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

Prosecution of company directors for day-to-day operational issues: SC ruling provides relief

By Dibisha Mishra (dibisha@vinodkothari.com; corplaw@vinodkothari.com)

Introduction:

While directors are the brain and neural control center of companies, but it is evident that the day to day affairs of  companies are not run by the board of directors , or even the executive directors of companies. Under circumstances can directors be prosecuted, merely because they hold board positions, for something as operational as the lack of safety measures in a smoking zone in a hotel? The SC in a recent ruling[1] of Shiv Kumar Jatia vs. State of NCT of Delhi has taken forward its earlier rulings in the case of Maksud Saiyed vs. State of Gujarat & Ors[2] and Sunil Bharti Mittal vs. CBI[3], and has held the doctrine of vicarious liability cannot be applied to offences under the IPC unless specifically provided for.

The concept of a corporate structure is based on the very premise of a business idea brought into by a group of persons [also known as promoters], backed up with funds from shareholders and creditors and set to implementation by directors who are elected by the shareholders. While shareholders continue to hold certain decision making powers, the directors are broadly responsible for the functioning and performance of the company. Having said so, it is also to be understood that a director of a company is not always in charge of everyday affairs. It depends upon the respective role assigned to different officers in a company.

Liability of officers for offences under Companies Act

The Companies Act, 2013 (‘the Act’), has explicitly identified officers who are in default for the purpose of the Act which includes directors and KMP.

Further, Section 149(12)(ii) of the Companies Act 2013 provides that liability of a NEDs arises only with respect to such acts of omission or commission by a company which had occurred with his knowledge, attributable through Board processes, and with his consent or connivance or where he had not acted diligently. Hence, obligation is on the ROC to verify relevant information and records before initiating prosecution against independent or nominee directors.

However, it is to be noted that the above provisions are to be considered only where there has been any contravention with the provisions of the Companies Act while in case of other statutes, respective provisions is to be seen.

Liability for criminal felonies

When a Corporate gets accused of a criminal offence, the individual to be prosecuted for the same remains a matter of consideration. The extent of liability of Non-Executive Directors in case of offences has been discussed in our earlier article[4]. The present article discusses the Supreme Court’s judgment[5] on the case of Shiv Kumar Jatia vs. State of NCT of Delhi which quashed the impugned order of the High Court and freed the Managing Director from the criminal liability imposed on the basis of doctrine of ‘vicarious liability’.

Facts of the case:

Shiv Kumar Jatia is the Managing Director of M/s. Asian Hotels which looks after Hyatt Regency Hotel. He had authorized Mr. PR. Subramanian to apply for lodging license of the hotel.

There was a contravention the condition of the lodging license which led to a hotel guest enter into a semi lit under-construction terrace for smoking. The guest fell from the terrace of 6th floor to the 4th floor and got injured. Case was brought before the High Court which ordered for prosecution the Managing director along with the other three accused by relying on the case of Sushil Ansal vs. State through CBI[6].

Shiv Kumar Jatia appealed before the Apex Court against such impugned order of the High Court where the case was decided in his favour vide judgment dated 23rd August, 2019.

Provisions of law considered:

Alleged offences under Section 336 and 338 of the Indian Penal Code

Section 336:

“Whoever does any act so rashly or negligently as to endanger human life or the personal safety of others, shall be punished with impris­onment of either description for a term which may extend to three months, or with fine which may extend to two hundred and fifty rupees, or with both.”

Section 338:

“Whoever causes grievous hurt to any person by doing any act so rashly or negligently as to endanger human life, or the personal safety of others, shall be punished with imprisonment of either description for a term which may extend to two years, or with fine which may extend to one thousand rupees, or with both.”

Apex court stated that the essential elements to prove an alleged offence under section 336 are:

  • an act
  • done rashly or negligently
  • to endanger human life or personal safety

while for section 338, the condition of grievous hurt is to be met in additional to elements in section 336.

Doctrine of vicarious liability

Under the doctrine of vicarious liability, one person is held responsible for the wrong doing of the other. Such liability arises only when both persons are somehow connected to each other like employee-employer relationship or principal-agent relationship. In case of corporates, the applicability of the said doctrine is to be determined on the basis of provisions of statute dealt with.

There is no vicarious liability unless the statute specifically provides so.

