If it wasn’t for the near-divine status of the parties butting heads in the Mistry-Tata spat, we could probably have put it all down to alpha male aggression. In truth, the unfolding dispute had at least two ‘burning questions’ over elements of corporate governance that demanded judicial determination. First, who controls a company; the majority shareholder or its Board of Directors? Second, if an independent director finds himself in conflict with the majority shareholder, should the law allow the shareholder to remove him? With the filing of the appeal against NCLATs December 18 order in Mistry v Tata Sons Limited, the Supreme Court will have the burden of addressing at least one of these two questions.
Let’s look at the facts projected to the courts. After succeeding Ratan Tata as the Executive Chairman, Cyrus Mistry implemented a succession of steps to reverse the decisions of the previous management. The previous management saw this as a programme to ‘undermine their legacy’ and retaliated by removing Mistry in something of a corporate coup conducted without due process. No committee was formed to consider Mistry’s removal, advance notice was not given of this intention, and indeed the item for his removal was not placed on the board meeting agenda.
The deed done, the allegations began to flow freely. The Tata group issued public notices in national print media making a series of dramatic revelations. These included the revelation that Mistry was a non-performer who caused continuing losses to the group, increased group indebtedness, lost market share, forced potential write-downs of some $18 billion, and took steps to seize exclusive control of several prominent group companies acting in concert with independent directors. To pre-empt certain regulatory vulnerabilities, Tata Sons tried to convert itself into a private company and lower its compliance burden.
In court, Mistry claimed he was expelled for resisting the oppressive extra corporate domination of the majority shareholder. NCLAT noted that some 550 emails showed that certain non-executive board members continually interfered with Mistry and tried to run the company by remote control. As opposed to giving advice, the Trustees dictated how the board was managed. Nominee directors of the majority shareholder routinely left board meetings to take instructions from the majority shareholder. The reality on the ground was clear enough, not least because there is universality to this reality.
Who should really control the company?
Given the changes we have made to the law in 2013, it really comes down to deciding who should really control the company: The majority shareholder or the Board of Directors? You could argue this issue either way. From a purely commercial standpoint, it’s the promoters’ money, enterprise and spirit that drive a successful company. If you take away their autonomy, what comes out the other end is a bureaucracy, not a business. But then again, how can you enforce any compliance at all if the promoters have carte blanche to beat down a Board of Directors and obliterate the distinct legal character of a corporate entity whenever it suits them?
The law’s solution to this problem circa 2013 is to reaffirm directors as fiduciaries of the company. The promoters have no such obligation, except when they wear the directors’ hats and to that extent. In the end, what we have is a situation where the promoter may dictate who gets appointed to the board wearing their shareholder cap but once these fiduciaries are installed, they cannot interfere with their discharge of their fiduciary duties except for matters that are reserved to them by law. If the shareholders have a fundamental disagreement with directors, they must call meetings of shareholders, hear the errant director’s views and take a reasoned decision at the shareholder meeting. In this paradigm, there really isn’t any space for backroom skulduggery or palace coups. This is where the Mistry-Tata spat raises questions that NCLAT decided in favour of Mistry.
In its judgment, NCLAT disbelieved the press statements in their allegations of mismanagement, suggesting that these emerged because the Tatas knew that their actions were both oppressive to the minority shareholders and in breach of compliance norms. Adopting steps to convert the company to a private one was but a tacit acknowledgement of this governing vulnerability. In culmination, NCLAT held that the board’s decision to remove Mistry was illegal and reinstated him as the Executive Chairman of Tata Sons (even though no one asked for it!). That settled the first of the burning questions, though not quite in the way anyone had expected!
This brings us to the other burning question associated with this case. NCLAT did not answer this question because it wasn’t part of this litigation. To set the context, the new company law of 2013 changed the way in which corporate governance was to be viewed in India in four material ways. First, it identifies independent directors as GRC drivers. The upshot of this is that the man who sits on the outside with no money in the company carries the moral burden of the company. Second, it enjoins independent directors to become protectors of minority shareholders, a sort of stake-less David taking on the might of the successful entrepreneur. Third, it asks independent directors to have an independent voice expected to "scrutinise the performance of management in meeting agreed goals and…monitor the reporting of performance". Finally, it expects independent directors to hold separate meetings in the absence of both management and promoter nominee directors, and review the performance of the rest of the Board. By definition, you could say that the law demands that every independent director be hostile to the promoter!
