This article is written by Diksha Paliwal. It provides a comprehensive analysis of the provisions relating to managerial remuneration for directors and key managerial personnel. Before this, the article briefly explains the term “remuneration” and gives an idea about the meaning of the term “managerial remuneration”. It delves into the various aspects of remuneration given to key managerial personnel and directors like allowances, salary, commissions, profit-related commissions, etc. It further discusses the role of the board of directors and the stakeholders in evaluating managerial remuneration.

It has been published by Rachit Garg.

Introduction

The increasing profits in the businesses are the result of the hard work of the people running them. Business yields greater profits due to the efforts of managers, directors, and other workers. Good pay to the managers and other directors attracts talented employees and also ensures that the ones already working stick to their jobs. Additionally, proper remuneration ensures that the challenging role of managing the entire affairs of the company is accomplished efficiently and with great éclat. 

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Undoubtedly, fixing up managerial remuneration is of utmost importance; nevertheless, one must keep in mind that while doing so, the perks like allowances and more, along with the pay given to them, do not go overboard. Maintaining proportionality while dealing with such matters is imperative. As far as the laws relating to this matter are concerned, the provisions are mentioned in the Companies Act, 2013 (hereinafter referred to as the Act of 2013). It keeps a balance between the unnecessary dissipation of profits by the company and ensuring reasonable and adequate remuneration for managerial personnel.

Section 197 of the Companies Act, 2013 deals with the provision of managerial remuneration for key managerial personnel and other directors of an Indian company. This article starts by giving a brief introduction to the term ‘remuneration’, followed by a comprehensive analysis of Section 197. It further deals with the impact of it on the company and its stakeholders. It also talks about the objective behind the enactment of the provision pertaining to managerial remuneration, along with the major factors and components that determine managerial remuneration. 

The article also throws light on major principles of remuneration, namely, the financial capacity of a company, its position in the market, present standards of the industry, performance evaluation, etc. The article, in order to provide a background on certain important factors related to the present topic, i.e., Section 197, explains the role of managerial personnel and their appointment process as per the provision provided under the Companies Act, 2013. It also talks about the course of action relating to managerial remuneration when a company faces uncertainties like losses. 

Meaning of managerial personnel and director

A “key managerial personnel” as enunciated under sub-section (51) of 2, in pursuance to the company is said to include:

  • the Chief Executive Officer or the managing director or the manager; 
  • the company secretary; 
  • the whole-time director; 
  • the Chief Financial Officer; and 
  • such other officers as may be prescribed for the time being. 

According to the definition clause provided in the Act of 2013, the term director, as mentioned in Section 2(34), means a director appointed to the Board of a company.

To read more about the above terms in detail, refer to https://cleartax.in/s/key-managerial-personnel-kmp-under-companies-act-2013 

Meaning of remuneration and managerial remuneration 

Collins Dictionary defines the term ‘remuneration’ as the money that is paid to a person in return for the work that he or she has done. The term owes its origin to the Latin term ‘remuneratus’ which means ‘to reward’. It is a return that an employee receives for his or her contribution to the organisation or company. It relates to needs, motivation, and rewards. Put simply, it is the financial compensation that a person working in an organisation or a company is offered in return for his or her service. Remuneration often gains importance as it concerns the outflow of money from the company, analysing net profits, and gaining approval from its stakeholders and the board of directors. 

The term “remuneration” is defined under Section 2(78) of the Companies Act, 2013. It defines the term as money or its equivalent provided or given to a person in return for the services provided by him. It also includes the perquisites, i.e., the benefits (defined under Section 17(2) of the Income-tax Act) enunciated under the Income-Tax Act, 1961. As per the above-stated section, the term “perquisites” includes;

  • Rent free accommodation;
  • Any concession in rental accommodation;
  • Payment made by the employer wherein the employee, on some earlier occasion, has paid for certain obligation;
  • Any benefit or amenity granted free of cost or at any concession in cases, namely, from the company to any employee who at that time is a director; by a company to an employee who has a certain substantial interest in the company; by company or employer to an employee other than the above two situations whose salary exceeds Rs. 50,000;
  • Any sum that is paid by the employer to affect the assurance on the life of the employee or to affect a contract of annuity;
  • Value of any other fringe benefit or amenity provided by the employer;
  • Any contribution made by the employer to the employee’s account;
  • Value of transfer of specified security or sweat equity shares by the employer to the employee or a former employee. This can be free of charge or at a concession rate, as the case may be.

