/her view. This cannot be a good reason for removing an independent director.

SEBI (Listing Obligation and Disclosure Requirements) Regulations 2015 requires that if the chairperson of the Board is a non-executive director at least one-third of the Board shall comprise of independent directors and if the entity does not have a regular non-executive chairperson, at least half of the Board shall comprise of independent directors. In absence of consensus, Board decisions are taken using majority rule. Non-independent directors are subservient to the controlling shareholder. Therefore, even if majority of independent directors do not support a decision, the Board can approve the same with the support of some independent directors.

In a family business and in companies in which there is concentration of ownership, independent directors are, at best, effective sounding boards for the management. They cannot protect the company’s interest effectively. Tata Sons by its move to remove Nusli Wadia is creating a bad precedence that will further weaken the inherently weak institution of independent directors. It gives credence to the general belief that only those independent directors, who maintain cozy relationship with the controlling shareholder, survive.