The Independent Committee: Governing a Conflicted Deal

An independent committee is a group of directors with no interest in the transaction, formed to take the decisions that conflicted directors cannot take. The committee gets its own advisers, keeps its own minutes and must be able to say no. Whether one is required, and what the board must do, is set by company law at mca.gov.in and by the Securities and Exchange Board of India (SEBI) at sebi.gov.in.

Everything in this sequence so far sits at the working level. A transaction team gathers the facts, runs the process and produces the analysis. Somebody has to decide what to do with that analysis. Normally the answer is uninteresting. A board decides, and deciding is what a board is for. The ordinary answer stops working when one or more of the people deciding would be better off if the answer were yes.

Consider a familiar scene. A household is buying a second hand scooter. The uncle who knows about scooters offers to negotiate, inspect it and settle the price. The offer is exactly what the household wants, right up to the moment it learns that the seller is his own brother in law and that he takes a cut of the sale. Nothing about him has changed. He is the same competent, decent person he was ten seconds earlier. The household now knows he has an interest in the outcome, and every judgement he makes about that scooter has to be read differently. The household does not stop trusting him as a person. The uncle's judgement is no longer neutral, and the household stops treating it as though it were.

The scooter story is the whole subject in a sentence. When the person exercising judgement also benefits from the judgement going one way, the judgement stops being usable as a control. An independent committee is what a board builds when that happens: a body of people who do not benefit either way, given the power that the interested people cannot honestly exercise. A committee is not an extra layer of caution. A committee replaces a control that has stopped working.

Harivansh Packaging Limited, invented and listed, is acquiring 100 per cent of Sundarban Polymers Private Limited, invented and unlisted. Devyani Kulkarni is the chief financial officer of Harivansh Packaging Limited and Ashwin Rege leads the transaction team. When the test that follows is applied to this purchase, the answer comes back no. The no stands, and it takes remarkably little change to flip it.

What makes a transaction conflicted?

A conflict of interestA situation where a person taking or influencing a decision would personally gain from the decision going one particular way. A conflict describes the person's position, not their behaviour. exists when somebody who influences the decision also has an interest in the outcome on the other side. The definition is that short, and notice what is missing from it. There is nothing in there about intention, about dishonesty, about anybody planning to do anything wrong. A conflict is a fact about where a person sits, and saying that the person is honest does not remove it.

People resist the point, so it is worth pressing on. Suppose Ashwin Rege, who leads the transaction team at Harivansh Packaging Limited, also stood to be paid something by the sellers of Sundarban Polymers Private Limited when the purchase completed. He is the same person he was yesterday. He may well behave impeccably. But now every recommendation he makes carries a second explanation alongside the honest one, and nobody reading his work later, including him, can separate the two. The conflict is not a prediction that he will do something wrong. The conflict is the fact that his work has stopped being independent evidence.

Governance controls have to survive that. A control that only works when the people inside it happen to be honest is not a control at all. The control fails precisely in the situation it exists for. So the response to a conflict is structural: change who decides, rather than asking the conflicted person to try harder. In the household version, the uncle does not stop being asked about engines. He stops being the one who settles the price.

Three shapes cover almost every conflict that arises on a transaction. One, a decision maker sits on both sides at once, holding an interest in the counterparty or being paid by it. Two, a controlling holderA shareholder, or a group acting together, holding enough of a company that its votes decide ordinary matters in practice. A controlling holder does not need to hold everything, only enough to prevail. gains something from the transaction that the other holders do not share. Three, the people running the business are among the people buying it. Each of them puts an interest and a decision in the same pair of hands, and each of them does so regardless of anybody's character.

What is an independent committee, and who sits on it?

An independent committee is a body of directors with no interest in the outcome, constituted by the board to take the decisions the conflicted directors cannot honestly take. Three things make it work, and they come as a set. The committee can instruct its own advisers. The committee receives the analysis and tests it rather than merely reading it. And it can refuse.

The third power gets quietly dropped, and dropping it changes what the body is. A committee that cannot say no is not a committee but a review step. The difference shows up only in the one case where it matters. Ninety nine times out of a hundred a review step and a committee produce identical paperwork, identical meetings and identical recommendations, because the transaction was going to proceed anyway. The hundredth time, when the answer should be no, the review step has no mechanism for producing one. A review step can express concern. A review step cannot stop anything.

