Remunerating NEDs and IDs in low-profit or no-profit years

Ambika Mehrotra

corplaw@vinodkothari.com

The role of non-executives (NEDs) and independent directors (IDs) in an organization in bringing their unbiased views, transparency and good governance in the corporate culture has already been recognized globally. The NEDs including IDs are not typically engaged in the day-to-day management but their responsibilities inter-alia include monitoring of the functioning of executive directors. This is quite essential in order to ensure that the decision making in the company is not dominated by individual choices.

As stated by Sir Vincent Powell-Smith in his book ‘Law and Practice Relating to Company Directors’, “apart from the working or executive directors, that is persons who are full-time executives, it is sometimes desirable to take in ” outside ” directors who have no association with the company other than as a director.”

It is to be noted that the unique role of such directors is evaluated by their ‘positive contribution’, in the board, as stated in the Report by Cadbury Committee[1], which is irrespective of the profits generated by the day to day business and working, However, the compensation for their contribution has always been linked to the profitability of the company by virtue of the provisions of Section 309 of the Companies Act, 1956 or corresponding Section 197 in the Companies Act, 2013.

Herein, it is pertinent to note that, while the role if NEDS/IDs demands them to bring independence to the board, the performance/profit based remuneration for non-executive directors has significant potential to conflict with their primary role in the organization. Accordingly, considering various stakeholder representations received by the Government regarding this inconsistency, the Company Law Committee (“CLC/Committee”) which was set up under the Chairmanship of Shri Injeti Srinivas in November, 2019[2] considered the need to have adequate compensation for such directors.

In line with same, the Central Government (CG) has recently laid down another set of amendments before the Lok Sabha on 17th March, 2020 by way of Companies (Amendment) Bill, 2020[3] (“CAB, 2020”). In this article we intend to discuss the said amendment along with the rationale behind the same.

Analysis of the amendments

The board is a mix of executives and non- executives, while the executives are being paid remuneration, the non- executives are only eligible for sitting fee and commission out of profits. Where the difference between the work domain is only as regards the day to day management of the company. Here, it is to be noted that although the non-executives do not involve in the everyday working of any organization, they carry the vintage of their experience in the company. It is interesting to note that while both the kind of directors bring in their bit of value in the company, however during a financial disrupt in a company, maybe through losses or inadequacy of profits, when there is a conflict in the minimum remuneration being paid, where the executive still receive the prescribed remuneration, the non-executives get to sacrifice their commission, which they were otherwise entitled to and they have to satisfy themselves with the sitting fee only.

In order to curb the said conflict, the CAB, 2020 has introduced provisions for allowing payment of adequate remuneration to NEDs in case of inadequacy of profits, by aligning the same with the provisions for remuneration to executive directors in such cases. This is backdrop of the discussion in the CLC Report which considered that the existing provisions in the CA, 2013, do not recognise payment of remuneration to non-executive directors, in case of losses or inadequate profits as it does for the managerial personnels in terms of Section 197 read with Schedule V.

Notably, the concept of minimum compensation to independent directors had also been incorporated in the Uday Kotak Committee report on Corporate Governance issued on October 5, 2017[4]. However, the above requirement of minimum remuneration did not extend to the case of inadequacy of profits.

While the Calcutta High Court in the matter of Hind Ceramics Ltd. vs Company Law Board And Ors[5] discussed that the minimum remuneration paid to the executives and non executives equally might severely impact the financial strength of the loss making entity in recovering the same for an uncertain term. However, on taking a close look at the active involvement of the non-executives in the company by virtue of their enhanced role and liabilities, it is required to re-consider the fact that the inconsistency in the payment of such non-executives as compared to the executives would not only de-incentivise the latter but also affect the retention of talented resources in a company.

Global Precedents

Considering the above, it may also be inferred that the limitation in the provisions of CA, 2013 w.r.t the payment of remuneration to IDs in case of losses or inadequacy of profits frustrates the whole intent of their unique role on the board. Even globally, various  countries have recognised that the level of remuneration for non-executive directors should reflect their time commitment and responsibilities of the role and not be linked to the performance of the company.

UK Corporate Governance Code

As per the UK Corporate Governance Code dated July 2018[6], which clearly provides that,

“Remuneration for all non-executive directors should not include share options or other performance-related element.”

The remuneration of non-executive directors is determined in accordance with the Articles of Association of the company or, alternatively, by the board.

OECD Report on Corporate Governance 

Similar provisions have been recommended in the Portuguese code of corporate governance, as referred in the report of the Organisation for Economic Co-operation and Development (OECD) based on Corporate Governance on Board Practices[7], which provides that the remuneration of the NEDs on the Board should not include a part depending on the performance or the value of the company.

ICGN’s Guidance on NED Remuneration

In addition to the above, the International Corporate Governance Network (ICGN) in its Guidance on Non-executive Director Remuneration[8] explains that the performance-based remuneration in any organisation has significant potential to conflict with a non-executive director’s primary role as an independent representative of shareholders. Although, ICGN is a strong advocate of performance-based concepts in executive remuneration, they do not uphold the same in case of remuneration to non- executives.

Conclusion

In view of the global stand in determining the remuneration to non-executives on  the basis of their value in the organisation without linking the same to the profits of the company, the amendments to be introduced vide the CAB, 2020 appear to be a boon for the IDs. At the same time, we cannot disregard the fact that, the concept of adequate compensation mentioned above applies to the companies facing losses or inadequacy of profits and it may be possible that this might increase the financial distress of the loss making company.  However, the positive aspect of the same still appears to be beneficial as regards the retention of experienced resources who shall remain motivated by being adequately remunerated.

Our other write- ups on similar topics may be viewed at:

  1. http://vinodkothari.com/2019/11/the-injeti-srinivas-committee-report-18-11-2019/
  2. http://vinodkothari.com/2019/11/clc-report-moving-company-law-a-step-closer-to-ease-and-peace/
  3. https://www.moneylife.in/article/norms-for-disqualification-of-directors-may-undergo-change/58842.html
  4. http://vinodkothari.com/category/corporate-laws/

[1] https://ecgi.global/sites/default/files/codes/documents/cadbury.pdf

[2] http://mca.gov.in/Ministry/pdf/CLCReport_18112019.pdf

[3] http://164.100.47.4/BillsTexts/LSBillTexts/Asintroduced/88_2020_LS_Eng.pdf

[4] https://www.sebi.gov.in/reports/reports/oct-2017/report-of-the-committee-on-corporate-governance_36177.html

[5] https://indiankanoon.org/doc/445116/

[6] https://www.frc.org.uk/getattachment/88bd8c45-50ea-4841-95b0-d2f4f48069a2/2018-UK-Corporate-Governance-Code-FINAL.pdf

[7] https://www.oecd.org/daf/ca/49081438.pdf

[8] https://www.top1000funds.com/pdf/ICGN_NED_Rem_Guidelines.pdf

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