Remuneration of Managerial Personnel

Note four things at once.

It applies to a public company. A private company is not subject to the section's percentage limits.

It covers directors and the manager together, not each separately.

The base is net profits under section 198.

And the exception matters arithmetically. Section 198(4)(b) would deduct directors' remuneration in computing net profits; for this purpose it is not deducted, so the percentage is taken on profits before managerial pay.

Crossing eleven per cent

First proviso: the company in general meeting may authorise the payment of remuneration exceeding eleven per cent of the net profits, subject to the provisions of Schedule V.

Until 12 September 2018 that proviso also required the approval of the Central Government. Those words were omitted. The decision now belongs to the members alone.

The inner limits

Second proviso: except with the approval of the company in general meeting by a special resolution:

• (i) the remuneration payable to any one managing director, whole-time director or manager shall not exceed five per cent of the net profits; and where there is more than one such director, the remuneration to all of them and the manager taken together shall not exceed ten per cent;
• (ii) the remuneration payable to directors who are neither managing directors nor whole-time directors shall not exceed (A) one per cent of the net profits if there is a managing or whole-time director or manager, and (B) three per cent in any other case.

So the five inner limits are: eleven overall, five to one, ten to all of them, one to the others where there is an executive, three to the others where there is not.

And note the words "except with the approval of the company in general meeting, by a special resolution". These inner limits are crossed by a special resolution, the requirement of a special resolution having been inserted in 2018.

Third proviso, inserted in 2020: the lenders come first. Where the company has defaulted in payment of dues to any bank or public financial institution, or to non-convertible debenture holders or any other secured creditor, the prior approval of that creditor must be obtained before the company obtains the members' approval.

The logic is plain. A company that is not paying its lenders should not be raising its directors' pay over the lenders' heads.

Fees, form and computation: section 197(2), (4), (5), (6) and (8)

Section 197(2). The percentages are exclusive of any fees payable to directors under sub-section (5). So sitting fees do not count towards the eleven per cent.

Section 197(4): who fixes it. The remuneration payable to the directors, including any managing or whole-time director or manager, shall be determined either by the articles, or by a resolution, or, if the articles so require, by a special resolution passed in general meeting; and the remuneration so determined shall be inclusive of the remuneration payable for services rendered by him in any other capacity.

The proviso excludes professional services. Remuneration for services rendered in another capacity is not included if (a) the services are of a professional nature, and (b) in the opinion of the Nomination and Remuneration Committee, where the company is covered by section 178(1), or of the Board in other cases, the director possesses the requisite qualification for the practice of the profession.

Both conditions must hold. A director who happens to give advice is not thereby a professional; the committee or Board must be satisfied he is qualified to practise.

Section 197(5): sitting fees. A director may receive remuneration by way of fee for attending meetings of the Board or a committee, or for any other purpose whatsoever as may be decided by the Board. The amount shall not exceed the prescribed amount, and different fees may be prescribed for different classes of companies and for independent directors.

Section 197(6): the form of payment. A director or manager may be paid either by a monthly payment, or at a specified percentage of the net profits, or partly one and partly the other.

Section 197(7) has been omitted by the Companies (Amendment) Act, 2019.

Section 197(8). The net profits for the purposes of the section are computed in the manner referred to in section 198.

No profits or inadequate profits: section 197(3)

Notwithstanding sub-sections (1) and (2), but subject to Schedule V, if in any financial year a company has no profits or its profits are inadequate, the company shall not pay to its directors, including any managing or whole-time director or manager, or any other non-executive director including an independent director, by way of remuneration any sum exclusive of any fees payable under sub-section (5), except in accordance with the provisions of Schedule V.

Two amendments have shaped this sub-section.

The words "or any other non-executive director, including an independent director" were inserted by the Companies (Amendment) Act, 2020. Before that, a loss-making company could not lawfully pay its non-executive and independent directors at all beyond sitting fees. This is the same change that added the proviso to section 149(9).

And the fallback of "previous approval of the Central Government" was omitted in 2018. The route is now Schedule V alone.

Excess drawn, refund and waiver: section 197(9) and (10)

Section 197(9). If any director draws or receives, directly or indirectly, by way of remuneration any sums in excess of the limit prescribed by the section, or without the approval required under it, he shall refund such sums to the company within two years or such lesser period as may be allowed by the company, and until such sum is refunded, hold it in trust for the company.

