Change in Business

Principle of Proportional Representation for Appointment of Directors

A Director is defined as an individual who directs, manages or controls the affairs of the company. A director is someone who is appointed to perform the functions and the duties of a company according to the provisions of the Companies Act, 2013.

Directors play an important role in managing the affairs of a company. Hence, their appointment is very critical for the growth and development of a company. In this article, we shall discuss the principle of proportional representation for the appointment of directors.

Overview

The company’s law provides for the appointment of directors through simple majority passing of a resolution in the general meeting of the shareholders. Therefore, the simple majority has the power to elect all directors and a considerable minority may not succeed in appointing even a single director. This may endanger the interests of the minority shareholders. In order to alleviate this disadvantage, section 265 of the erstwhile Companies Act 1956 had provided that the minority shareholders shall have the opportunity to place their representative on the board of directors where the company adopted the system of proportional representation for appointment of directors by providing in its articles of association.

Section 163 of the Companies Act, 2013

The provisions related to the principle of proportional representation for appointment of directors have been included in the Companies Act, 2013. Section 163 of the Companies Act says that the articles of a company shall provide for the appointment of not less than two- thirds of the total number of directors in a company according to the principle of proportional representation, whether by single transferable vote or through the system of cumulative voting or otherwise. Such appointments shall be made once in every three years, and the casual vacancies of the directors may be filled as contained in sub section (4) of section 161 of the Companies Act, 2013.

Analysing the meaning of Section 163 of Companies Act

Section 163 replaces section 265 of the erstwhile Companies Act 1956. The latter section applied to the public or private company, which is subsidiary of a public company whereas the former section applies to all companies.

If we break down this section, we understand that the articles of association provide for the appointment of not less than two-thirds of the total number of directors which means that the need of provisions in the article is essential for invoking the section. It is important to note here that it is not necessary for companies to have such provisions in their articles.

The principle of proportional representation allows the minority shareholders to appoint their directors, thereby ensuring that the interests of the minority shareholders are not affected. Use of the term “otherwise” in this section tells us that this section can be implemented by any other process than by single transferable vote or cumulative voting.

Main features of the Principle of Proportional Representation for the Appointment of Directors

• One of the features of this system is that it has overriding authority. Section 163 of the companies Act, 2013 says that “notwithstanding anything contained in this Act……” this means that this section overrides all the other sections of the Companies Act, 2013. If a company adopts provisions as mentioned in this section, in accordance with the principle of a proportional representation system, it will relish the overriding factor of this section.

Section 162 contains that the appointment of directors should be voted individually, but such provisions contradict the provisions of section 163. However, due to the overriding power of section 163, the provision contained in section 162 gets excluded.

• Another feature of this system is that section 163 says that the articles of the company may provide for the appointment. This means that they would only apply if the articles of association provide for such a provision of appointment. The article of association of a company may provide for the appointment of the directors of a company on proportional representation method if they choose so. It is not mandatory for a company to adopt the provision. A company can choose not to have the appointment of its director following the principle of proportional representation. It suggests that the need for provisions in the articles is decisive for invoking section 163 of the Companies Act, 2013.
• This form of appointment of directors in a company ensures a fair representation of the interests of the minority shareholders. In the usual course, it might not be possible for minority shareholders to keep their nominee directors in the board to protect their interests. This may keep them apprehensive about the proper functioning of the company. The basic intention behind this proportional representation for the appointment of directors is to take care of the interests of the minority shareholders.
• Another feature of the proportional representation for the appointment of directors is its applicability. The provision of this section is applicable to the public as well as private companies whereas the earlier Act of 1956 was applicable only for a public company or a private company which was subsidiary of a public company. Therefore, it can be said that the present provisions of the Companies Act 2013 provide a wider scope in favour of the minority shareholders.
• Under the system of proportional representation, the appointment of directors can be made once every three years. This phrase indicates that the stipulation of three-year tenure is not mandatory.
• One of the notable features of this section is about the number of directors that can be appointed. The section says that the articles of association of a company may provide for appointment of not less than two-thirds of the total number of the directors. Therefore it means that it requires that where a company practices the principle of proportional representation, it will appoint at least two-thirds of its directors under this system. However, there is no limit on the maximum number of directors who can be appointed by this system of proportional representation.
• In case of Casual vacancies of directors, such directors shall be filled as provided in the subsection (4) of section 161 of the, 2013. It mandates that the casual vacancy, subject to any regulations in the articles of the company or in default of, shall be filled by the Board of Companies Act Directors at the Board meeting. It is important to note that such appointment shall not be effected through the circulatory resolution of the board.

It further provides that when a person is appointed, he shall hold office till the date up to which the director, in whose place he is appointed, would have held the office if it were not vacated.

Method of Appointing Directors under Principle of  Proportional Representation System

There are two ways of appointing directors of a company under the principle of proportional representation system. These are:

• Single Transferable voting
• Cumulative Voting

These are explained below:

Single Transferable Voting

Under single transferable voting, every shareholder regardless of his shareholding, is entitled to one vote per post of directors to be appointed. For instance, there are five posts of directors to be appointed out of eight candidates. In this case, each shareholder can cast one vote each, irrespective of the number of shares he holds, in favour of up to five candidates. The five candidates who get the highest number of votes in order shall get elected.

Minority shareholders can cast their votes only in favour of their nominated candidate skipping others. It may ensure the required number of votes to win for their nominated candidate, and other shareholders vote might get distributed among several candidates. By virtue of this method, minority shareholders can be in a position to place their nominee director in the board.

Cumulative voting

Each shareholder is entitled to have the number of votes as per his shareholding under this system. For instance, a shareholder has a total of 500 shares in a company, and there are total five directors to be elected out of eight candidates. In this case, he is eligible to cast a total of 2500 number of votes. Either he can use all of these votes for a single candidate or else he can divide his votes amongst the candidates.

If a group of minority shareholders decides to cast all their votes to their nominated candidate, then the nominated candidate has a good chance of getting enough number of votes to ensure that he gets elected as votes of other shareholders may get distributed in favour of other candidates to fill the remaining vacancy of directors.

Under any of these two methods, the interests of the minority shareholders are protected in the company.

Other methods

A company can adapt to methods, other than the Single Transferable Voting or Cumulative voting, as provisioned in the articles of association of a company and approved by the majority shareholders in the general meeting, to appoint directors in accordance with the system of proportional representation.

Exemption from Section 163

The Central Government issued a notification on June 5, 2015, granting an exemption for applicability of section 163 of the Companies Act, 2013 to certain government companies. Minority shareholders shall have no scope of choosing their nominee directors in such companies based on the principle of proportional representation.

Removal of Directors

Section 169(1) of the Companies Act 2013 provides the method to remove the director of a company with the condition that nothing contained in this subsection shall apply where the company has availed the option given to it to appoint not less than two-thirds of the total number of directors in accordance to the principle of the proportional representation system.

Hence, any director appointed under Section 163 of the Companies Act cannot be removed as per section 169(1). The way of removal of directors appointed by way of proportional representation system is not clear.

Conclusion

The prospect of proportional representation for the appointment of directors looks very sensible as it looks to safeguard the interests of the minority shareholders, but it is not clear to what extent this is implemented. The provisions have been kept optional, and it is up to the companies whether to implement the provisions of the section.