Do shareholders have a say in Non-executive Directors remuneration in case of adequacy of profits?

• Introduction

• It is well settled principle that the one who owns the function cannot see it with unbiased view. “Nemo Judex In Causa Sua,” means no one should be a judge in their own case. This principle ensures fairness and impartiality by preventing a director from making decisions in situations where they might have a personal or vested interest that could compromise their judgment. If we take this forward, the Managing Director or whole time director(s) are responsible for functioning of the company as they are in-charge of the business operations. There should be someone who is looking at the entire functioning with un-biased mind who may be independent director or non-executive director. The role which NEDs play in the company thus become very crucial. Selecting such NEDs also play very important role which will be useful for the functioning of the company.

• The Companies Act, 2013 (“the Act”) expressly provides the process for appointment and remuneration of managerial personnel i.e. managing directors, whole-time directors and managers under section 196 and 197 of the Act. But the process to be followed for remuneration of Non-executive directors (“NED”) is stated only under section 197 of the Act. The provisions are very clear about the applicability of Schedule V in cases where there is inadequate profit or no-profit. But the applicability of Schedule V in case of adequate profits for remuneration to NED is not clearly stated in section 197 of the Act. This article is an attempt to understand whether Schedule V of the Act shall apply to remuneration of NED in cases of adequate profits.

• To understand whether Schedule V is applicable in case of adequacy of profit for remuneration to NED, we need to understand how the other aspects relating to NED are made applicable in the Act. We need to understand in detail the definition, duties, responsibilities, liabilities of NED. We also need to understand why there is a need of NEDs and what is their role in functioning of any company.

• We have understood the importance of NED in the functioning of the company. Now let us understand the term “NED”. It is used in the Act in many sections viz, Section 149, Section 165, Section 178, Section 197 etc… of the Act. It is not defined under the Act. But who is executive director is defined under clause (k) of sub-rule (2) of the Companies (Specification of definitions details) Rules, 2014 as under :-

“executive director” means a whole time director as defined in clause (94) of section 2 of the Act.

Understanding the meaning of ‘Non-Executive Director’

• If we refer to clause (94) of section 2 of the Act, it states as under:-

“whole-time director” includes a director in the whole-time employment of the company.

In short, executive director includes a director in whole-time employment of the company.

• If we see Oxford Business English Dictionary, Longman Business English Dictionary:- The Term ‘Non-executive’ means someone who has a non-executive role and is not involved in the daily management of a company or other organisation but attends board meetings and gives advice. The expression used to describe somebody who is not employed by a company but takes part in meetings of the board of directors and gives independent advice.  

• The Hon’able Supreme Court has held that, “Non-executive Directors are persons who are not involve in the day-to-day affairs of the running of the company and are not in charge of and not responsible for, the conduct of the business of the company. Non-executive director is not doubt a custodian of the governance of the company but is not involved in the day-to-day affairs of the running of its business and only monitors the executive activity”.[1]

• The Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) 2015 (“the LODR”) does not define the work executive or non-executive director. But it regulation 2 of the LODR Regulations, it states as follows

“All other words and expressions used but not defined in these regulations, but defined in the Act or the Companies Act, 2013, the Securities Contracts (Regulation) Act, 1956, the Depositories Act, 1996 and .or the rules and regulations made thereunder shall have the same meaning as respectively assigned to them in such Acts or rules or regulations or any statutory modification or re-enactment thereto, as the case may be.

• The Act requires certain companies to have audit committee, nomination and remuneration committee , corporate social responsibility committee etc.. The composition which is mentioned in the section mandates companies to have maximum NED or Independent Directors. Independent directors are the next level of NEDs who also meet the criteria given under sub-section (6) of section 149 of the Act.
  • It can be inferred that NED means a director who is not into whole time employment of the Company. He is custodian of the governance of the company but is not involved in the day-to-day affairs of the Company.

• Whether NED will be considered as “officer in default” ?

