If you don’t like it, say (and record) it!

Refuge under law for non-executive directors possible only when they act with prudence.

Private equity is not just another source of capital for companies but it also thrives on the experience that general partners bring to portfolio companies. One of the common ways to add value by general partners is through nomination of persons who have experience in relevant sector or business nominates as directors to the board of directors of portfolio companies. Such directors are typically non-executive.

Extensive literature can be found on the question of liability of non-executive directors. Knowledge or connivance are core elements to implicate non-executive directors for their actions or omissions.

3 recent orders passed by Securities and Exchange Board of India (SEBI) and Securities Appellate Tribunal (SAT) brings to the fore significance of such non-executive directors acting with prudence.

In April 2016, SAT found 2 independent directors of Edserv Softsystems (BSE: 533055) guilty for suppression of material facts and misstatements made in the prospectus of its initial public offering. Ignoring submissions of the independent directors that they were not liable for acts of the management that was not brought to their notice through board process, SAT (while observing that these directors were members of the audit committee as well as signatories to the offer documents) temporarily barred them accessing capital markets.

In another order passed by the SEBI on 2 June 2017, a non-executive director of Newland Agro Industries (who claimed to have resigned during non-compliant capital raising processes run by Newland Agro Industries) was held liable to refund the capital, along with interest, to the subscribers. SEBI relied on the Madras High Court’s decision in Madhavan Nambiar (2002 108 Comp Cas 1 Mad) and, in context of duty of a director to act diligently, noted that “…there is no difference or distinction between whole-time or part time director or nominated or co-opted director and the liability for such acts or commission or omission is equal.

As much it is the fiduciary duty of a director to act in the best interest of the company, it is equally important a duty of a director (and in particular of non-executive or independent directors) to record her or his dissent. This vital principle came to the rescue of two independent directors of Zylog Systems (BSE: 532883) who SEBI very recently (20 June 2017) exonerated from liability for non-payment of dividend. Even though one of the independent directors was the chairman of the audit committee of Zylog Systems, the directors not only resigned soon after becoming aware of the non-compliance but, even prior to their resignation, had expressed their dissent with request to take appropriate steps.

Considering the way jurisprudence is evolving in India, it is critical for non-executive or independent directors now than ever before – if you don’t like it, say (and record) it!

Author is a Partner at Khaitan & Co, one of India’s premier law firms. Views are personal.

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