Independent directors carry a heavy burden
This enlarged role also comes with grave risk. Sec 149 provides that "Independent Director shall be…liable only in respect of acts of omission or commission by a company which had occurred with his knowledge, attributable through board processes, and with his consent or connivance or where he had not acted diligently." (Emphasis Supplied). So what does "acted diligently" mean for an independent director? That is explained in Schedule IV. Schedule IV, Part 1, Guidelines of Professional Conduct Clause 1 requires Independent Directors to "uphold ethical standards of integrity and probity". Clause 9 of the same part expects them to "assist the company in implementing the best corporate governance practices". Schedule IV, Part II, Role and Functions, Clause 4 expects them to "satisfy themselves on the integrity of financial information". This responsibility comes riding on the back of Sec 23M of the Securities Contracts Regulation Act, which sends an independent director to 10 years in jail with Rs 25 crore in penalties for failing in his duties. I think we can fairly agree that independent directors carry a heavy burden in this new dispensation, and it would behove them to discharge this responsibility with great seriousness.
What does all this have to do with the Mistry-Tata spat? Clearly, independent directors of Tata Group companies were aware that the cheese has moved. We must not forget that Indian Hotels, Tata Motors, Tata Chemicals, Tata Consultancy Services and Tata Steel are all listed companies.
As the ripples created by Cyrus Mistry's removal from Tata Sons spread downstream, it forced independent directors of these companies to reconcile possible conflicts of interest between their fiduciary responsibilities and their personal relationships with the Tatas. This played out in full glare of the media.
As far back as November 4, 2016, independent directors of Indian Hotels came out in support of Mistry. The Tatas reacted by claiming that Mistry was trying to deviously take over Indian Hotels amongst others with the support of independent directors. On November 10, 2016, the independent directors of Tata Chemicals came out in full support of Mistry because they believed he had done a good job. The company reacted by calling an EGM for December 23 to remove Mistry and independent director Nusli Wadia from the Board. Wadia reacted by issuing notice claiming defamation. On November 12, 2016, three of six independent directors of Tata Steel came out in support of Mistry. The Tatas reacted by claiming Wadia was galvanising other independent directors to act against the Tatas. The company then called an EGM on December 21 to remove Mistry and Wadia from this board as well. As you can expect, Wadia issued another defamation notice. Similarly, Tata Motors called an EGM on December 22, 2016, to remove Mistry and Wadia as directors. Wadia issued yet another defamation notice. I pause at this point because the rest was inevitable.
This is where we encounter a great irony playing out in the corridors of India's most respected companies. The law wants all independent directors to act in accordance with their fiduciary duties and protect the best interest of the company as they see fit in their individual judgment. Yet, when they do so, the majority shareholder makes all manner of alarming allegations and removes them. An independent director has no stake per se in that company and usually reacts by resigning, if he is not removed first! In either event, there is no script by which he climbs a white horse and storms a bastion he has no ability to overrun in search of an outcome he has no stake in.
In the upshot, what we have here is a failure to translate a legal principle into a practical reality. When some independent directors exercised their independence and took an independent line of action, one of India's most respected business houses decided that such independence of judgment is simply unacceptable and has ejected from the boards. When the executive chairman of this same business house decided that certain legacy policy decisions needed changing, the promoters chose to protect their legacy rather than the business of the corporate house.
In rendering its recent judgment, NCLAT has implemented the spirit of the 2013 amendments to Indian’s corporate law even if the results are rather excessive. Given the track record of NCLAT’s previous judgments before the Supreme Court, there are reasons to expect that the Supreme Court would overturn this new judgment, not least because of its excesses. Should this happen, India would have come full circle and back to the beginning. Where does that leave our new (sic) corporate governance norms?
Ranjeev C. Dubey is the founder of the Gurgaon-based corporate law firm N South and the author of ‘Legal Confidential’, the bestselling expose’ of the real world of Indian courts.
First Published: IST