• We can see from the judgement of the Supreme Court mentioned in para 1.7 above that he is custodian of the governance of the Company. This is further getting strengthen in the definition of the “officer in default” in clause (60) of section (2) of the Act :-

(60) “officer who is in default”, for the purpose of any provision in this Act which enacts that an officer of the company who is in default shall be liable to any penalty or punishment by way of imprisonment, fine or otherwise, means any of the following officers of a company, namely:—

(i) whole-time director;

(ii) key managerial personnel;

(iii) where there is no key managerial personnel, such director or Directors as specified by the Board in this behalf and who has or have given his or their consent in writing to the Board to such specification, or all the Directors, if no director is so specified;

(iv) any person who, under the immediate authority of the Board or any key managerial personnel, is charged with any responsibility including maintenance, filing or distribution of accounts or records, authorises, actively participates in, knowingly permits, or knowingly fails to take active steps to prevent, any default;

(v) any person in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act, other than a person who gives advice to the Board in a professional capacity;

(vi) every director, in respect of a contravention of any of the provisions of this Act, who is aware of such contravention by virtue of the receipt by him of any proceedings of the Board or participation in such proceedings without objecting to the same, or where such contravention had taken place with his consent or connivance;

(vii) in respect of the issue or transfer of any shares of a company, the share transfer agents, registrars and merchant bankers to the issue or transfer;

• In the above definition sub-clause (iii) mentions that in case of where there is no key managerial personnel, such director or Directors as specified by the Board in this behalf and who has or have given his or their consent in writing to the Board to such specification, or all the Directors, if no director is so specified

• Further, sub-clause (vi) clearly states that “every director, in respect of a contravention of any of the provisions of this Act, who is aware of such contravention by virtue of the receipt by him of any proceedings of the Board or participation in such proceedings without objecting to the same, or where such contravention had taken place with his consent or connivance;”

• As stated in sub-clause (vi), the Act cast responsibility on all directors for compliance with the provisions of the Act.

• As per the above analysis, it can be inferred that all the directors are officers in default if they are aware of the event of default through any of the board processes.

• Duties of Directors- whether applicable to NEDs[MMJC1] h?t  

• Section 166 of the Act defines duties of Directors as follows :-

3. Duties of Directors

(1) Subject to the provisions of this Act, a director of a company shall act in accordance with the articles of the company.

(2) A director of a company shall act in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of environment.

(3) A director of a company shall exercise his duties with due and reasonable care, skill and diligence and shall exercise independent judgment.

(4) A director of a company shall not involve in a situation in which he may have a direct or indirect interest that conflicts, or possibly may conflict, with the interest of the company.

(5) A director of a company shall not achieve or attempt to achieve any undue gain or advantage either to himself or to his relatives, partners, or associates and if such director is found guilty of making any undue gain, he shall be liable to pay an amount equal to that gain to the company.

(6) A director of a company shall not assign his office and any assignment so made shall be void.

(7) If a director of the company contravenes the provisions of this section such director shall be punishable with fine which shall not be less than one lakh rupees but which may extend to five lakh rupees.

• Section 166 of the Act covers all directors whether executive, non-executive, whole time, independent etc.

• Hence as far as duties are concerned, directors are perceived as “trustees” of the Company. They have fiduciary responsibilities towards all stakeholders.

4. Appointment and Remuneration of NED:-

• The Act broadly divides the directors into following categories
• Managing or whole-time directors or executive directors
• Non-executive directors
• Independent directors

• Section 196 of the Act prescribes the process for appointment of managing director or whole-time director or manager. This section requires approval the Board of directors and shareholders for appointment including terms and conditions of such appointment and remuneration payable.

• Sub-section (4) of Section 196 states that :-

“(4) Subject to the provisions of section 197 and Schedule V, a managing director, whole-time director or manager shall be appointed and the terms and conditions of such appointment and remuneration payable be approved by the Board of Directors at a meeting which shall be subject to approval by a resolution at the next general meeting of the company and by the Central Government in case such appointment is at variance to the conditions Specified in Part I of that Schedule.

