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12 June, 2017
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’s to do with their appointment, ‘true’ independence, removal, resignation or generally their very existence! Anything remotely connected to what such directors do is presented as wrong. From a legal stand point, however, the law of director’s liability and fiduciary duties applies equally to independent directors. Such directors do not have any meaningful defence available to them by the mere taxonomy of the position held by them. Why then is the sentiment so negative?
Critics argue that the key issue emanates from the method of appointment of such directors because they feel that the people chosen are typically those that are close to promoters and can influence decision making. But practically, a total stranger on board could be the worst choice even for truly independent decision making.
How can this issue be resolved, which is essentially a result of a conflict of interest between different categories of stakeholders? Should we do away with the concept of independent directors? Criticise everyone who occupies such a position? Resort to media trials for the 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
A new voting regime must be introduced that requires the 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
The key argument against the majority of minority voting rule is that it is not practical and that the controllers of the business may influence votes to achieve their desired result and then influence the independent directors too. The fear of succumbing to promoter influence was summarised with great wit in 2002 by the then Vice Chancellor Strine of the Delaware Chancery Court:
“.. when 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 making a proposal for public shareholders 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’s not just India, but also the developed economies that are grappling with the same issue relating to promoter’s influence.
Why Majority of Minority Rule?
The list of matters requiring majority of minority vote in India has increased within a short span of time. Majority of minority voting mandatorily applies to listed companies for a resolution considering material related party transactions, delisting, reduction in public shareholding pursuant to a scheme of arrangements in certain cases, etc. This shows that the law makers, promoters and listed companies have very well digested such a regime for other critical proposals. This change in voting regime is indeed done to ensure that the suspicion with which certain (arguably) one-sided or 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 its 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.
Catch up and Resolve
When law gets smart, people get smarter. And most of the time it is the law that is trying to catch up. Therefore, we should give up an approach that keeps law static when the environment is dynamic. Majority of minority rule has the ability to take away the inherent negativity surrounding the issue relating to the method of appointing independent directors.
[1] Leo E. Strine, Jr., The Inescapably Empirical Foundation of the Common Law of Corporations, 27 Del. J. Corp. L. 499 (2002).
[2] Lucian A. Bebchuk and Assaf Hamdani, Independent Directors and Controlling Shareholders, 165 U. Pa. L. Rev. 1271 (2017).
For further information, please contact:
Gautam Gandotra, Partner, Cyril Amarchand Mangaldas
gautam.gandotra@cyrilshroff.com