Thus, any money given or paid, irrespective of the form in which it is paid, in return for the services rendered by that person constitutes remuneration. It also includes any amenity, benefit, or facility that a company provides to any person for his or her service, which amounts to remuneration. Also, the monetary equivalent of the above-referred things must be included in the remuneration of the person in pursuance of the services that are provided by him or her. 

The term ‘managerial remuneration’ is nowhere defined in the Companies Act, 2013. It is used as a term that connotes the remuneration that is paid to managerial personnel. It is a very significant topic under corporate governance, which ensures fair pay to key managerial personnel and other directors. The central legislation pertaining to company matters, i.e., the Companies Act, 2013 entails provisions concerning managerial remuneration. It is embodied under Section 197 of the 2013 Act. Managerial Remuneration can be defined as the benefits and remuneration given to the top management of the company, like the CEO, managing director, board of directors, whole-time director, its manager, etc. in respect of any financial year. The computation of managerial remuneration that is to be given is decided according to the provisions of Section 198 of the Act of 2013. 

Back then, it was a settled principle that directors had no claim to be paid certain remuneration by the company in pursuance of the services they provided. The rationale behind this principle was that they have a fiduciary relationship with the company. Thus, the directors cannot pay themselves or receive other benefits from the company’s assets. In this correspondence, Lord Lindley, in re George Newman & Co. (1895), opined that the directors possess no right to be paid for the services rendered by them. They are not authorised to pay themselves or each other or make any presents from the assets of the company unless expressly authorised by any law or instrument that regulates the company, or by the shareholders in a properly conducted meeting. The shareholders in a meeting organised for such purpose, in a properly regulated manner can decide to remunerate the directors.

Appointment of key managerial personnel 

The appointment of key managerial personnel is mandated under Section 203 of the Companies Act, 2013. It mandates the appointment of key managerial personnel, which includes the managing director, CEO, or manager, and in their absence, a whole-time director, Company Secretary, and Chief Financial Officer. The appointment of the above-stated managerial personnel is essential for a listed company or every other public company having a paid-up share capital of Rs 10 crore or more. 

As far as every whole-time manager is concerned, he must only be appointed by way of a board resolution, which contains the terms and conditions of appointment and remuneration. 

Unless the articles of the company provide otherwise or the company possesses multiple businesses, the chairperson of the company, as well as the managing director or Chief Executive Officer shall not be appointed and reappointed at the same time. 

Section 197: an overview

The above-stated provision talks about the remuneration that is to be paid to key managerial personnel and other directors of the company. Remuneration that a company pays to its directors is solely a matter of contract between the company and its directors, however, while doing so, the company must adhere to the provisions of Section 197 of the Companies Act, 2013. 

Maximum remuneration limit

The first clause of the Section lays down the maximum remuneration payable by a public company. Section 197(1) states that for a financial year, the total managerial remuneration that is paid by a public company to the managerial personnel and other directors, including the managing director, whole-time director, and its director, shall not be more than 11 percent of the net profits of the company. This net profit is calculated as prescribed under Section 198 of the Act of 2013. Also, this remuneration is not deducted from the gross profits. 

The proviso clause of Section 197(1) states that a company may exceed the limit of 11 percent and authorise the payment of remuneration exceeding 11 percent in a general meeting. However, it is important to note that the company must do so in compliance with Schedule V. 

The proviso further states that the remuneration paid to any one managing director, whole-time managing director, or manager shall not exceed 5 % of the net profits of the company. Also, if there is more than one such director, then the exceeding limit for remuneration to all such directors and managers must not exceed 10% when taken together. In the case of remuneration that is paid to directors who are neither the managing directors nor the whole-time directors, the remuneration shall not exceed 1% of the net profits of the company, if there is a managing or whole-time director or manager. In any other case, it shall not exceed 3 percent. 

In cases where there is any default in payment of dues by the company to any bank or other financial institution, prior approval is necessary before obtaining such approval for payment of remuneration in the general meeting.