Provided that a notice convening Board or general meeting for considering such appointment shall include the terms and conditions of such appointment, remuneration payable and such other matters including interest, of a director or Directors in such appointments, if any:

Provided further that a return in the prescribed form shall be filed within sixty days of such appointment with the Registrar.”

• Sub-section(4) provides that the appointment of managing director, whole-time director or manager has to be in compliance with section 197 of the Act.

• Section 196 does not contain any provision for appointment and remuneration of NED.

• Sub-section (1) of Section 197 of the Act, states as follows:-

• The total managerial remuneration payable by a public company, to its Directors, including managing director and whole-time director, and its manager in respect of any financial year shall not exceed eleven per cent. of the net profits of that company for that financial year computed in the manner laid down in section 198 except that the remuneration of the Directors shall not be deducted from the gross profits:

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

• Sub-section (1) of Section 197 uses the word “managerial” remuneration though it covers limits on remuneration of all directors including managing directors, whole-time directors and managers.

• Schdule V provides for conditions to be fulfilled for appointment and remuneration of managing director, manager, or whole time director. Part I of Schedule V states as follows,

“No person shall be eligible for appointment as managing or whole-time director or a manager (hereinafter referred to as managerial person).”

• Here, the question is whether the title can restrict the section to only managerial remuneration?

• To answer this, the Supreme Court expressed itself as follows:

“it is well settled that the headings prefixed to sections or entries cannot control the plain words of the provision; they cannot also be preferred to for the purpose of constructing the provisions when the words used in the provision are clear and unambiguous ; nor can they be used for cutting down the plain meaning of the words in the provision. Only in the case of ambiguity or doubt the heading or sub-heading may be referred to as an aid in construing the provision but even in such a case it could not be used for cutting down the wide applicable of the clear words used in the provision.” [2]  

• If we see sub-section (1) of section 197 it clearly mentions that “to its directors including …” further in clause (ii) of second proviso to sub-section (1) it also clearly mentions “the remuneration payable to directors who are neither managing directors not whole-time directors ….”

• Hence, we can safely take a view that ‘ we need not restrict the section to “managerial” remuneration. But it is covering remuneration for all the directors.

• The summary of limit on remuneration under Section 197 is as follows :-

• It is appliable to all public limited companies
• It states overall limit of remuneration of 11 % of the net profits computed as per section 198 of the Act
• The company in general meeting may authorise payment of remuneration exceeding 11% of the net profits subject to the provisions of Schedule V.
• Upto 5% remuneration to one Managing or whole-time director or manager. If the company wants to pay more than 5% to one Managing or whole-time director or manager then special resolution to be passed at general meeting.
• The remuneration payable to directors who are neither managing nor whole time directors shall not exceed 1% in case there is managing or whole time director or manager and 3% in other case. If the company wants to pay more than 1% or 3% then special resolution to be passed at general meeting.

• If we look at the construct of section 197 it is divided as follows:-

• Compliance where the company has adequate net profit
• Compliance in case of no profit or inadequate net profit

• In case of company having no profit or in-adequate net profit following compliances needs to be done for payment of remuneration
• Payment of remuneration to managing director, whole-time director or manager in case of inadequacy :-
  • Compliance with Section 196 of the Act -i.e. approval by the Board of Directors and approval of shareholders in next general meeting. (Approval of Nomination and Remuneration Committee (NRC) and Audit Committee (ACM) if any)
  • Compliance with Section 197 read with Schedule V of the Act.
  • Any other applicable provisions of the Act and the LODR

• Payment of remuneration to NED  in case of no profits or inadequacy of profits:-
  • Approval of the NRC, ACM, Board of directors
  • Approval of shareholders by way of special resolution as stated under sub-section (1) of section 197 of the Act  and compliance with Schedule V of the Act.