Three features to state in an answer. The refund is due within two years, or less if the company allows; the money is held in trust until refunded; and the sub-section catches both excess and want of approval.

Section 197(10): waiver. The company shall not waive the recovery of any sum refundable under sub-section (9) unless approved by the company by special resolution within two years from the date the sum becomes refundable.

The proviso, inserted in 2020, again puts the lenders first: where the company has defaulted in payment of dues to any bank, public financial institution, non-convertible debenture holders or other secured creditor, the prior approval of that creditor must be obtained before the waiver is approved.

The rest of section 197

Section 197(11). Where Schedule V is applicable on grounds of no profits or inadequate profits, any provision increasing a director's remuneration, whether in the memorandum, articles, an agreement, or a resolution of the company or the Board, shall not have effect unless the increase is in accordance with the conditions specified in that Schedule.

Section 197(12): the pay ratio. Every listed company shall disclose in the Board's report the ratio of the remuneration of each director to the median employee's remuneration and such other details as may be prescribed.

Section 197(13): insurance. Where a company takes insurance on behalf of its managing director, whole-time director, manager, Chief Executive Officer, Chief Financial Officer or Company Secretary, indemnifying them against liability for negligence, default, misfeasance, breach of duty or breach of trust in relation to the company, the premium shall not be treated as part of the remuneration. Proviso: if such person is proved to be guilty, the premium shall be treated as part of the remuneration.

That proviso is neat. The company may insure honest officers freely; if the officer turns out to be guilty, the premium becomes his pay and counts against the limits.

Section 197(14): commission from a holding or subsidiary company. A director in receipt of a commission from the company who is a managing or whole-time director is not disqualified from receiving remuneration or commission from any holding or subsidiary company, subject to disclosure by the company in the Board's report.

Section 197(15): the penalty. Any person in default is liable to a penalty of one lakh rupees, and where the default is by a company, the company is liable to a penalty of five lakh rupees.

Section 197(16): the auditor's statement. The auditor shall, in his report under section 143, state whether the remuneration paid to the directors is in accordance with this section, whether any director's remuneration is in excess of the limit, and such other details as may be prescribed.

Section 197(17) is transitional: applications pending with the Central Government under the section as it stood before the 2017 amendment abate, and the company must obtain approval under the amended section within one year.

Calculation of profits: section 198

Section 198(1) sets the method in one sentence. In computing net profits for section 197, credit shall be given for the sums in sub-section (2) and shall not be given for those in sub-section (3); and the sums in sub-section (4) shall be deducted and those in sub-section (5) shall not be deducted.

So the section is four lists: two of receipts and two of outgoings.

Sub-section (2), credit shall be given for: bounties and subsidies received from any Government or public authority constituted or authorised by any Government, unless and except so far as the Central Government otherwise directs.

Sub-section (3), credit shall NOT be given for:

• (a) profits by way of premium on shares or debentures issued or sold by the company, unless the company is an investment company within clause (a) of the Explanation to section 186;
• (b) profits on sales of forfeited shares;
• (c) profits of a capital nature, including profits from the sale of the undertaking or any part of it;
• (d) profits from the sale of immovable property or fixed assets of a capital nature, unless the business of the company consists wholly or partly of buying and selling such property or assets. Proviso: where the sale price exceeds the written-down value, credit shall be given for so much of the excess as is not higher than the difference between original cost and written-down value, which is to say the depreciation written back, and no more;
• (e) any change in the carrying amount of an asset or liability recognised in equity reserves, including surplus in the profit and loss account, on measurement at fair value; and
• (f), inserted in 2018, any amount representing unrealised gains, notional gains or revaluation of assets.

Clauses (e) and (f) are the modern heart of the section. They stop a company from turning an accounting write-up into a bonus.

Sub-section (4), the deductions. All the usual working charges; directors' remuneration; bonus or commission paid to staff, engineers, technicians or persons employed whole-time or part-time; taxes on excess or abnormal profits notified by the Central Government; taxes on business profits imposed for special reasons and so notified; interest on debentures; interest on mortgages and on loans and advances secured by a charge on fixed or floating assets; interest on unsecured loans and advances; expenses on repairs not of a capital nature; outgoings including contributions under section 181; depreciation to the extent specified in section 123; the excess of expenditure over income of an earlier year so far as not already deducted; compensation or damages payable under a legal liability including breach of contract; insurance against that risk; and bad debts written off or adjusted during the year.