Remuneration exclusive of any fees

Section 197(2) provides that the above-mentioned percentage limits are exclusive of any fees that are to be paid under sub-section (5). 

Remuneration in cases of inadequate or no profit

Clause (3) of Section 197 provides for the course of action that is to be taken in the event a company suffers losses, makes no profit, or makes an inadequate profit. It states that in the above cases of loss or no profits, the company shall not pay to its directors, including any managing or whole-time director or manager or any other non-executive director, any remuneration that is exclusive of any fees that are payable to the director under Section 197(5), and this shall be done in compliance with the provisions of Schedule V. 

Payment to directors in any other capacity

Section 197(4) states that the remuneration that is to be paid to the directors of a company, shall be computed in a manner that complies with Section 197. Also, this should be done either by the company’s articles of association, by a resolution, or by a special resolution if there exists a provision requiring the same in the AOA of the company. Also, the remuneration given to the director determined through the aforesaid procedure is inclusive of any other services rendered by him in any other capacity as well. 

Remuneration paid for the purposes mentioned in the above paragraph, i.e., remuneration paid in any other capacity, shall not include the services rendered that are of a  professional nature. Also, the remuneration for the work done in any other capacity shall not be included if the company is covered under Section 178(1) as per the opinion of the Nomination and Remuneration Committee or if the board of directors in other classes has the essential qualification for the practice of the profession.  

Fees for attending meetings

Section 197(5) states that a director can also be paid remuneration by way of fees for attending board or committee meetings, based on the decisions taken by the board. The proviso of the sub-section states that the aforesaid fees shall not exceed the prescribed amount. It also states that the fees for different classes of companies and fees for independent directors may be as prescribed.

Procedure for payment of remuneration 

Section 197(6) of the Act of 2013 provides for the way by which a director or a manager may be paid remuneration. The director or manager can either be paid monthly or at a specified percentage of the net profits of the company, or a combination of both, as the case may be.

Section 197(7): repealed

Sub-section 7 of the Companies Act 2013 was omitted by the Companies (Amendment) Act, 2019. 

Computation of net profits

Section 197(8) of the Act provides that the net profits are to be computed in the manner laid down under Section 198. 

Refund of remuneration in certain circumstances

Sub-section (9) and (10) of Section 197 were substituted by the Companies (Amendment) Act, 2017. The first subsection states that if a director draws or receives any amount of remuneration that exceeds the prescribed limit, without approval, he shall refund the sums to the company within two years or as directed by the company. Sub-section (10) states that the company is not allowed to waive the sum that is refundable unless the same is approved in a special resolution within two years from the date such sum becomes refundable. The proviso of this sub-section further states that such a waiver by the company can only be done with the prior approval of a concerned bank or any other financial institution, non-convertible debenture holders, other secured creditors, etc. if there is any default in payment of dues on the part of the company from such institutions. 

Effect of Schedule V 

Section 197(11) states that any increase or change in the amount of remuneration payable to the directors or managers in the event of no profits, inadequate profits, or any other case shall be in accordance with the provisions of Schedule V.

Disclosure Report 

According to Section 197(12), the company is required to disclose in its board report the ratio of the amount of remuneration paid to each director to the median employee’s remuneration and such other necessary details as may be prescribed. 

Apart from this, Rule 5 of the Companies (Appointment and Remuneration of Managerial Personnel) Rule, 2014, lays down certain aspects or points that a disclosure report must include. These are, the ratio of remuneration paid to each of the directors to the remuneration of a median employee in any financial year; the percentage increase in the remuneration of each of the directors or other key managerial personnel in a financial year; the increase in the percentage of the median remuneration of employees in the financial year; the total number of permanent employees; the average increase in salaries of employees other than the key managerial personnel; and the statement that remuneration policy is in accordance with the provisions of Section 197. 

Insurance premiums not to be included in remuneration 

Clause (13) of the Section states that the premium paid by the company in cases where the company has taken any insurance on behalf of the CEO, Chief Financial Officer, or CS for indemnifying them in different scenarios like negligence, breach of trust or duty, misfeasance, etc. will not be termed as remuneration. However, if such a person is found guilty, the premium will be considered remuneration. 

