Monthly Remuneration to Non-Executive Directors, permissible?

Introduction

Monthly remuneration to Non-Executive Director (hereinafter referred as, "NED") refers to a fixed, regular payment made to non-executive directors (who are not involved in the day-to-day management of the company) on a monthly basis for their services rendered to the company.

Let's find out whether it is permissible for a company to pay monthly remuneration to its NED.

Legal Provisions

Section 197 of the Companies Act, 2013, allows a Company to pay remuneration (excluding sitting fees) to its NED subject to the prior approval of the shareholders of the Company as follows:

1. 1% of net profits of the Company, if there is an existing managing or whole-time director or manager.
2. 3% of the net profit in any other case i.e. where there is no managing or whole-time director or manager.

The Companies (Amendment) Act, 2017 allows for the modification of the above percentages through a special resolution passed by shareholders in a general meeting.

Section 197(6) of the Act states that a director (whether executive or non-executive) or a manager may receive remuneration in the form of a monthly payment (salary), a specified percentage of the company's net profit (commission), or a combination of both methods.

Remuneration referred to above may be paid to Non-Executive Directors as may be decided by the Board of Directors of the Company from time to time, depending on the extra time that may e devoted and contributions made by the Non-Executive Directors to the Company.

An Independent Director shall not be entitled to any stock option and shall receive sitting fees and reimbursement of expenses for participation in meetings of the Board or committee thereof and profit-related remuneration up to a specified percentage of net profits in such proportion, as may be permissible under the Companies Act, 2013 and any other applicable law at the discretion of the Board.

Prior to the enactment of the Companies (Amendment) Act, 2020, there was no explicit provision in the Companies Act allowing the payment of commission to non-executive directors in the event of a public company experiencing losses or inadequate profits. However, Section 197(3) of the Act was amended through the Companies (Amendment) Act, 2020, to permit a company, regardless of its profitability, to pay remuneration to all its directors (both executive and non-executive) in accordance with the provisions outlined in Schedule V of the Act.

There are two situations:

1. Profit is either adequate or not adequate or
2. There is no profit

Adequacy of profits must be tested with reference to the proposed remuneration. Assume, for a company having other executive directors, the total amount of remuneration proposed to be paid to all NEDs is Rs 40 lacs, based on a ceiling of 1% of net profits (computed according to sec. 198). If the profits of the said company are less than Rs 40 crores, the profits will be considered inadequate to pay Rs. 40 lacs. Also, if the company has incurred losses, it is a case of loss.

It is important to note here that even in the case of inadequate profits or losses, the sitting fees paid by the company are not a part of the remuneration to directors.

A single approval may be obtained for the payment of commission to Non-Executive Directors (NEDs) and Independent Directors (IDs), provided that the remuneration is paid in accordance with the company's remuneration policy, which is generally applicable to all directors. There is no requirement to seek separate approval for the remuneration of each individual director. The remuneration policy may include a general formula or matrix that distinguishes between directors based on their respective contributions.

Approvals authorities for payment of remuneration to NEDs

The approval of the following authorities will be required:

a. Audit committee (AC), being falling under any transaction with related parties,
b. Nomination and Remuneration Committee (NRC);
c. Board of directors;
d. Shareholders; and
e. Secured creditors/ NCD holders/ PFIs/ banks, in case of any default in payment to them.

Conclusion

In conclusion, Section 197(6) of the Companies Act provides flexibility in the remuneration structure for directors and managers. It allows companies to compensate their directors, whether executive or non-executive, through a monthly payment (salary), a specified percentage of the company's net profit (commission), or a combination of both. This provision ensures that companies can tailor the remuneration packages to suit their financial status, governance structure, and the specific roles and responsibilities of their directors and managers, thereby fostering alignment with both corporate performance and individual contribution.

Disclaimer: This article provides general information existing at the time of preparation and we take no responsibility to update it with the subsequent changes in the law. The article is intended as a news update and Affluence Advisory neither assumes nor accepts any responsibility for any loss arising to any person acting or refraining from acting as a result of any material contained in this article. It is recommended that professional advice be taken based on specific facts and circumstances. This article does not substitute the need to refer to the original pronouncement.