The Law on the subject is encapsulated in Chapter XIII of the Companies Act, 2013 (hereinafter "The Act") and provisions contained in Section 196, 197 and 198 read with Schedule V to the Act , are in the main to be examined for a proper understanding of the nuances of the law.
At the outset, it must be stated that the extant provisions in the law are applicable only where it comes to appointment of "Managerial person" which expression as mentioned in Part I of Schedule V collectively refers to the person appointed as Managing or Whole time director or Manager.
No applicability of provisions to the appointment of Chief Executive Officer who is not part of the Board
The Act has given rise to a new terminology for a managerial resource who carries the euphemism of a Chief Executive Officer"(CEO) and is supposed to belong to the highest echelons in the Corporate hierarchy and is ranked alongside the Managing director or Manager and considered as a Key Managerial Person (KMP) under Section 2(51) of the Act.
As evident from s plain reading of Section 134(1) , the Act contemplates that the CEO need not always be an integral part of the Board and even in such a case, it is ironic that it is expected that the incumbent shall sign the financial statements of the company as a CEO on behalf of the Board.
It is somewhat paradoxical that the law should permit a person to be designated as CEO which expression literally suggests that he is the lynch pin of the company and yet he need not be either the Managing or Whole- time director or for that matter even the Manager and hence kept out of the ambit of provisions relating to managerial remuneration. While stating this, one is conscious of the exception carved out under the second Proviso under Section 203 which contemplates the appointment of CEOs for each business vertical in the case of a company with multiple businesses .We are not referring in our discussion to such genre of CEOs.
Our reference is only to refer to those holding the reins of Management at the apex and appointed by the Board as CEOs and yet could be out of the Board structure.
Thus appointing someone as the CEO and yet not considering him as the MD or Whole time director would be a paradox which the Statute cannot continue to sustain.
That the Law allows one to be anointed as the CEO without subjecting his appointment and remuneration to determination by the shareholders is inexplicable and does not stand to logical reasoning. When a person appointed by the Board as Manager is subject to regulation under the Act even though he need not be part of the Board ,it is inconceivable that there is no compulsion in the law to subject the appointment of a CEO and the remuneration payable to him ,to approval by members and this is clearly an aberration in the Statute which calls for immediate intervention by the Powers that be.
It defies logic that when one is appointed CEO without being made part of the Board.There is no procedure for even informing the Registrar about such appointment as the relevant form calls for information only to be furnished for appointment of "managerial persons" which adage ironically need not adorn the office of the CEO in all cases.
Part I of Schedule V needs review
Part I of Schedule V sets out the conditions that are to be fulfilled for the appointment as Managing or Whole- time director or Manager.
It is pertinent to note that this part of Schedule V does apply even in the case of such appointments in Private companies as it is only the remuneration payable to managerial persons appointed in public companies is subject to regulation under Section 197 read with Schedule V.We would hasten to add that private companies need to ensure that their managerial persons satisfy the eligibility criteria laid down in Part I of Schedule V.
One of the conditions laid down in Part I of the above Schedule is that the incumbent shall, inter alia, be a resident of India. It is pertinent to note that the Act does not define a resident except that sub-section(3) under Section 149 stipulates that every company shall have at least one director who stays in India for a total period of not less than one hundred and eighty two days during the financial year, This is the only yardstick available in the Act as to the test of residency of a person. In the above predicament, one has to necessarily fall back as is permitted by the General Clauses Act , on the tests for determination of residential status as provided under Section 6 of the Income Tax Act, 1961.As per Section 6 a person is considered as a resident for tax purposes if he is in India for at least 182 days in the financial year.There is no requirement that the above period of stay is continuous.
Part I of Schedule V inexplicably provides for continuous stay of the incumbent in India for not less than twelve months immediately preceding the date of appointment as managerial person
Despite the fact that the test for residency stands explained clearly as above, inexplicably Explanation I under Part I of the above Schedule provides that for the purpose of this Schedule , resident in India includes a person who has been staying in India for a continuous period of not less than twelve months immediately preceding the date of his appointment as managerial person and who has come to stay in India-
i)for taking up employment in India or
ii)for carrying on a business or vocation
(There is an apparent goof- up in the spelling of "Vocation "in the above Explanation to the Schedule as it is misspelt as "Vacation") in India .
The above Explanation contradicts the tests of residency and if the Explanation were to be readin isolation, it would mean that one would not be eligible for appointment as managerial person unless he has stayed in India continuously during the twelve months preceding the appointment and has come to India to take up employment or a vocation. By the above logic, even a single day’s absence from India would make him ineligible for appointment.This obviously cannot be the intent of the Statute.
The law has to be read harmoniously consistent with its objectives .
Considering the above, the Explanation I in Schedule V needs to be reviewed in the light of the foregoing.
Serious flaw exists in Section II of Part II of Schedule V
Section II of Part II of the above Schedule sets out the limits as regards managerial remuneration in the case of a company which suffers from the affliction of either inadequacy or absence of net profits. It is important to note that vide Notification No.S.O.1256( E) dated 18.3.2021 the expression "other director" has been inserted in the Section which has made it possible for a company without profits or inadequacy of net profits to pay remuneration according a graded scale as set out to directors who do not hold an executive position in the company.
Explanation under Section III of the Schedule which has been inserted from the above date states that for the purposes of Section I ,Section II and Section III ,the term "other director" shall mean a non-executive director or an independent director.