Sub-section (5), what shall NOT be deducted.

• (a) income-tax and super-tax payable under the Income-tax Act, 1961, or any other tax on the company's income not falling under clauses (d) and (e) of sub-section (4);
• (b) compensation, damages or payments made voluntarily, that is, otherwise than under a legal liability of the kind in sub-section (4)(m);
• (c) losses of a capital nature, including loss on sale of the undertaking, but not the excess of the written-down value of an asset sold, discarded, demolished or destroyed over its sale proceeds or scrap value; and
• (d) any change in the carrying amount of an asset or liability recognised in equity reserves on fair value measurement.

The symmetry is worth pointing out in an answer. Capital profits are not credited and capital losses are not deducted; fair value movements are neither credited nor deducted; income-tax is not deducted, but a tax on excess profits is.

Recovery on restatement: section 199

Where a company is required to re-state its financial statements due to fraud or non-compliance with any requirement under this Act and the rules made thereunder, the company shall recover from any past or present managing director or whole-time director or manager or Chief Executive Officer, by whatever name called, who during the period for which the financial statements are required to be re-stated received the remuneration, including stock option, in excess of what would have been payable to him as per restatement of financial statements.

Note four things.

Recovery is mandatory. The section says the company shall recover.

It reaches past officers, not only serving ones.

It includes stock options, not merely cash.

And the measure is the difference between what was paid and what would have been payable on the restated figures.

It is expressly without prejudice to any other liability under this or any other law.

Fixing remuneration where profits are absent: section 200

Notwithstanding anything in the Chapter, a company may, while according its approval under section 196 to any appointment, or to any remuneration under section 197 in cases where the company has inadequate or no profits, fix the remuneration within the limits specified in the Act at such amount or percentage of profits as it may deem fit; and while fixing it the company shall have regard to:

• (a) the financial position of the company;
• (b) the remuneration or commission drawn by the individual in any other capacity;
• (c) the remuneration or commission drawn by him from any other company;
• (d) the professional qualifications and experience of the individual; and
• (e) such other matters as may be prescribed.

The marginal note still reads "Central Government or company to fix limit", but the words giving the Central Government that role were omitted in 2018, and what survives is the company's power, guided by the five matters above. The marginal note is a leftover, and an answer that relies on it will misstate the law.

Applications: section 201

Section 201(1). Every application to the Central Government under section 196 shall be in such form as may be prescribed.

Section 201(2). Before any such application is made, (a) the company shall issue a general notice to its members indicating the nature of the application proposed; (b) the notice shall be published at least once in a newspaper in the principal language of the district in which the registered office is situate and circulating in that district, and at least once in English in an English newspaper circulating in that district; and (c) copies of the notices, with a certificate of due publication, shall be attached to the application.

Note what section 201 now serves. Since 2018 the Central Government's role in remuneration has gone; the application that remains is the one under section 196(3), for the appointment of a person who has attained the age of seventy where the special resolution was not passed.

A worked example

Ambernath Alloys Limited is a public company. Its net profits computed under section 198, without deducting directors' remuneration, are five crore rupees. It has one managing director, one whole-time director, and six other directors of whom four are independent.

The ceilings.

• Overall, to all directors and the manager together: eleven per cent of five crore, that is fifty-five lakh rupees.
• To any one of the managing or whole-time directors: five per cent, that is twenty-five lakh.
• To both of them together: ten per cent, that is fifty lakh.
• To the six other directors together: there is a managing director, so one per cent, that is five lakh.

Had there been no managing or whole-time director or manager, the other directors' ceiling would have been three per cent, fifteen lakh.

Sitting fees. The company pays each director a fee for attending Board and committee meetings, within the prescribed amount. Those fees are excluded from all the percentages by section 197(2).

Crossing a limit. The company wishes to pay the managing director thirty-five lakh, which is seven per cent. That exceeds the five per cent inner limit, so it needs the approval of the company in general meeting by a special resolution: second proviso to section 197(1). If the total to all directors and the manager also exceeded fifty-five lakh, the first proviso would require the members' authorisation, subject to Schedule V. Since 12 September 2018 no Central Government approval is needed for either.

A defaulting company. Ambernath Alloys has defaulted on its term loan to a bank. Then, by the third proviso, the bank's prior approval must be obtained before the company obtains the members' approval. The same requirement applies under the proviso to section 197(10) if the company later wants to waive a refund.

