Managerial Remuneration

The first proviso: above eleven per cent. The company in general meeting may authorise payment exceeding eleven per cent, subject to Schedule V. The words "with the approval of the Central Government" were omitted in 2018.

The second proviso: the inner caps. Except with the approval of the company in general meeting by a special resolution:

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

The third proviso: the lenders' veto. 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 approval in general meeting.

That proviso is worth an examination sentence. It recognises that once a company is in default, the money being voted to managers is in substance the creditors', so the creditors get the first say.

197(2): the percentages are exclusive of fees payable to directors under s.197(5), that is, sitting fees.

197(3): no or inadequate profits. Notwithstanding sub-sections (1) and (2) but subject to Schedule V, a company with no profits or inadequate profits shall not pay its directors, including any managing or whole-time director or manager, or any other non-executive director, including an independent director, any remuneration exclusive of sitting fees except in accordance with Schedule V. The words allowing recourse to Central Government approval where Schedule V could not be complied with were omitted in 2018; the words extending the sub-section to non-executive and independent directors were added by the 2020 Act, which is what made it lawful for a loss-making company to pay them beyond sitting fees at all.

197(4): who fixes it. Remuneration shall be determined by the articles, or by a resolution, or, if the articles so require, by a special resolution in general meeting, and is inclusive of remuneration for services rendered in any other capacity, unless the services are of a professional nature and, in the opinion of the Nomination and Remuneration Committee or the Board, the director possesses the requisite qualification for the practice of the profession.

197(5): sitting fees. A director may receive remuneration by way of fee for attending meetings of the Board or committees or for such other purposes as may be decided by the Board, provided the amount does not exceed the prescribed sum, with a proviso for different fees for different classes of companies and a further proviso that fees for independent directors and women directors shall not be less than the fee payable to other directors.

197(6) and (7): remuneration to a managing or whole-time director may be paid monthly, or at a specified percentage of net profits, or partly by one and partly by the other; and, s.197(7) having been omitted in 2019, the independent director's position is governed by s.149(9).

197(9) and (10): refund and waiver. Where a director draws or receives, directly or indirectly, by way of remuneration any sums in excess of the limits or without the approval required by the section, he shall refund it to the company within two years or such lesser period as may be allowed, and until refunded hold it in trust for the company. The company shall not waive recovery of such sum unless approved by the company by special resolution within two years from the date the sum becomes refundable, with the third proviso to s.197(9) requiring, where the company has defaulted to a bank, public financial institution, non-convertible debenture holder or other secured creditor, that creditor's prior approval before the waiver.

197(11) to (16): disclosure and audit. Provisions on insurance premiums for indemnifying officers, the position of a director in a holding and subsidiary company, the requirement that the Board's report disclose the ratio of each director's remuneration to the median employee's remuneration and other prescribed details, and the auditor's duty to state in his report whether the remuneration paid is in accordance with this section.

Sections 198 to 202: the surrounding machinery

198: how net profits are computed. The section prescribes the credits to be included, the sums not to be deducted, and the sums to be deducted, in computing net profits for the purposes of s.197. Its detail is arithmetical rather than doctrinal, and the point to carry is that "net profit" here is a statutory construct, not the profit shown in the accounts.

199: recovery in the case of restated financials. Without prejudice to any liability under this Act or any other law, where a company is required to re-state its financial statements owing to fraud or non-compliance with any requirement under this Act and the rules, the company shall recover from any past or present managing director, whole-time director, manager or chief executive officer who during the period received remuneration in excess of what would have been payable under the restated financials, the excess remuneration, including stock option value.

200: who fixes the limit now. The section, as amended, empowers the company to fix, while according approval, the remuneration within the limits in the Act, having regard to the financial position of the company, the remunerative position of the individual concerned, the professional qualifications and experience of the individual and such other matters as may be prescribed. Its marginal note still names the Central Government, and that is a stale label, not a source of power.

201: applications. Prescribes the form and procedure for applications to the Central Government under this Chapter, including the requirement of a general notice to members stating the nature of the application, published in the prescribed manner in the district language and in English, and a certificate of due publication with the application. Applications survive because s.196(3)(a)'s second proviso and Schedule V still contemplate some Central Government functions; what has gone is Government approval of remuneration as such.

202: compensation for loss of office. A company may make payment to a managing or whole-time director or manager, but not to any other director, by way of compensation for loss of office or as consideration for retirement or in connection with it. The section then lists the cases where no payment shall be made, including where the director resigns in view of the reconstruction or amalgamation of the company and is appointed in the resulting entity, where he resigns otherwise than on such reconstruction, where his office is vacated under s.167, where the company is being wound up by reason of his negligence or default, where he has been guilty of fraud or breach of trust or gross negligence or gross mismanagement in the conduct of the affairs of the company or its subsidiary or holding company, and where he has instigated or taken part directly or indirectly in bringing about the termination of his office. Sub-section (3) caps the payment at remuneration for the unexpired residue of his term or three years, whichever is shorter, calculated on the average remuneration of the preceding three years, and sub-section (4) forbids payment where the company is in winding up if its assets, after payment of costs, are insufficient to repay the shareholders their contributed capital.