Think of a residents' association putting a repainting contract out to tender. One member's brother runs a painting business and has quoted. The association can do one of two things. The association can ask that member to leave the room while the quotes are opened and let the remaining members choose, including choosing his brother if the quote is genuinely the best. Or it can let him stay, hear him out, and then have the whole association vote, his vote included. The second version has more discussion in it and less control. The first is a committee. The second is a conversation.

Who sits on it, then? People with no interest in the outcome. The bar sounds lower than it is, and it is harder to meet than people expect. Being capable, senior or well regarded is not enough. The question is narrow: does this person gain or lose depending on which way the decision goes? Independence as a matter of law, and whether a board is required to constitute a committee at all, is set by company law through the Ministry of Corporate Affairs at mca.gov.in and, for a listed company, by SEBI at sebi.gov.in. The current text there governs.

How is a transaction tested for whether it needs one?

Three questions, asked in this order, and each of them is about who is deciding rather than about how good or bad the transaction looks.

Question one. Does anybody deciding also sit on the other side? Sitting on the other side means holding an interest in the counterparty, being paid by it, or being connected to it closely enough that the counterparty's gain is their gain. Question two. Does a controlling holder benefit differently from everybody else? Not merely benefit. A controlling holder benefits from every good decision the company makes, along with all the other holders. Differently. Question three. Is management buying, in whole or in part, what it currently runs? The shape has a name, the management buyout, and it puts the people with the best information about a business on the side that wants to pay less for it.

A conflict discovered after the price is discussed taints work that has already been done, so the test comes before the price. Sequencing is the step most often skipped, and it is the most expensive one to skip. If the test is run at the start and the answer is yes, a committee can be constituted and left to design the process from a blank sheet. If it is run after the price is agreed, a conflicted process already sits behind the transaction and there is no honest way to unwind it. The process can only be inspected.

Answering question two on Harivansh Packaging Limited takes one fact from the register, and only one. The promoter and promoter group hold 58.0 per cent, so the free floatThe part of a listed company's shares held by anybody outside the promoter and promoter group, and therefore the part that trades freely in the market. is 42.0 per cent. On the 18.00 crore shares in issue that is 10.44 crore shares held by the promoter groupThe people and entities who set up or control a company, taken together with the relatives and companies grouped with them for disclosure. The contents of the grouping are defined by SEBI. and 7.56 crore in the float.

Read what that table does and does not say. At 58.0 per cent the promoter group decides ordinary matters without needing anybody else, so a controlling holding exists. The table does not by itself say the transaction is conflicted. Question two is not answered by the size of the holding. Question two is answered by asking what the holding receives here that the other 42.0 per cent does not, and a controlling holder can sit at 58.0 per cent through a hundred transactions without ever triggering it.

Does this transaction need an independent committee?

The three questions now go to the purchase at hand, and the answer they give stands whatever it turns out to be.

Question one, does anybody deciding also sit on the other side. On the record as it stands, no. The sellers of Sundarban Polymers Private Limited are unconnected with the directors of Harivansh Packaging Limited. Nobody on the buying side is paid by the selling side, and no director holds an interest in the target.

Question two, does a controlling holder benefit differently from everybody else. A controlling holding certainly exists, at 58.0 per cent. So work through what it receives. The consideration is cash, paid to unconnected sellers. Afterwards every holder of Harivansh Packaging Limited, promoter group and free float alike, holds the same slice of the same enlarged business that they held of the smaller one. The promoter group does not receive a payment, does not sell anything and does not acquire a right the float does not have. The answer is no. The related partyA person or company connected to the company closely enough that dealings between them are treated as needing extra approval and disclosure. The list of who counts as one is defined in law. question was asked here and came back negative. An answer of no is not the same as never asking.

Question three, is management buying what it runs. No. The buyer is a separate listed company with its own board, and the people running Sundarban Polymers Private Limited are not among the purchasers.

Three noes, so this transaction as recorded does not require an independent committee. That refusal is not a shortage of material. The refusal is the material. Most transactions are not conflicted. Telling an ordinary transaction from a conflicted one is precisely the skill the test exists to build.