Professional services. A director who is a practising architect designs the company's new plant and is paid a fee. Under section 197(4) remuneration in another capacity is normally included in his remuneration, but the proviso excludes it where the services are of a professional nature and the Nomination and Remuneration Committee, this being a company covered by section 178(1), is of opinion that he possesses the requisite qualification for the practice of the profession. Both being satisfied, the fee is outside the limits.

Computing the profits. During the year the company sold a plot of land at a profit of eighty lakh rupees. Its business is making alloys, not dealing in land, so under section 198(3)(d) that profit is not credited, except that where the price exceeds the written-down value, credit is given for so much of the excess as does not exceed the difference between original cost and written-down value. It also revalued its buildings upward by two crore. Under section 198(3)(f) that revaluation is not credited at all. And it received a State subsidy of ten lakh, which is credited under sub-section (2).

On the other side, it paid income-tax, which is not deducted under section 198(5)(a), and made a voluntary ex gratia payment to a supplier, which is not deducted under clause (b); but it deducted interest on its debentures and on its secured and unsecured loans, depreciation to the extent specified in section 123, bad debts written off, and its contribution to a charitable fund under section 181, all under sub-section (4).

Excess drawn. The managing director in fact draws forty lakh although only thirty-five lakh was approved. Under section 197(9) he must refund five lakh within two years, or such lesser period as the company allows, and holds it in trust for the company until he does. The company may waive it only by special resolution passed within two years from the date the sum became refundable: section 197(10). He is also liable to a penalty of one lakh rupees, and the company, if in default, to five lakh rupees: section 197(15). And the auditor must state in his report under section 143 whether the remuneration is in accordance with the section and whether any director's remuneration exceeds the limit: section 197(16).

A restatement. Two years later the company is required to re-state its financial statements because of a fraud. On the restated figures the managing director's entitlement for those years was eighteen lakh a year lower. Under section 199 the company shall recover that excess, including any stock option, and it may recover from him whether or not he is still in office.

A bad year. In the following year the company makes no profit. It may not pay remuneration to its directors, including the managing and whole-time directors and any non-executive or independent director, except in accordance with Schedule V, sitting fees apart: section 197(3). In fixing what to pay within those limits, the company must, under section 200, have regard to its financial position, the individual's remuneration in any other capacity, his remuneration from any other company, and his professional qualifications and experience.

Insurance. The company insures its managing director and Chief Financial Officer against liability for negligence and breach of duty. The premium is not part of their remuneration under section 197(13), unless either is proved to be guilty, in which case the premium becomes part of his remuneration.

Disclosure. Being listed, the company must disclose in the Board's report the ratio of each director's remuneration to the median employee's remuneration: section 197(12). And where the managing director also draws a commission from the company's subsidiary, that is not a disqualification, but it must be disclosed in the Board's report: section 197(14).

Distinctions that carry marks

What this does NOT mean

It does not mean the Central Government approves excess managerial remuneration. That requirement was omitted with effect from 12 September 2018; the members decide.

It does not mean the eleven per cent includes sitting fees. Section 197(2) makes the percentages exclusive of fees under sub-section (5).

It does not mean net profits means book profit. It means profits computed under section 198, and for section 197 without deducting directors' remuneration.

It does not mean a loss-making company can pay nothing to its independent directors. Since the 2020 amendment, section 197(3) lets it pay them in accordance with Schedule V, and the proviso to section 149(9) says the same.

It does not mean excess remuneration is merely a debt. It is held in trust for the company until refunded: section 197(9).

It does not mean a waiver is in the Board's gift. It requires a special resolution within two years of the sum becoming refundable, and where the company has defaulted to a lender, that lender's prior approval.