Consequent upon the above it has now become possible to pay remuneration on a regular basis subject to the approval of members, to the independent directors /non-executive directors of those companies which are suffering losses or have inadequacy of net profits such that they are unable to incentivize the independent directors by paying remuneration based on net profits as in the case of profit making companies. The above amendment has provided for a financial compensation of sorts, the lack of which was a sore point for the continuance of Independent directors in loss making companies.
One important question that emerges is whether in the case of a company which is paying net profit based commission to its directors, can they be paid a regular remuneration as contemplated in Section II in addition to their share of the net profits.
Given that the amendment to Section II to pay compensation to independent directors is endemic to cases of companies which suffer losses in our view one cannot pay remuneration to Independent directors over and above the commission already being paid to them. One cannot obviously have the cake and eat it too !.
Section II has no scope for paying remuneration to Promoter directors acting as Managing Directors in loss-making companies or in companies having inadequate profits
Item A in Section II of the above Schedule sets out the thresholds of remuneration that is payable for each incumbent and the same is linked to the "Effective Capital " of the company as defined in Explanation I under Section IV of Schedule V.
That the thresholds provided are merely illustrative is clear from the fact that the proviso which immediately follows the threshold table stipulates that remuneration in excess of the above limits could be paid with the approval of the shareholders by special resolution.
It is important to note that up until 12.9. 2018, the limits laid down could only be doubled by special resolution. At present there is flexibility within the Schedule to pay any amount exceeding the prescribed thresholds with the consent of the members by special resolution.
Item B in the above Section as reproduced below makes intriguing reading:
Quote
"(B) In case of a managerial person or other director who is functioning in a professional capacity (remuneration as per Item (A) may be paid)if such managerial person or other director is not having any interest in the capital of the company or its holding company or any of its subsidiaries directly or indirectly or through any other statutory structures and not having any direct or indirect interest or related to the directors or promoters of the company or its holding company or any of its subsidiaries at any time during the last two years before or on or after the date of appointment and possesses graduate level qualification with expertise and specialized knowledge in the field in which the company operates".
Unquote
As the proviso subsequent to what is quoted above is not relevant for the purposes of this discussion we are not articulating on the same.
Suffice to say that Item B only contemplates payment of managerial remuneration in case of a loss- making company only in cases where the incumbent is acting in a professional capacity and is not related in any manner directly or indirectly with the promoters or directors of the company or any of its subsidiaries during the last two years preceding the commencement date of his office. In addition, he should possess graduate level qualification and to boot have specialized knowledge in the industry in which the company is involved.
Does the above mean that one cannot pay remuneration to a person who has shareholding interest in the company or is related to the promoters , in the case of a company afflicted with losses or inadequacy of net profits.
The above unlikely legal position doubtlessly emerges and such a conclusion would be contrary to the intent of law.Existence of profits cannot be the sine Quo non for payment of remuneration to a director who is either a promoter or related to the promoters and striving for the success of a company in an executive capacity. Profits can never be an economic barometer for measuring the efficiency of a company.During the recent pandemic companies fell like autumn leaves in spite of the fact companies put their best foot forward.
The Statute cannot allow a situation where remuneration cannot be paid to the executive head who happens to be the chief protagonist merely because the company is not into profits. Item B in Part II of the Schedule has been rendered infructuous and should be deleted.
The above is therefore a clear drafting anomaly which requires urgent attention. It is pertinent to note that the ICSI has recently raised this issue with the MCA and sought a suitable clarification which it is fervently hoped shall come through before long.
Can the Schedules prevail in case of conflict with the Act
The above discussion brings us to an important question as to whether a Schedule to the Act as in this case Schedule Vcan be in conflict with the Act and if so which will prevail.
At the outset, it may be noted that Schedules appended to the Statutes form a part of the statute.(Ujagar Prints v Union of India (AIR 1989 SC 516).
Schedules are added towards the end and their use is to avoid encumbering the Sections in the Statute with matters of excessive detail. The division of a statute into Sections and Schedules is a mere matter of convenience and a Schedule may contain a substantive enactment which may even go beyond the scope of a Section to which the Schedule may appear to be connected by its heading.(CIT, WB v Calcutta National Bank Ltd.(AIR 1959 SC 928).However if the language in the Schedule 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 the body of the Act and the Schedule, the Act will prevail.(Aphali Pharmaceuticals Ltd v State of Maharashtra (AIR 1989 SC 2227).
It is pertinent to note from the above that Part II in the Schedule goes beyond the provisions of Section 197 by postulating that remuneration shall remuneration in case of loss can be paid only to a managerial person who operates in a professional capacity without any equity stake in the company. It unwittingly transgresses the Act which does not seek to make any distinction where it comes to paying remuneration to a promoter acting in an executive capacity or a non-promoter acting purely as a professional.
Our surmise is that in the face of so many changes that have been made to Schedule V, the fact that it should be consistent with the mother legislation has perhaps been lost sight of.
That said, it is imperative that the MCA gives attention to the issue raised by the ICSI as discussed above.
Conclusion
Given the vastness of the areas covered in the provisions in the Act relating to managerial remuneration it is well neigh impossible to capture the contents in the Act, considering the limitations of a discussion paper.
We have therefore endeavoured to cherry pick and only focus on certain pain areas in the law to provide to the fraternity some food for thought. There are many other issues which need to be focused but we shall park them for introspection on a later date.
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