A worked example

Deccan Alloys Limited, a public company, computes net profits under s.198 for the year at ten crore rupees. It has one managing director, one whole-time director, and six non-executive directors.

The overall ceiling. Eleven per cent of ten crore is one crore ten lakh rupees, which is the total payable to all directors and the manager under s.197(1), exclusive of sitting fees under s.197(5). Paying more needs the general meeting, subject to Schedule V; it does not need Central Government approval.

The inner caps. Without a special resolution, the managing director alone may take no more than five per cent, that is fifty lakh rupees; the managing and whole-time directors together no more than ten per cent, that is one crore; and the six non-executives together no more than one per cent, that is ten lakh rupees, there being a managing director. To exceed any of these, a special resolution is required.

A defaulting company. If Deccan Alloys is in default to its bankers, the bank's prior approval must be obtained before the general meeting approves any excess, third proviso to s.197(1).

A loss year. Suppose the following year produces no profits. Section 197(3) forbids paying the directors, including the independent directors, anything beyond sitting fees except in accordance with Schedule V. There is no longer any route through the Central Government where Schedule V cannot be complied with.

An overpayment. Suppose the managing director in fact drew seventy lakh rupees without a special resolution. He must refund the excess within two years, and holds it in trust for the company until he does, s.197(9). The company may waive recovery only by special resolution within two years of the sum becoming refundable, and, being in default to its bank, only with the bank's prior approval.

A restatement. If the accounts for that year are later restated because of fraud, s.199 requires the company to recover from the managing director the excess remuneration, including the value of stock options, over what would have been payable on the restated figures.

A pay-off. Suppose the whole-time director's office is terminated with two years of a five-year term left. The company may pay him compensation for loss of office under s.202, but not more than his remuneration for the unexpired residue of the term or three years, whichever is shorter, computed on the average of the preceding three years. If instead his office had been vacated under s.167, or if he had been guilty of fraud, breach of trust, gross negligence or gross mismanagement, no compensation may be paid at all.

Distinctions

What it does NOT mean

Not that the Central Government has disappeared from the Chapter. It retains functions under s.196(3)(a)'s second proviso and under Schedule V and s.201; what it no longer approves is remuneration under s.197.

Not that the eleven per cent is of accounting profit. It is of net profits computed under s.198, a statutory calculation.

Not that excess pay is simply repayable on demand. Section 197(9) fixes a two-year period, imposes a trust in the meantime, and s.197(10) permits waiver only by special resolution within two years, with lender approval where the company is in default.

Quick revision

s.197(1): public company, all directors and the manager, eleven per cent of s.198 net profits; above it, general meeting subject to Schedule V, no Central Government approval since 12 September 2018; inner caps of five per cent for one managing or whole-time director or manager, ten per cent for all of them, one per cent for non-executives where there is an executive and three per cent otherwise, exceeded only by special resolution; lenders' prior approval where the company is in default.

s.197(2): exclusive of sitting fees. s.197(3): no or inadequate profits, Schedule V only, and the sub-section now covers non-executive and independent directors. s.197(4): fixed by articles, resolution or special resolution; inclusive of other-capacity services unless professional and the director is qualified. s.197(5): sitting fees within the prescribed limit, not less for independent and women directors. s.197(9) and (10): refund within two years, held in trust meanwhile; waiver only by special resolution within two years, with lender approval where in default. s.197(12) to (16): disclosure of the ratio to median employee remuneration, and the auditor's statement on compliance.

s.198: statutory computation of net profits. s.199: recovery of excess remuneration on restatement for fraud or non-compliance. s.200: the company fixes the limit; the marginal note is stale. s.201: applications, with general notice to members in the district language and English and a certificate of due publication. s.202: compensation payable only to a managing or whole-time director or manager, never to any other director; barred in the listed cases including vacation under s.167 and fraud or gross negligence; capped at the unexpired term or three years, whichever is shorter, on the average of three years' remuneration; barred in winding up where assets are insufficient to repay capital.

Test yourself

1. Who approves remuneration above eleven per cent of net profits? The company in general meeting, subject to Schedule V. The Central Government's approval was omitted from the first proviso to s.197(1) with effect from 12 September 2018.

2. What is required to pay one managing director more than five per cent of net profits? Approval of the company in general meeting by special resolution, second proviso to s.197(1); and, if the company is in default to a bank, public financial institution, non-convertible debenture holder or other secured creditor, that creditor's prior approval first.

3. A company with no profits wishes to pay its independent directors a commission. May it? Only in accordance with Schedule V, s.197(3), which since the 2020 amendment expressly extends to non-executive and independent directors; there is no longer any Central Government route where Schedule V cannot be met.

4. A managing director has drawn more than the section permits. What follows? He must refund the excess within two years or such lesser period as may be allowed, and holds it in trust for the company meanwhile, s.197(9); the company may waive recovery only by special resolution within two years, and, where it is in default to lenders, with their prior approval.

5. When may compensation for loss of office not be paid? Among other cases in s.202(2): where the director resigns on a reconstruction or amalgamation and is appointed in the resulting entity, where he resigns otherwise, where his office is vacated under s.167, where the company is wound up by reason of his negligence or default, where he has been guilty of fraud, breach of trust, gross negligence or gross mismanagement, and where he instigated or took part in bringing about the termination of his office.