Provision pertaining to disqualification from remuneration

Section 197(14) states that any director who is in receipt of any commission from the company and who is managing director or whole-time managing director will not be disqualified from getting paid any remuneration or commission in pursuance to or subject to its disclosure in the board report. 

Penalty

Section 197(15) provides for the consequences that will follow non-compliance of Section 197. It provides for a penalty of one lakh rupees if any of the directors or other key managerial personnel are found at fault, and if the non-compliance is done by the company, then a penalty of five lakh rupees will be levied. 

Statement regarding compliance with Section 197

Section 197(16) of the Act makes it compulsory for the company’s auditor to make a statement in its report prepared under Section 143 of the Act of 2013 that the remuneration paid to the directors and managers is in accordance with Section 197.  

Approval in accordance with Section 197

Clause (17) provides that after the commencement of the Amendment Act of 2017, any application addressed to the Central Government that is made under this provision and that is pending shall stand abated. The company, after such a period of one year, makes a fresh application and takes approval in accordance with this Section.      

Thus, the remuneration that is to be paid to any director, including any managing or whole-time director of a company, is to be determined in accordance with Section 197 read with Section 198 (computation of net profits) and Schedule V of the Act of 2013. This must be done either by way of what is mentioned in the Articles of the company, by a resolution, or if the AOA so requires, by passing a special resolution in a company’s general meeting. The genuine professional fees that are paid to a director for rendering his professional services are not to be included in the remuneration. The Section also provides for the payment of remuneration to a director who is neither in full-time employment nor a managing director, which can be made either on a monthly basis or at a specified percentage of the net profits. It also provides that for directors who are not in full-time services, the remuneration that is paid to them does not require the Central Government’s approval, provided the same is within the prescribed limit.

Recovery of managerial remuneration 

Section 199 of the Act of 2013 provides for the recovery of managerial remuneration from any managing director, whole-time director, manager, or Chief Executive Officer in case the remuneration is not paid in accordance with Section 197, if there is any non-compliance with the requirements mentioned in the Act of 2013, or if it is found to be in excess of what is shown or restated in the financial statements. This also includes stock options. 

Criteria for consideration of remuneration

While computing remuneration that has to be paid to managerial personnel and other directors, the company is required to consider the following parameters, namely:

  • The company’s financial and operating performance in the last three preceding financial years.
  • The company’s relationship between performance and remuneration that is being rendered.
  • Does there exist any difference in the remuneration policy of the directors and other employees, and if so, the rationale behind the same?
  • The securities held by the directors, along with the options and details of the shares pledged at the end of the preceding final year.
  • The proportionality of remuneration among the directors and the directors of the board, along with other employees.  

Fixation of payable remuneration limit by Central government or company

Section 200 of the Act of 2013, provides that in the event a company suffers a loss or makes inadequate or no profits, the central government or the company may fix the remuneration limit for the time being, in accordance with the limit specified in the Act. while fixing such a limit, the government or the company has to keep in mind certain parameters, namely;

  • Company’s financial position;
  • Remuneration or commission drawn from the company by that individual in any other capacity;
  • Remuneration or commission drawn by that individual from any other company;
  • Qualifications and professional qualities of the individual; and
  • Other parameters as may be prescribed. 