What changes if one fact changes?

A transaction that needs no committee teaches the test better than an invented conflict would. Hold the transaction completely still and move a single fact at a time.

First change. Suppose the sellers of Sundarban Polymers Private Limited included a member of the promoter group of Harivansh Packaging Limited. Question two now reads differently, and the 58.0 per cent stops being a neutral fact on the register and becomes a holding on both sides of a payment. The controlling holder would be receiving cash that the free float does not receive, from a company the controlling holder decides for. The answer flips to yes.

Second change. Suppose the buyer were the management team of Sundarban Polymers Private Limited rather than Harivansh Packaging Limited. Question three flips, and now the people who know most about the business are the people setting the price they pay for it.

Look at what did not move in either case. Enterprise value is Rs 1,320 crore, being 10.0 times the target's earnings before interest, tax, depreciation and amortisation (EBITDA) of Rs 132 crore. Take off the Rs 180 crore of net debt sitting in Sundarban Polymers Private Limited and the equity value paid to the sellers is Rs 1,140 crore. Not one rupee of that bridge changes when the sellers' identity changes, and enterprise value is never the amount handed to sellers in the first place.

A conflict is a fact about who is deciding rather than a fact about the price, so the same Rs 1,140 crore equity value at the same 10.0 times entry multiple can sit inside a transaction that needs a committee and one that does not. Anybody who tries to detect conflicts by staring at the numbers will never find one, because the numbers are silent on the subject. Conflicts are found by reading the list of people and asking, of each of them, what they get if this completes.

What does the committee actually do, and when?

Five things, in an order that matters more than the list. The committee agrees the process. Then it instructs its own advisers. Then the analysis arrives. Then the committee tests that analysis. And then it either recommends or it does not.

The first of those five matters most. Agreeing how the transaction will be run happens at the very start, so a committee formed to bless a completed negotiation has been handed only the least useful part of its job. Agreeing the process means settling questions that have no numbers in them at all. Who is approached, and is it more than one party? Which information goes out, and to whom? Who negotiates, and who do they report to? Which alternatives are being tested against this one, including the alternative of doing nothing? Every one of those questions is answered forever the first time somebody acts, and a body that arrives later can only ask what the answers turned out to be.

Take the wedding version. A household is booking caterers for a wedding, and one aunt has a nephew in the catering business. If she is asked, before any quotes are sought, to stay out of the tendering and the rest agree they will collect three quotes on a written specification, the process protects itself. If instead she quietly arranges everything, her nephew is chosen, and only afterwards is a committee of cousins asked to look at the price, they have a genuinely hard job. The price may even be fine. But the other two caterers were never asked, so nobody will ever know what they would have quoted.

Look at where the two committees start on the milestones of this transaction. The invented sequence here runs approach and confidentiality, indicative offer and term sheet, confirmatory diligence, documentation, signing, the conditions period, completion. Twenty two weeks ran from term sheet to completion, of which the conditions period was nine. Elapsed spans vary widely from one transaction to the next, so the useful figure is not the twenty two weeks but where inside them the committee was formed.

Why does a committee need its own advisers?

Because advisers already engaged by the company report to the people whose position is the problem. The argument is that short, and it does not depend on anybody doing anything improper.

Consider how those advisers came to be there. Somebody on the executive side selected them, agreed what they would do, set the fee and decides whether they are used again. Their work may be excellent. Their conclusions may be exactly what an independent adviserAn adviser engaged and instructed by the committee itself rather than by the company's executives. The reporting line runs only to the committee. would have reached. But they were framed by the questions the executive side chose to ask, and they were tested by nobody outside that side. A committee reading only the analysis produced by the conflicted side has not read anything independent, however good the analysis is.

The same reflex belongs in a hospital corridor. If a doctor recommends an expensive procedure and a second opinion is wanted, the second doctor is not nominated by the same clinic. Not because the first doctor is dishonest, and not because the nominated colleague would be. The reason is structural: a second opinion arranged by the first opinion is not a second opinion, whatever it says.

The committee's own advisers do not give it a better answer. The advisers give it a second set of questions. An adviser instructed by the committee can be asked what the analysis assumed, what happens if those assumptions are wrong, what the alternatives look like and what a different framing of the same facts would produce. Questions like those are the committee's real work, and they can only be put to somebody whose next instruction does not depend on the executives liking the reply.