• In case of company having adequate net profit following compliances needs to be done for payment of remuneration
• Payment of remuneration to managing or whole-time director or manager in case of adequacy of profits :-
  • Approval of NRC, ACM and the Board of directors
  • Approval of shareholders as per section 196 of the Act
  • Approval of shareholders by passing special resolution as per Section 197 of the Act
  • Compliance with Schedule V of the Act [MMJC2] 

• Payment of remuneration to NED in case of adequacy of profits:-
  • .
  • Following is the relevant extract of sub-section (1) and sub-section (2) of section 197 of the Act :-

“Provided further that, except with the approval of the company in general meeting, By a special resolution

(i) the remuneration payable to any one managing director; or whole-time director or manager shall not exceed five per cent. of the net profits of the company and if there is more than one such director remuneration shall not exceed ten per cent. of the net profits to all such Directors and manager taken together;

(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 of the company, if there is a managing or whole-time director or manager;

(B) three per cent. of the net profits in any other case.]

⁵[Provided also that, where the company has defaulted in payment of dues to any bank or public financial institution or non-convertible debenture holders or any other secured creditor, the prior approval of the bank or public financial institution concerned or the non-convertible debenture holders or other secured creditor, as the case may be, shall be obtained by the company before obtaining the approval in the general meeting.]

(2) The percentages aforesaid shall be exclusive of any fees payable to Directors under sub-section (5).

(3) Notwithstanding anything contained in sub-sections (1) and (2), but subject to the provisions of 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 wholetime director or manager or any other non-executive director, including an independent director], by way of remuneration any sum exclusive of any fees payable to Directors under sub-section (5) hereunder except in accordance with the provisions of Schedule V”

• It can be inferred from above that when there is adequacy of profits, section 197 of the Act is not requiring any resolution at general meeting further it is also not referring to the Schedule V for remuneration to NED.

• If we refer to Schedule V, it contains 4 Parts:-

• Part I – Conditions to be fulfilled for the appointment of a managing or whole time director or a manager without Central Government approval
  • Part II – Remuneration
  • Part III- Provisions applicable to Part I and Part II 
  • Part IV- Exemption power to Central Government

• Analysis of Parts of Schedule V of the Act and its applicability to remuneration to NED in case of no-profits or in adequate profits or  adequate profits :-

1. Part I of the Schedule V of the Act does not apply in case of appointment or remuneration of NED.
2. Part II of the Schedule V contains V sections.:-
   1. Section I states that in case of adequate profits the Company can pay remuneration to managerial person or persons or other director or directors not exceeding the limits specified in such section. 
   1. Section II contains the provisions in case of no profits or inadequacy of profits
   1. Section III contains the provisions in case of no profits or inadequacy of in special circumstances.
   1. Section IV contains the perquisites not included in managerial remuneration.
   1. Section V contains the provisions for remuneration payable to managerial person in two companies.

• Part III- 1 of the Schedule V states as follows :-
  • The appointment and remuneration referred to in Part I and Part II of this Schedule shall be subject to approval by a resolution of the shareholders in general meeting.

• As stated in para 4.16, section 197 of the Act does not refer to Schedule V in case of adequate net profits for remuneration to directors other than managing or whole-time director or manager.

• Schedule V Part III contains provision that in case of appointment and remuneration referred to in Part I – which is adequate profit and within limits of Section 197 of the Act, approval of by a resolution shareholders in general meeting shall be required. But the section is silent on applicability of schedule V in case of adequacy of profits for directors other than managing or whole-time director or manager.

• In case of listed Companies, clause (a) of sub-regulation (6) of regulation 17 of LODR provides as follows :-

“(a) The board of directors shall recommend all fees or compensation, if any, paid to non-executive directors, including independent directors and shall require approval of shareholders in general meeting.”

• For listed Companies, approval of shareholders is required for payment of remuneration to NED as per clause (a) of sub-regulation (6) of regulation 17 of LODR.

• Now, the question is whether approval of shareholders is required for payment of remuneration to NED in case it is within the limits of Section 197 of the Act?

• Here the main questions are

1. Whether a Schedule is considered at par with the Section or it is sub-ordinate legislation?
2. Whether there can be any inference to strengthen the requirement of having shareholders approval as per Schedule V for remuneration to NED looking at the provisions applicable to NEDs their roles and responsibilities?

