By JAYANT M. THAKUR
Chartered Accountant
Background
Finally, the requirement of
obtaining approval from the Central Government for paying managerial
remuneration by public companies has been removed. The amount of managerial
remuneration that can be paid is now an internal matter with the Board and,
where applicable, the Nomination and Remuneration Committee and the
shareholders. Shareholders consent by a special resolution is also needed wherever
the remuneration is in excess of limits prescribed in section 197 (1) of the
Companies Act, 2013.
For over last several decades,
though the laws relating to companies have been progressively reformed and made
liberal, managerial remuneration remained an area where sanction of the Central
Government was required to pay remuneration in excess of the limits prescribed
in section 197 read with Schedule V of the Act.
The limits on managerial
remuneration are mainly in the form of percentage of net profits and which
continues except that the approval of the Central Government is now not
required. There are overall limits for total managerial remuneration and then
sub-limits are provided for specified categories of directors. In case of loss
or inadequacy of profits absolute amounts are prescribed upto which a company
could pay remuneration. These are discussed in detail later herein. Paying
managerial remuneration beyond these limits required approval of the Central
Government. This requirement of taking government approval has been dropped
with effect from 12th September 2018. The new rules require
shareholders approval – special resolution. Hence, self governance has replaced
approval of the Central Government.
However, for listed companies SEBI
has prescribed additional requirements to ensure that promoters do not over pay
themselves without approval of the shareholders.
Summary
of existing provisions
The existing
provisions on limits on managerial remuneration are contained in section 197
read with Schedule V of the Companies Act, 2013. An overall limit for
managerial remuneration is provided at 11% of net profits. In other words,
executive and non-executive directors can be paid in the aggregate not more
than 11% of the net profits, calculated in the manner prescribed in section 198
of the Act. Payment of managerial remuneration beyond these limits required
approval of the Central Government. Within this limit, a single working
director (i.e., managing/whole-time director / executive director / manager)
could be paid remuneration upto 5% of the net profits, and all working
directors together could be paid 10% of the
net profits.
All non-executive directors could
be paid commission upto 1% of net profits and, if there was no working
director, then upto 3% of the net profits. The term manager and managing
director and whole-time director are defined in sub-section (53), (54) and (94)
of section 2 of the Act.
It is reiterated that sanction of
shareholders and central government was required to pay remuneration in excess
of the prescribed limits.
Needless to emphasise, obtaining
approval of the Central Government was a time consuming and possibly an
arbitrary affair. Even if shareholders agreed and approved, they could not take
such decisions. The limits on remuneration in case of inadequate profits were
arbitrary too, based on what the government perceived as fair remuneration.
Companies in need of talent at times were not able to hire the right person.
Moreover, the possibility of existing talent moving to other companies or even
migrating abroad loomed large generally for India and particularly during the
period when a company was going through a rough patch or even when the company
was expanding its activities and / or there existed circumstances beyond the
control of the management – for example – recession, market conditions and
period of restructuring operations.
As mentioned earlier, substantial
changes have been made which will ensure that the decisions of managerial
remuneration would be in accordance with good corporate governance practices
rather than government approval. The only approval required is of the
shareholders through a special resolution. This affirms the principle of
shareholders democracy. There have been several recent cases where shareholders
have showed growing disapproval by voting against remuneration they perceived
high. In many cases, this may be represented by substantial negative votes and
in some cases, actual rejection of the resolution itself by sufficient number
of negative votes.
Before we go into the specifics of
the changes, let us consider certain basics:
To which companies do the limits on managerial
remuneration apply?
The limits on managerial
remuneration apply to public companies, whether listed or not. They do not
apply to private companies, even if large in size.
What
is managerial emuneration?
Managerial remuneration is the
remuneration paid to directors, including those who are employees – such as
managing or whole time directors – that is –working directors and those who are
not employees of the company – i.e., the non-executive directors. Managerial remuneration could be in the form
of salary, perquisites and / or commission. However, sitting fee for attending
board or committee meetings is not managerial remuneration.
Further, fees paid to professional
directors for professional services under certain circumstances is not
managerial remuneration.
Period
of appointment
The appointment of working director
could be made for a term of upto 5 years.
Changes
now made
The limits on managerial
remuneration remain largely as they are. Thus, the limits on managerial
remuneration as a percentage of net profits (including sub-limits for
individual directors) continue. Similarly, the minimum remuneration that can be
paid in case of inadequacy of profits also continues more or less as they
existed previously. However, if remuneration is desired to be paid beyond these
limits, the approval of the shareholders by way of a special resolution is
required. Approval of the Central Government is no more required. Hence,
shareholders now have the final say on managerial remuneration. The management
and the Board will thus have to present a good case to the shareholders for
payment of such higher managerial remuneration.
Approval
of lenders, etc.
Section 197 also provides for a
situation where the company has defaulted on payment of dues to banks/public
financial institutions or non-convertible debenture holders or any other
secured creditors. Their prior approval would be required before seeking
approval of the shareholders for paying remuneration higher than the prescribed
limits. Such approval is also required waiving the recovery of remuneration
paid in excess of prescribed limits. This requirement ushers in the concept of
involving consent of other stakeholders whose interests are affected in the
event of loss or inadequate results of operation.
SEBI
places further restrictions
SEBI in the meantime has separately
made amendments to Regulation 17 of the SEBI (Listing Obligations and
Disclosure Requirements), 2009, though with effect from 1st April
2019. These are:
1. It
is now required that in a year where the annual remuneration of a single non-executive
director exceeds 50% of the total annual remuneration payable to all non-executive
directors, approval of members by special resolution shall be obtained.
2. Amendments
are made with regard to managerial remuneration to promoters or members of the
promoter group. The amended provisions require that if the managerial
remuneration to a single promoter is Rs. 5 crores or 2.50% of net profits, whichever is higher, then the approval of
the shareholders by way of special resolution shall be obtained.
3. Where
the proposed managerial remuneration to all promoters put together exceeds 5%
of the net profits, then too approval by way of special resolution is required
to be obtained.
The above requirements apply to
companies who have listed their specified securities on recognised stock
exchanges. Regulation 15(2) details the applicability giving exceptions.
Limits
on remuneration to independent directors
There is no change in the limit of
remuneration of independent directors – the cumulative limit is 1% or 3% of net
profits depending on whether the company has managing / executive / whole time
director or not.
Shareholders’ democracy is becoming
visible as in some instances re-appointment of independent directors has been
objected to, even if unsuccessfully. This is the beginning of shareholder
activism.
Approval
of Central Government continues to be required in certain other matters
The approval of the Central
Government will continue to be required in cases of appointment of such
managerial persons where the requirements relating to
qualifications/disqualifications are not complied with.
Conclusion
Companies will thus have much
greater freedom and flexibility in paying their top executives. In particular,
companies with lesser profits (for whatever reasons) will find relief. The
requirements of recommendation and review by Nomination and Remuneration
Committee (where applicable) and approval of the shareholders by
ordinary/special resolution will help in providing the required balance.
The timing of the amendments,
though, is a little awkward for companies desiring to take benefit of these
relaxations. Most companies may have already convened their annual general
meetings for 2018 and these matters may have not been proposed or proposed as
per earlier law. Thus, companies may need to approach the shareholders again to
seek their approval to take advantage of these relaxations.