Significant changes in remuneration after the passing of the Act of 2013

  • Directors will not be paid any remuneration in the absence of any provision for the same in the company’s articles of association (AOA), or otherwise, if such payment of remuneration is sanctioned by the company in a general meeting. In a situation where unauthorised remuneration is furnished, i.e., without there being an express provision in the articles of association or the general meeting, the remuneration can be claimed back. In the event that a company is wound up, such remuneration can be recovered from the directors by the liquidators. 
  • The provision pertaining to the payment of remuneration to the directors of the company, including the CEO or managing director and other key managerial personnel, as mentioned in Section 2(51) is mentioned under Section 197 of the Act of 2013. It provides that the remuneration that is to be paid to the aforesaid persons must only be determined by the Articles of Association of a company, by a resolution, or if the AOA of the company requires it to be determined by passing a special resolution in the general meeting of a company.
  • The above-stated provision enumerates the overall maximum remuneration that is to be paid to the directors and other key managerial personnel by a public company or a subsidiary of a public company. As per this, the total managerial remuneration that is to be paid in a financial year must not exceed 11% of the net profits of the company.
  • The net profit is calculated in pursuance of the manner laid down in Section 198 of the Act of 2013. It is noteworthy that the remuneration payable to the directors is not to be deducted from the gross profits. 
  • The set boundary of 11% is exclusive of the fees paid for attending the meetings of the board of directors.
  • The Act of 2013 entails that a company may also authorise, in its general meeting, remuneration exceeding the limit of 11 %, provided it is done in compliance with Schedule VI. 
  • In cases when a company faces losses or makes no profits at all in a financial year, the company may pay a minimum remuneration of any sum, however, the same must be done in an authorised way.  
  • The Central Government’s approval is not needed in the event of payment of remuneration in case the appointment of managing director or manager has been done in pursuance to the provisions and in accordance with Schedule V of the Companies Act, 2013. 
  • In the event that it is proposed that the payment of remuneration shall be by way of commission, then no remuneration will be paid to the directors in case of loss. 
  • Also, a director may get remuneration in terms of fees for attending the board or committee meetings. However, this fee paid shall not exceed the amount as may be prescribed. 
  • The auditor is required to submit in his report whether the remuneration paid to the directors is in accordance with the provisions of the Companies Act, 2013.
  • The penalty is levied in the event of non-compliance with the provisions pertaining to the remuneration.
  • The listed companies are required to disclose in their board report, the ratio of remuneration paid to each of the directors to the remuneration of a median employee, and all the other details as may be prescribed.

Conclusion

In a corporate world largely driven by money and benefits, incentives and remuneration play a huge role in determining the success of the business as it motivates the directors and managers of the company to manage the company efficiently. Maximum remuneration payable to managerial personnel must be strictly in compliance with Section 197 of the Act of 2013. Since a company works through its board of directors, it is important that the remuneration paid to them for their services satisfy multifarious criteria, and to regulate this, the provision pertaining to managerial remuneration was enumerated. Having a well-balanced and regulated policy pertaining to the payment of remuneration significantly improves a corporation’s performance. Thus, Section 197 of the Act of 2013 lays down the maximum limits of remuneration that can be paid, individual limits for each director, provision for payment of remuneration in case of no profits or inadequate profits, penalty for no-compliance with this Section, the overriding effect of Schedule V, payment of remuneration to directors working in any other capacity, what to be included in remuneration and what not to be included, sitting fees for directors for not attending committee or board meetings, and disclosure in board reports. 

FAQs 

How does Schedule V have an overriding effect on the provisions of Section 197 of the Act of 2013?

Section 197(11) of the Act of 2013 states that in cases of inadequate or no profits, provisions pertaining to increase or change in the remuneration shall have no effect unless they are in accordance with Schedule V of the Companies Act, 2013 and hence this Schedule has an overriding effect over the Section in certain conditions. Even when there are express provisions for an increase in the company’s Memorandum of Association, special resolution, agreement, AOA or a general meeting, the provisions of Schedule V will have an overriding effect.

Are the term perquisites included in managerial remuneration?

No, the term prerequisites, i.e., in a layman’s can be connoted as benefits are not included in managerial remuneration as also discussed in the above paragraphs. 

What are the permissible forms of remuneration?

A director can be paid either on a monthly basis or based on a specified percentage of the net profits of the company or partly in one way and partly in another. 

Which provision in the Companies Act, 2013 deals with the disclosure of remuneration in the Board’s report?

According to Section 197(12) of the Act of 2013, every listed company is obligated to disclose the ratio of the remuneration that is being paid to each of its directors and the remuneration to the median employee, as well as other details as may be prescribed. The disclosure is to be made in the board report of the company. 

What are some relevant provisions of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (SEBI Listing Regulations) concerning remuneration to the directors?

Regulation 17 of the above-mentioned SEBI Regulations deals with the provision for remuneration. Firstly, it states that it is mandatory that the shareholder’s approval be obtained prior to the payment of remuneration to the non-executive directors. Secondly, this requirement for approval does not apply when the non-executive directors are being paid the sitting fees for attending the board or committee meetings, provided the same is paid within the prescribed limits. Further, it provides that independent directors are not entitled to stock options, and the shareholders have to specify the maximum limit of stock options that can be granted to non-executive directors. 

References

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