INDEPENDENT DIRECTORS' APPOINTMENT : TIME FOR A SOLUTION BASED APPROACH
By Gautam Gandotra*
Independent directors are being criticised on their being independent. Critics feel that people who are appointed as independent directors are close to promoters so that decision making can be influenced. In this article, the author makes out a case for solution based approach to ensure that 'independence' of independent directors is no longer doubted.
INTRODUCTION
1. It seems we live in an independent director-bashing era. News articles, blogs, scholarly write-ups are replete with criticism relating to independent directors, whether it relates to their appointment, 'true' independence, removal, resignation or generally about their very existence! Anything remotely connected to what such directors do seems wrong. From a legal liability stand point, the law of director's liability and fiduciary duties applies equally to independent directors. Such directors do not have any meaningful defense available to them by the mere taxonomy of the position held by them. Why then is the sentiment so negative ?
1.1 Critics argue that the key issue emanates from the method of appointment of such directors because they feel such people are appointed as independent directors who are close to promoters so that decision making can be influenced. Practically, one cannot get a total stranger on board as such a person could turn out to be the worst choice even for a truly independent decision making. How then is one to resolve this issue which essentially is a result of conflict of interest between different categories of stakeholders - doing away with the concept of independent directors, criticising everyone who occupies such a position, resorting to media trial for conduct of the Board of directors. The answer lies in taking a solution based approach to ensure that we do not paint a sorry picture of corporate governance in our country.
NEED FOR A NEW VOTING REGIME
2. A new voting regime must be introduced that requires appointment of independent directors through majority of minority vote of the public shareholders. The United Kingdom has adopted a dual-voting structure for election of such directors in controlled listed companies, requiring both a simple majority vote and a majority of minority vote; if the result of these two votes conflict, then another meeting can be held within 90-120 days and this time the appointment happens through a simple majority vote. This approach is slightly lenient as opposed to the majority of minority voting simpliciter as a resolution passed through majority of minority (public shareholders) vote could essentially get washed away in a subsequent resolution passed through simple majority (in effect, promoters) vote.
A FEAR WHICH IS NOT SO THEORETICAL
3. The key argument against the majority of minority voting rule is that such voting rule is not practical and also, that the controllers of the business may influence votes to achieve the same result and then influence the independent directors too. The fear of succumbing to promoter influence was summarized with great wit by the then Vice Chancellor Strine of the Delaware Chancery Court as follows - calling controllers of the business a 'gorilla' and the independent directors "little chimpanzees" :
"....[W]hen an 800-pound gorilla wants the rest of the bananas, little chimpanzees, like independent directors and minority stockholders, cannot be expected to stand in the way, even if the gorilla putatively gives them veto power. Lurking in the back of the directors' and stockholders' mind is the fear that the gorilla will be very angry if he does not get his way. As a result, we cannot fully trust the traditional protective devices that the law uses to validate interested transactions."1
Recently, while putting forth a proposal for public investors to have the power to influence the election or retention of some "enhanced independent" directors, Harvard Law School Professor, Lucian A Bebchuk and Hebrew University Professor, Assaf Hamdani took Leo Strine's amusing 800-pound gorilla metaphor forward saying that, if independent directors cannot be expected [in the freeze out context] to oppose the big gorilla when it seeks the rest of the bananas, we should not expect them to resist the big gorilla when it pursues a peach, a mango, or any other fruit that it may fancy.2 This shows that it is not just India but also the developed economies that are grappling with the same issue.
WHY MAJORITY OF MINORITY RULE ?
4. The list of matters requiring majority of minority vote is increasing within a short span of time. Majority of minority voting rule mandatorily applies to the listed companies for a resolution considering material related party transactions, delisting, reduction in public shareholding pursuant to scheme of arrangements in certain cases, etc. This shows that the law makers, promoters and listed companies have very well digested such regime for other critical proposals. This change in voting regime is indeed done to ensure that the suspicion with which certain arguably one-sided and coercive transactions are seen are dealt with in a fair way by giving the less powerful block a better say in the decision making. Why then, should the appointment of independent directors be subject to a simple majority regime when their existence seems to be the cause of immense grief for many? It's time to come up with a regime that stops presuming that independent directors are guilty.
CONCLUSION
5. When law gets smart, people get smarter and most of the times, people are already too smart and law is trying to catch up. Therefore, keeping law static when the environment is dynamic is an approach should be given up. Majority of minority rule has the ability to take away the inherent negativity surrounding the issue relating to method of appointing the independent directors.
