MANAGERIAL REMUNERATION SHACKLES FINALLY REMOVED

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 12^th 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 1^st 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.