What are the committee's minutes for?

The minutesThe written record of what a meeting considered and decided, kept as the formal account of the meeting afterwards. are the only durable evidence that a process actually happened. Everything else about a committee lives in the memories of the people who were in the room, and memories are not evidence a year later, least of all to the person trying to reconstruct what they themselves thought.

So what belongs in them? Four things: the matters the committee considered, the questions it asked, the answers that came back, and the reasons for the view it took. A minute recording a conclusion without the questions is evidence of a meeting rather than of a process. The sentence to watch for is the one that says the committee considered the transaction and recommended it. The sentence is true and it is also empty. The minute records the destination and none of the journey, and the journey is the entire thing the committee exists to produce.

Compare two versions of the same meeting. In the first, the minute reads that the committee considered the proposed acquisition and recommended it to the board. In the second, it records that the committee asked how the counterparty was identified and what alternatives had been tested, records the answers it got, records that it instructed its own advisers to test the analysis, records what those advisers said the analysis assumed, and then records the reasons for the view it took. The second is longer and slower to write, and enormously more useful. Somebody reading it in two years can see what was and was not asked.

The difference is plain in an ordinary school register. If a parents' committee records only that it approved the annual budget, nobody afterwards can tell whether anybody queried the largest line in it. If it records that the largest line was queried, what the answer was, and that a second quote was called for, the record itself has done work.

What can a committee not fix?

Three things, and being clear about them is what stops a committee from becoming a talisman that people wave at hard situations.

A committee cannot make a bad price good. Refusing a price is a real power, and refusing is the only thing a committee can do about a bad one. A committee that recommends a purchase at a price it has tested has not thereby made that price correct. A committee cannot supply information nobody has. If the target's largest customer is quietly planning to move next year and has told nobody, no amount of committee diligence will produce that fact, and the transaction will be priced without it. And it cannot create independence in a director who does not have it. Putting a conflicted director on a committee called independent changes the letterhead and nothing else.

A committee is a process controlA safeguard that governs how a decision gets made, in contrast to one that tries to govern what the decision turns out to be., and a sound process can still reach a decision that turns out badly. That is not a defect in the idea. The limit is an honest description of what any process control can deliver. Compare it with a household choosing a school. The household can visit three schools, talk to parents, check the fees against the budget and take the decision carefully, and the child can still be unhappy there. The care was not wasted and it was never a promise about the outcome. The record of what was considered survives, so the care leaves behind a decision that can be defended and, more usefully, learned from.

The distinction between a good process and a good outcome is set out separately. Hold on to the short version. A committee's work is judged on what it asked, not on what happened afterwards, and anybody who judges it the other way will draw the wrong lesson in both directions.

How do a lender, an analyst and an investor read this?

Three readers, three different first questions, and none of them starts with the quality of the analysis.

A lender being asked to fund a purchase reads the governance as a question about whether the borrower can be relied on to have tested the transaction. If the borrower's board has an obvious conflict and no committee, the lender's own credit process has to do work that should already have been done, and it will price or condition accordingly. If a committee exists, the lender's first question is not what it concluded but when it was formed. A committee formed after the price was agreed tells the lender almost nothing about how the price arose.

An analyst covering Harivansh Packaging Limited reads it as a question about the free float. The 42.0 per cent outside the promoter group cannot outvote 58.0 per cent on ordinary matters, so the float's protection on a conflicted transaction comes from process and disclosure rather than from arithmetic. An analyst therefore watches for whether the process was independent and whether the reasons were published, and treats the price itself as a separate question answered by the valuation work rather than by the governance.

An investor already on the register asks the plainest version of all: is anything reaching somebody here that is not reaching me? On this transaction the answer is no. Cash goes out to unconnected sellers, and every holder ends up with a proportionate slice of the same combined business. The question is worth repeating on every transaction, and it is exactly test question two in ordinary language.

And the household version, where the reflex should live. If a relative offers to arrange something on a household's behalf, the useful question is never whether the relative is trusted. The useful question is what the relative gets if it goes ahead. The question is worth asking early, asking out loud, and asking of everyone in the room including the person asking it.