FOOTNOTES
* Partner in Cyril Amarchand Mangaldas. Views expressed are personal.
By Gautam Gandotra*
Independent directors are being criticised on their being independent. Critics feel that people who are appointed as independent directors are close to promoters so that decision making can be influenced. In this article, the author makes out a case for solution based approach to ensure that 'independence' of independent directors is no longer doubted.
INTRODUCTION
1. It seems we live in an independent director-bashing era. News articles, blogs, scholarly write-ups are replete with criticism relating to independent directors, whether it relates to their appointment, 'true' independence, removal, resignation or generally about their very existence! Anything remotely connected to what such directors do seems wrong. From a legal liability stand point, the law of director's liability and fiduciary duties applies equally to independent directors. Such directors do not have any meaningful defense available to them by the mere taxonomy of the position held by them. Why then is the sentiment so negative ?
1.1 Critics argue that the key issue emanates from the method of appointment of such directors because they feel such people are appointed as independent directors who are close to promoters so that decision making can be influenced. Practically, one cannot get a total stranger on board as such a person could turn out to be the worst choice even for a truly independent decision making. How then is one to resolve this issue which essentially is a result of conflict of interest between different categories of stakeholders - doing away with the concept of independent directors, criticising everyone who occupies such a position, resorting to media trial for conduct of the Board of directors. The answer lies in taking a solution based approach to ensure that we do not paint a sorry picture of corporate governance in our country.
NEED FOR A NEW VOTING REGIME
2. A new voting regime must be introduced that requires appointment of independent directors through majority of minority vote of the public shareholders. The United Kingdom has adopted a dual-voting structure for election of such directors in controlled listed companies, requiring both a simple majority vote and a majority of minority vote; if the result of these two votes conflict, then another meeting can be held within 90-120 days and this time the appointment happens through a simple majority vote. This approach is slightly lenient as opposed to the majority of minority voting simpliciter as a resolution passed through majority of minority (public shareholders) vote could essentially get washed away in a subsequent resolution passed through simple majority (in effect, promoters) vote.
A FEAR WHICH IS NOT SO THEORETICAL
3. The key argument against the majority of minority voting rule is that such voting rule is not practical and also, that the controllers of the business may influence votes to achieve the same result and then influence the independent directors too. The fear of succumbing to promoter influence was summarized with great wit by the then Vice Chancellor Strine of the Delaware Chancery Court as follows - calling controllers of the business a 'gorilla' and the independent directors "little chimpanzees" :
"....[W]hen an 800-pound gorilla wants the rest of the bananas, little chimpanzees, like independent directors and minority stockholders, cannot be expected to stand in the way, even if the gorilla putatively gives them veto power. Lurking in the back of the directors' and stockholders' mind is the fear that the gorilla will be very angry if he does not get his way. As a result, we cannot fully trust the traditional protective devices that the law uses to validate interested transactions."1
Recently, while putting forth a proposal for public investors to have the power to influence the election or retention of some "enhanced independent" directors, Harvard Law School Professor, Lucian A Bebchuk and Hebrew University Professor, Assaf Hamdani took Leo Strine's amusing 800-pound gorilla metaphor forward saying that, if independent directors cannot be expected [in the freeze out context] to oppose the big gorilla when it seeks the rest of the bananas, we should not expect them to resist the big gorilla when it pursues a peach, a mango, or any other fruit that it may fancy.2 This shows that it is not just India but also the developed economies that are grappling with the same issue.
WHY MAJORITY OF MINORITY RULE ?
4. The list of matters requiring majority of minority vote is increasing within a short span of time. Majority of minority voting rule mandatorily applies to the listed companies for a resolution considering material related party transactions, delisting, reduction in public shareholding pursuant to scheme of arrangements in certain cases, etc. This shows that the law makers, promoters and listed companies have very well digested such regime for other critical proposals. This change in voting regime is indeed done to ensure that the suspicion with which certain arguably one-sided and coercive transactions are seen are dealt with in a fair way by giving the less powerful block a better say in the decision making. Why then, should the appointment of independent directors be subject to a simple majority regime when their existence seems to be the cause of immense grief for many? It's time to come up with a regime that stops presuming that independent directors are guilty.
CONCLUSION
5. When law gets smart, people get smarter and most of the times, people are already too smart and law is trying to catch up. Therefore, keeping law static when the environment is dynamic is an approach should be given up. Majority of minority rule has the ability to take away the inherent negativity surrounding the issue relating to method of appointing the independent directors.
FOOTNOTES
* Partner in Cyril Amarchand Mangaldas. Views expressed are personal.
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