  • The court referred to the judgment[7] of Maksud Saiyed vs. State of Gujarat & Ors, where the Court held that the Penal Code does not contain any provision of vicarious liability on the part of the Managing Director/ Director of the company where the accused is a company.
  • Further, the case of Sunil Bharti Mittal vs. CBI[8] was also referred to wherein it was held that:

“a corporate entity is an artificial person which acts through its officers, directors, managing director, chairman etc. If such a company commits an offence involving mens rea, it would normally be the intent and action of that individual who would act on behalf of the company. It would be more so, when the criminal act is that of conspiracy. However, at the same time, it is the cardinal principle of criminal jurisprudence that there is no vicarious liability unless the statute specifically provides so.”

This means where the statutory provision itself does not specifically attract the doctrine of vicarious liability, an individual cannot be implicated under the same.

Existence of Active Role and Criminal Intent

It was stressed that in the absence of any statutory provision incorporating vicarious liability, an individual cannot be made accused, unless there is a sufficient evidence of his ‘active role coupled with criminal intent’. Further such criminal intent must have direct nexus with the accused.

In the given case, the Managing Director was outside the country on the day of the accident. Moreover, mere authorizing an official for obtaining license cannot be construed to his active role with criminal intent. Hence, the same was also failed to be established before the Court.

Judgment

The Apex Court held that there is no specific provision of applicability of doctrine of vicarious liability in the Indian Penal Code. Further, the allegations made on the Managing Director could not establish any active role coupled with criminal intent having direct nexus with the accused.

Concluding the same, the Court passed the judgment that the allegations made on the Managing Director was vague in nature and the criminal proceedings against Shiv Kumar Jatia as passed by the High Court were quashed.

Time and again the court have taken the view that merely because of holding the position as a director/managing director, a person cannot be vicariously held liable for offence committed by Companies. It has to be proved how he was responsible for, or in control of, or negligent in conducting the affairs of the company. In the absence of definite averments, a director cannot be deemed to be liable.

 

[1] https://sci.gov.in/supremecourt/2018/31728/31728_2018_6_1502_16190_Judgement_23-Aug-2019.pdf

[2] https://indiankanoon.org/doc/159121041/

[3] https://indiankanoon.org/doc/159121041/

[4] http://vinodkothari.com/wp-content/uploads/2017/03/Umesh_K_-Modi_vs_Deputy_Directorate_of_Enforcement.pdf

[5] https://sci.gov.in/supremecourt/2018/31728/31728_2018_6_1502_16190_Judgement_23-Aug-2019.pdf

[6] https://indiankanoon.org/doc/152261427/

[7] https://indiankanoon.org/doc/159121041/

[8] https://indiankanoon.org/doc/159121041/

Analysis of Companies (Amendment) Act, 2019

Managerial Remuneration: A five decades old control cedes

Relatives’ interest affecting the independence criteria of IDs

By Munmi Phukon & Smriti Wadehra (corplaw@vinodkothari.com)

Introduction

The Ministry, on 7th May, 2018[1], has come out with certain changes in some of the Rules prescribed under the Companies Act, 2013. One of such changes has been made in the Companies (Appointment and Qualification of Directors) Rules, 2014. The amendment is being made under Rule 5 of the said Rules which pertains to qualification of independent directors (IDs) considering the enforcement of the changes in section 149(6)(d) brought by the Companies (Amendment) Act, 2017 w.e.f the aforesaid date.[2] Read more

Flexible MBP rules come to life pursuant to Amendment Act, 2017

By Pammy Jaiswal (pammy@vinodkothari.com),(corplaw@vinodkothari.com)

Introduction

MCA vide its notification dated 7th May, 2018[1] has enforced another set of 28 sections of the Companies (Amendment) Act, 2017 (‘Amendment Act’). The notification has enforced sections primarily dealing with the definition of associate company, doing away with ratification of auditors, charge registration, delay in filing of returns along with additional fees, annual return, etc.

With the third set of enforcement notification, MCA has made corresponding changes in the following Companies Rules under the Companies Act, 2013 (‘Act, 2013’)[2].

  • Companies (Meeting of the Board and its Powers) Rules, 2014 (‘MBP Rules);
  • Companies (Prospectus and Allotment of Securities) Rules, 2014 (‘PAS Rules’);
  • Companies (Appointment and Qualification of Directors) Rules, 2014 (‘AQD Rules’);
  • Companies (Audit and Auditors) Rules, 2014 (‘AA Rules’);
  • Companies (Share Capital and Debenture) Rules, 2014 (‘SCD Rules’); and
  • Companies (Specification of Definition and Details) Rules, 2014.

This write up compiles the changes brought in the following Companies Rules namely:

1.        MBP Amendment Rules, 2018[3]

 

Sr. No.

