Establishing the independent status of an independent director

In an earlier post last week, it was contended that there are some inadequacies in the independent directorship practice in Nigeria which detract from the utility of having independent directors on boards. [See here] These adequacies of the provisions of the existing corporate governance codes in Nigeria are indicators that the regulatory framework for independent directorship in Nigeria requires further improvements. There is no corporate governance code currently in force in Nigeria that captures all the criteria by which the independent status of an independent director may be evaluated. The Code of Corporate Governance in Nigeria 2011 issued by the Securities and Exchange Commission takes the credit for being the corporate governance code in Nigeria with the broadest provision on this issue. Nevertheless, its provisions on the subject matter, as have been pointed out in a recent article [see here], still fall short of international best practice on the matter.

There are nine discernible criteria for ascertaining the independent status of independent directors that can be gleaned from a perusal of the corporate governance codes of several countries. We shall briefly look at these criteria so as to highlight them with a view to their being included in future reviews of the corporate governance codes in Nigeria. It must be stated upfront that these nine discernible criteria cannot be said to be exhaustive, especially given the peculiar circumstances of Nigeria. The nine criteria appear below.

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1.             Employment test

A director who is an employee of the company on whose board he sits cannot be independent. This is so because he has an additional interest in the company that is sufficiently material to influence his decisions in his handling of the affairs of the company. Thus, every executive director of a company cannot be an independent director of the same company. The employment test is not limited to present employment. A director who has been an employee of the company in the last couple of years is also adjudged not to be independent. There is no consistency in corporate governance codes on the cool off period. However, a period of three years and five years seem to be common in a lot of corporate governance codes.

2.             Shareholding test

The shareholding of a director can affect his independent status. A director who is also a substantial shareholder of the company is considered not to be independent because of the large stake he has in the company through his shareholding. It is believed, and rightly too in my opinion, that the huge investment in the shares of the company is adequate to colour his decisions in handling the affairs of the company. Apart from a director who is a substantial shareholder, under this test any director who represents a substantial shareholder on the board of a company is similarly considered not to be independent.

3.             Familial relationship test

Family relationship too is a bar to being considered independent. Accordingly, anybody who has a family relationship with either a director who does not satisfy the employment test or shareholding test is also considered not to be independent. There is some disparity as to the degree of familial relationship that is sufficient to constitute a bar to independence. While it is clear that direct family members are obviously caught in the loop, there is an absence of such uniformity in relation to other family members, for example, in the case of extended family members. It is however noteworthy that family relationship can be a criterion for impugning the independent status of a director.

4.             Material business dealings test

Having material business dealings with the company on whose board a person sits as a director is also a bar to independence. Thus, where a director is a big customer of the company or a major supplier of the company, he cannot be said to be independent because he has additional business interests in the company which is capable of colouring his judgment and interfering with his independence of character which independent directors are expected to have.

5.             Professional, consultancy and advisory relationship test

Similar to the material business dealings test above is the professional, consultancy and advisory relationship test. A director who directly or through his firm offers extra services to the company on whose board he sits, in the nature of professional, consultancy or advisory services is considered not to be independent on account of the professional, consultancy or advisory services he renders to the company. Some corporate governance codes provide for a look back period regarding this criterion, but there is no consistency in corporate governance codes on the length of the look back period.

6.             Additional income test

Where a director receives compensation from the company beyond his director’s fee and allowances (for example, sitting allowance and transport allowance), he is adjudged not to be independent. Examples of additional payments which constitute an impediment to the independent status of a director are performance-related pay scheme, participation in incentive plans, share-based remuneration schemes (such as, share options), and pension scheme. Some corporate governance codes provide that the additional payment should be substantial to constitute an impediment.

7.             Long tenure test

A director who has served for a long period of time on the board is considered not to be independent. The rationale for this provision is that such a director would have attained some familiarity with the executive directors on account of his long period on the board which is capable of tainting his independent status. There is no uniformity in corporate governance codes on the length of time on the board that amounts to long tenure. However, period of nine years is popular.

8.             Affiliation test

A director who is affiliated with another company or director is adjudged not to be independent. The two dimensions to the affiliation test relate to companies in the same group (for example, holding and subsidiary companies) and board cross-membership and/or interlocking directorship.

9.             Omnibus clause

Strictly speaking, this is not a test. It is a catch-all phrase usually inserted in corporate governance codes to take care of test situations that may arise in future which the corporate governance code did not specifically provide for. This is so because it is recognised that the criteria listed may not be exhaustive in view of the fact that new developments in future could introduce a dimension which the corporate governance code did not envisage and so did not provide for it specifically.