• To answer the first question stated in para 5.1 (a),  we need to refer to principles of interpretation of statue for understanding, when section does not require approval of shareholders, whether schedule can mention extra conditions for the same?

• Schedule appended to the statutes form part of the statute.[3]

• The division of a statute into sections and Schedules is a mere matter of convenience and a Schedule therefore may contain substantive enactment[4] which may go even beyond the scope of a section to which the schedule may appear to be connected by its heading. In such a case a clear positive provision in a schedule may be held to prevail over the prima facie indication furnished by its heading and the purpose of the Schedule contained in the Act[5]. However, if the language is not so clear, the provision in the Schedule may be construed as confined to the purpose indicated by its heading and the section in the statute to which it appears connected. In case of conflict between body of the Act and the Schedule the former prevails.[6]

• This is very clearly coming out in the Schedule V about requirement of having approval of shareholders for remuneration to directors even in case of adequacy of profits as per Part II -Section 1 read with Part III of the Schedule.

• Schedule V got amended vide notification S.O 1256(E) dated 18^th March 2021 , relevant amendment in Part II section I is stated below:-

in Section I,

in the first para, after the words ―managerial person or persons, the words ―or other director or directors shall be inserted;

• The regulator was aware of the fact that Part III of the schedule V contains approval of shareholders for appointment and remuneration falling under Part II-Section I. Hence while amending the section I -of Part II they could have also amended Part III to exclude approval of shareholders for directors other than managing or whole time directors.

• To answer the second question in para 5.1 (b) , if we see the theme of the Act relating to the NEDs, they are considered as officers in default in the circumstances stated under paragraph 2.2 and 2.3. They are also duty bound to all the stakeholders as stated under paragraph 3.1. They also have limits on remuneration as stated in section 197 of the Act. Since, they have all duties and responsibilities their remuneration will also need to be approved by the shareholders of the Company.

• Since, PART II[MMJC3]  of schedule V remains the same even post amendment of Section I of Part II, it means the regulator wanted to bring NEDs under approval of shareholders in case of adequacy of profits too.

• If we refer the judgements stated in para 5.3 and 5.4 about Schedule, it is very clear that when it is substantive enactment which may go beyond the section. Here the intent is shareholders should be aware how much directors are drawing as a remuneration from the company.

Hence in this case Schedule V is to be considered at par with section and the compliance with Part III becomes mandatory for all public companies

---

[1] Chintalpati Srinivas Raju V Securities and Exchange Board of India (2018) 210 Comp Cas 285 AIR 2018 2411

[2] Frick India Ltd V Union of India AIR 1990 SC 689 p 693

[3] A.G Lamplough, (1878) 3Ex D 214, p 229 :38 LT 87:47 LJ QB 555 (Brett LJ), Udaipur Prints V Union of India AIR 1989 SC 516

[4] A.G V Lamplough, (1878) 3Ex D 214, p 229 :38 LT 87:47 LJ QB 555 (Brett LJ), Udaipur Prints V Union of India AIR 1989 SC 516

[5] IRC V Gittus (1920) I KB 563m p. 576 (LORD Sterndale MR)

[6] Aphali Pharmaceuticals Ltd V State of Maharashtra AIR 1989 SC 2227, p 2239 1989 (4) SCC 378

---

 [MMJC1]This point is not needed. This is not adding much value to conclusion. It is highlighting role of NED which is already fairly highlgihted above with the help of SC judgment

 [MMJC2]My submisson this may be deleted. This is summary of what has been discussed till now. This may distract reader from the topic.

 [MMJC3]Part 2, section 1 – remuneration payable by companies having profits begins with phrase “subject to provisions of section 197’ – The use of words subject to has the effect of making the provisions conditional upon of some other provision which follows those words. The use of words subject to has reference to effectuating the intention of the law and the correct meaning is ‘conditional upon’.  So if remuenration is exceeding limits then members approval would be required.

Part III read with Part II requiring approval of members approval for remuneration would be subject to provisions of section 197 which states members approval when limits are exceeded