Matter Description

Prior to Amendment

 

Nature of Amendment

 

Impact of the Amendment

 

1. Participation of directors through VC mode for restricted items Section 173 of the Act, 2013 does not allow the participation of directors in board meetings for discussing certain matters in the nature of unpublished price sensitive information (‘UPSI’). Matters dealing with (i) the approval of annual financial statements; (ii) the approval of the Board’s report; (iii) the approval of the prospectus; and (iv) the approval of the matter relating to amalgamation, merger, demerger, acquisition and takeover are required to be approved in a duly convened board meeting without the participation of directors in video-conferencing mode.

 

In view of streamlining the provisions of the Amendment Act, rule 4 of the MBP Rules have been amended to allow the participation of the directors through VC even for the restricted matters provided the directors physically present form the requisite quorum for the meeting.

 

The intent of law for the bringing such amendment is to allow wider participation of directors and provide flexibility in terms of mode of participation.

 

The matters for which VC has now been enabled are matters in the nature of UPSI and therefore, the officer convening the meeting has to ensure that while using such mode of participation, confidentiality of the information is maintained.

 

2. Constitution of the Audit and the Nomination and Remuneration Committee Section 177 and 178 of the Act, 2013 requires the certain classes of companies to constitute audit committee and nomination and remuneration committee with independent directors forming majority and one-half of the total strength respectively. The law requires for constituting such committees for every listed company which also includes private listed companies.

 

However, MCA vide its notification dated 5th July, 2017 had waived the requirement of appointing an independent director in certain public companies viz. JV companies, WoS and a dormant company.

 

 

 

The requirement of constituting an audit committee and a nomination and remuneration committee shall be required for listed public companies only in addition to other classes of public companies.

 

Private companies which have their debt securities listed have now been explicitly exempted from constituting audit committee and nomination and remuneration committee.

 

The amendment is a clarificatory change and allows the private listed companies to uphold their privacy. However, relevant terms of reference of an audit and nomination and remuneration committee will any ways be looked after by the board or any sub-committee so constituted.

3. Passing of prior special resolution in case of crossing limits laid under section 186 Section 186 of the Act, 2013 requires passing of prior special resolution in case the limits laid under the said section are exceeded (60% of the PUSC, free reserves and securities premium account or 100 of free reserves and securities premium account, whichever is more). It further requires to state the upper limit upto which loans, guarantee, security or investment shall be made by the company. The details of such loans, guarantee, security or investment so made is required to be disclosed in the financial statements as well.

 

The amendment has done away with the requirement of obtaining prior special resolution for the said purposed in excess of the prescribed limits.

 

No impact, only the language has been altered.

2.        SCD Amendment Rules, 2018[4]

 

S.no Matter description

 

Prior to amendment Nature of amendment Impact of amendment
1. Issue of sweat equity shares

 

The expression of ‘employees’ for the purpose of issue of sweat equity shares by unlisted companies  meant a permanent employee of the company who had been working in or outside India, for atleast one year.

 

 

The Amendment Act, 2017 omits the requirement for a period of one year to elapse after the commencement of the business for the issue of sweat equity shares.

 

The amendment in the rules is in line with the aforesaid change and does away with the condition for an permanent employee in or outside India to be working for atleast one year.

 

In case of issue of sweat equity shares by unlisted companies they are required to comply with SHD Rules in this regard.

 

The issue of sweat equity shares can now be done to permanent employees working in or outside India, irrespective of their period of employment in the Company.

 

Conclusion

The amendment in the aforesaid rules is a reflex action pursuant to the enforcement of relevant section of the Amendment Act under the third phase (read our write-up here). The amendment under the MBP Rules is a welcome change and allows flexibility in business operations by a company.


[1] http://www.mca.gov.in/Ministry/pdf/CompaniesAmendmentNoti_07052018.pdf

[2] http://www.mca.gov.in/MinistryV2/companiesact2013.html

[3] http://www.mca.gov.in/Ministry/pdf/CompaniesBoardsPowersRules_07052018.pdf

[4]  http://www.mca.gov.in/Ministry/pdf/SharecapitalRule2018_11042018.pdf

FAQs on Disqualification of Directors under Companies Act, 2013

By Team Vinod Kothari & Company (corplaw@vinodkothari.com)

This version is dated October 3, 2017

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Continuing the crackdown on shell companies, MCA in its Press Release[1] issued on September 6, 2017, expressed that the government will soon take steps against the directors of the shell companies which have not filed returns for three or more years. Post this, the Registrar of Companies of the respective states started issuing the list of disqualified directors[2] u/s 164 (2) (a) of the Companies Act, 2013. Read more