Granted that the above criteria for determining the independent status of independent directors can be gleaned from a careful perusal of various corporate governance codes, they cannot be said to be exhaustive. There are some factors which in practical terms can still impugn a director’s independence but which have not found their way into corporate governance codes yet. However, these tests constitute a basic starting point. As basic as these tests are, there is no corporate governance code in force in Nigeria at the moment that provides for all the criteria. Thus, the tests for determining the independent status of independent directors in Nigeria reveal an aspect of the inadequacies in the provisions of the corporate governance codes presently in force in Nigeria in relation to independent directorship. In a subsequent post, another aspect of the inadequacies on independent directorship situation in Nigeria would be explored.

Independent Directors: 111 Frequently Asked Questions Aptly Answered

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2 comments on “Establishing the independent status of an independent director
  1. Charles Mafua says:

    From the above article, it clear that the Companies and Allied Matters Act (CAMA) didn’t expressly provide for the requirements or in this case, “tests” of an independent director, yet this is our leading statute in governing the affairs of a company in Nigeria. I’m just saying that the CAMA stull has room for improvement.
    Furthermore, these tests stated above are stringent steps to find an independent director, I will say out of ten independent directors you will find just one person that will satisfy the above stated tests and clause as the case may be. What I did like to concentrate on is, if he’s not working for the company, he has no financial relationship with the company and he knows he’s not going to be on the board for a long period, he doesn’t have any familial relation, he has no shares inter alia, how will one then determine that he would be loyal to the board he is serving? “Loyality is my basis of trust.” This independent director has nothing at stake if everything goes wrong, he/she knows that he will not receive an extra renumeration in rendering his services. I did like to put that if the director is not assured of his place in the board, it is only logical to think that he would not guarantee the board he’s working for his loyality and best interests.

  2. Roteryor says:

    In response to this article (i.e. criteria for determining the independent status of independent directors in Nigeria: a critical evaluation) and having observed the criterion for determining an independent director, I agree with the assessment of the writer that the operation of these directors as rightly mentioned is a form of panacea to address the evident failure of corporate governance thus their presence is something that cannot be underestimated in ensuring good corporate governance and it can only be achieved through qualitative input on the part of the independent director.
    In assessing the overall criteria for appointing an independent director I have noticed some points which might be considered in terms of a identifying the best practice for appointing an independent director.
    A form of repetition of tests is evident in determining the independence of these so-called directors which can ordinarily be subsumed into some general criterion giving a streamlined set or series of tests to determine the level of independence rather a flow of consequential events being benchmarked as tests.
    For instance, the affiliation test which bars appointment by virtue of association can be likened to the tests of long tenure, share-holding and familial relationship. The fundamental element in these tests is that of duration affecting the independent initiative of the director regardless of time impeding the integrity of the director owing to some unjustified engagement in the course of employment or his representation being in-line with the shareholder having the most significant amount of financial interest in the company or family ties or supervisory function based on structural positioning. In redress, if the nature of association in relation to the sound judgment of the director is in any way calculated to impair or has already been impaired from circumstances deducible, his appointment should be terminated.
    In recourse to the Security and Exchange Commission Code 2011 as regard the tests in the international practice, a similar line of argument can be deduced from the codified tests on share-holding and familial relationship.
    More so, the general provision on determining the independence of the director as regards the professional, consultancy and advisory service test which bars a person who has acted in a past with the company from working in that capacity is a test worth considering. This declaration doesn’t explain issues of contracting a person who has knowledge on the issue based on his past experience to investigate. This test clearly denies expert opinion in proffering solutions as intended to be a function of an independent director. In my opinion it is very difficult to separate the two and expect efficient results.
    On the issue of material business dealing test, the perception as to the scope of “business interest” as suggested by the test is loose making interpretation unlimited inferring meaning from various sources. The 2011 SEC Code is also not shy from this as it isn’t concise in determining what constitute as the “business interest” between the supplier or customer and the company as the code states.
    In conclusion and affirmation, the approach towards drafting such codes must be succinct as regard glaring issues affecting the performance of an independent director rather than duplicating tests on the same point which is unwarranted. Laudable efforts have been seen by drafters of the codes in creating a blanket test which will accommodate unforeseen circumstances. Thus, thumbs up on the omnibus test being set in place as a witty ploy to prevent exploitation on the codes as highly commendable.

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