Quick revision

• 197(1): total managerial remuneration of a public company to its directors and manager shall not exceed eleven per cent of net profits computed under section 198, directors' remuneration not being deducted in that computation; the general meeting may authorise more, subject to Schedule V; and except with the approval of the company in general meeting by a special resolution, five per cent to any one managing or whole-time director or manager, ten per cent to all of them together, one per cent to the other directors where there is such an executive and three per cent where there is not; where the company has defaulted to a bank, public financial institution, non-convertible debenture holders or other secured creditor, that creditor's prior approval comes first.
• 197(2), (4), (5), (6), (8): percentages exclusive of sitting fees; remuneration determined by the articles, a resolution, or a special resolution if the articles so require, and inclusive of pay in any other capacity unless the services are professional and the Nomination and Remuneration Committee or the Board is satisfied he is qualified to practise; sitting fees within the prescribed amount, with different fees prescribable for classes of companies and independent directors; payment monthly, as a percentage of net profits, or partly both; net profits as in section 198.
• 197(3): where there are no profits or profits are inadequate, nothing may be paid to directors, including non-executive and independent directors, except sitting fees and what Schedule V allows.
• 197(9) and (10): excess or unapproved sums must be refunded within two years and are held in trust meanwhile; waiver only by special resolution within two years, with the defaulting company's lender approving first.
• 197(11) to (17): where Schedule V applies, an increase has no effect unless it conforms to the Schedule; a listed company discloses the ratio of each director's remuneration to the median employee's; insurance premium is not remuneration unless the person is proved guilty; a managing or whole-time director may take commission from a holding or subsidiary company, disclosed in the Board's report; penalty one lakh rupees on a person and five lakh on a company; the auditor must report on compliance; and pre-2017 applications abate.
• 198: credit Government bounties and subsidies; do not credit premium on shares or debentures (save for an investment company), forfeited-share profits, capital profits, profits on sale of immovable property or fixed assets (save the depreciation written back, and save where the business is dealing in them), fair value changes, and unrealised or notional gains and revaluation; deduct working charges, directors' remuneration, staff bonus and commission, notified excess-profits and special business-profits taxes, interest on debentures, on secured and on unsecured loans, non-capital repairs, section 181 outgoings, depreciation under section 123, unabsorbed past excess of expenditure, legal compensation and damages, insurance against that risk, and bad debts; do not deduct income-tax, voluntary payments, capital losses (except the shortfall on an asset sold, discarded, demolished or destroyed), and fair value changes.
• 199: on a restatement due to fraud or non-compliance, the company shall recover from any past or present managing or whole-time director, manager or Chief Executive Officer the remuneration, including stock option, in excess of what the restated accounts would have supported.
• 200: the company, when approving an appointment under section 196 or remuneration under section 197 where profits are inadequate or absent, may fix the remuneration within the limits specified in the Act, having regard to the financial position of the company, the individual's remuneration in any other capacity and from any other company, his professional qualifications and experience, and any prescribed matters.
• 201: an application to the Central Government under section 196 shall be in the prescribed form, preceded by a general notice to members, published once in the principal language of the district and once in English, the notices and a certificate of due publication being attached to the application.

Test yourself

1. State the limits in section 197(1). Total managerial remuneration of a public company to its directors and manager: eleven per cent of net profits computed under section 198. Within that, and except with the approval of the company in general meeting by special resolution: five per cent to any one managing or whole-time director or manager; ten per cent to all of them taken together; one per cent to directors who are neither managing nor whole-time directors where there is such an executive or a manager; and three per cent in any other case.

2. Who may authorise remuneration above eleven per cent? The company in general meeting, subject to Schedule V. The words requiring the approval of the Central Government were omitted with effect from 12 September 2018.

3. Are sitting fees counted in those percentages? No. The percentages are exclusive of fees payable to directors under section 197(5): section 197(2).

4. What happens if a director draws more than he is entitled to? He must refund it to the company within two years, or such lesser period as the company allows, and until it is refunded he holds it in trust for the company: section 197(9). The company may waive recovery only by special resolution passed within two years from the date the sum became refundable, and where it has defaulted to a lender, only with that lender's prior approval: section 197(10).

5. Name four sums for which credit shall not be given in computing net profits. Any four of: premium on shares or debentures issued or sold (unless the company is an investment company); profits on sales of forfeited shares; profits of a capital nature, including on the sale of an undertaking; profits from the sale of immovable property or fixed assets of a capital nature, save where the business is dealing in them and save the depreciation written back; changes in the carrying amount of assets or liabilities on fair value measurement; and unrealised gains, notional gains or revaluation of assets: section 198(3).

6. When must a company recover remuneration already paid? Where it is required to re-state its financial statements due to fraud or non-compliance with the Act or the rules, it shall recover from any past or present managing director, whole-time director, manager or Chief Executive Officer the remuneration, including stock option, received during that period in excess of what would have been payable on the restated statements: section 199.