The Ministry of Corporate Affairs, by way of a notification dated March 18, 2021, amended Part II of Schedule V of the Companies Act, 2013 (“Act”) to introduce separate limits to the annual remuneration payable to non-executive directors and independent directors, in cases where the company has no profits or inadequate profits [1]. The amendment is effective from the date of the notification, i.e., from March 18, 2021 onwards.

Until this amendment came into effect, non-executive directors and independent directors were only entitled to receive remuneration by way of fee for attending board meetings, and certain profit linked commissions which could only be paid if the company had earned profits in the particular year. There was no separate provision under the Act that allowed such directors to draw remuneration if the company had no profits or inadequate profits. On the contrary, managers or managing / whole-time directors were entitled to remuneration even in case of no profits or inadequate profits of a company, subject to limits under Section 197(3) read with provisions of Schedule V of the Act. This amendment aligns the provisions applicable to non-executive directors to those applicable to executive directors, such that non-executive directors are now also entitled to remuneration up to the permissible limits under the Act in scenarios where companies have no profits or inadequate profits.

The amendment is pursuant to recommendations of the Company Law Committee Report dated November 14, 2019 (“CLC Report“), which noted the increased responsibilities of independent directors in companies and the need to adequately remunerate such directors. The CLC Report further noted the crucial role played by independent directors in bringing objectivity into functioning of the board and improving its effectiveness, and suggested that independent directors be appropriately compensated for their time and critical advice even in case of no profits or inadequacy of profits as is permitted for executive directors[2].

The amendment to Schedule V of the Act prescribing limits for remuneration payable to non-executive directors and independent directors is set out below. These limits are applicable to each non-executive and independent director in a company individually.

A company may fix remuneration for non-executive and independent directors in accordance with the above limits by passing a board resolution followed by an ordinary resolution of the shareholders. Such remuneration will also have to be approved by the nomination and remuneration committee of the company (in case the company is covered under Section 178(1) of the Act). Remuneration in excess of the above limits is payable by the company on passing a special resolution to that effect. Note that a resolution for payment of remuneration in case of no profits or inadequate profits cannot be passed for a period exceeding three years.

In case of adequate profits, non-executive directors and independent directors may be paid upto 1% of the net profits of the company if there is a managing / whole-time director or manager in the company, and upto 3% of the net profits in any other case. The company may also pay remuneration in excess these limits by passing a special resolution at a general meeting.

The amendment is applicable to both listed as well as unlisted public companies. Private companies are not impacted by this amendment as they do not fall under the purview of Section 197 of the Act that prescribes limits on managerial remuneration.

It should be noted that this amendment is of an enabling nature. It merely allows, and does not mandate, companies to remunerate their non-executive directors and independent directors in a year when there are no profits or there is inadequacy of profits. However, the amendment is a much needed change as the erstwhile provisions did not provide for payment of remuneration to non-executive directors and independent directors in cases of no profits or inadequate profits. Companies will now be able to adequately remunerate their non-executive directors and independent directors, which should help them to attract qualified professionals as well as retain talent on their boards.

Authors:

Kunal Kumbhat, Partner
Vidhisha Ambade, Associate

Footnotes:

[1] Ministry of Corporate Affair Notification S.O. 1256(E) dated March 18, 2021.
[2] Report of the Company Law Committee, Ministry of Corporate Affairs dated November 14, 2019.