A Discussion on the New Remuneration Regime for Independent Directors under the Companies (Amendment) Act, 2020

Introduction

The Companies Act, 2013 is the legislative framework, which has been the regulatory mechanism for companies in India, was recently amended and the Companies (Amendment) Act, 2020 came into being. It does not wholly replace the former law but incorporates certain amendments into it.  

The Amendments brought into the Remuneration Regime for Independent Directors

In March, 2021, the Ministry of Corporate Affairs (MCA) notified the amendments to Sections 149 and 197 of the Companies Act, 2013.This amendments allows the payment of remuneration by companies to independent or non-executive directors, in situations of inadequacy or absence of profits on the part of the company. An independent director, defined under section 149(6) of the Act as someone who is a director separate from the managing director, a whole-time director or a nominee director. He or she is someone who, in the opinion of the company’s Board, a person of integrity and experienced in a particular field or fields. They cannot be someone related to the promoters of the company or be a current or former promoter of the company or its subsidiary, themselves.

Independent Directors aid in improving the creditability and the general governance of a company. The independent director does not have any kind of relationship with the company which could affect their judgment. The independent director’s role encompasses bringing more transparency in a company and ensuring optimised use of the company’s resources and finances.

Prior to the 2020 amendment, the independent directors were not allowed to be paid remuneration under section 197(3) of the Companies Act, 2013, except for the sitting fee under section 197(5) of the Act, by a company which had incurred loss or had earned inadequate profit but the managerial personals could be paid remuneration even in these cases. Although, under normal circumstances a public company, under section 149(9) of the 2013 Act, no independent director is allowed to hold stocks of the concerned company but they may be allowed remuneration in the form of fees as provided under section 197(5), the reimbursement of expenses for attending the Board meetings and profit related commission, the extent of which is decided by the Board members. Section 197 also mentions that, the total remuneration that a public company can pay to its directors cannot exceed 11% of the net profits made by the company in a given financial year. The 2020 Amendment Act had received the President’s assent back in September 2020 but additional amendments to it were notified in December, 2020, January, February and March of 2021.  

Expected Benefits of the Amendments

These amendments were much needed as it will help attract and retain motivated and talented independent directors. It will be beneficial for small companies without adequate profits to make payments to their independent directors. Since the independent directors aren’t restricted to being on the board of only one company like the executive directors, they can earn remunerations from several companies which in turn will lead to many companies receiving guidance from experienced individuals. The independent directors invest their precious time so putting strains on payment of their remunerations hinders them from dedicating themselves to this position. This amendment will lead to benefits on the part of both companies and the independent directors.

Other Relevant Amendments by the Companies (Amendment) Act, 2020

Further changes that the MCA brought in through the 2020 amendment is the amendments notified with regard to Part II of the Schedule V of the 2013 Act. Section 197(3) was to be read with Schedule V and it governed the payment of remuneration to managerial directors, whole-time directors and managers. After the amendment made to it by the Central Government in March of 2021 in the exercise of its powers conferred under Section 467(1) and (2) of the Companies Act, 2013, under the heading of “Remuneration” certain additions were made to it, in order to accommodate payment of remuneration to Independent Directors (IDs) and Non-Executive Directors (NED).

Basis and Needs for these Amendments

In Section I of Schedule V, the words “or other director or directors” has been inserted after the words “managerial person or persons” occur and in Section II the words “or other director” has been added after wherever the words “managerial person” occur. [1]This amendment was inspired by the Company Law Committee’s (CLC) report in 2019. In this report[2] the CLC had recommended that the Sections 149(9) and 197(3) should be amended in such a way, so as to fit the IDs and NED to receive remunerations fixed by the companies they are associated with, in accordance to the amendment in Schedule V. Since, under Rule 4 of the Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014, the sitting fees that can be paid to any director for being in attendance in any Board or Committee meeting doesn’t exceed INR 1 Lakhs per meeting, there is an unfair remuneration regime prevalent for IDs and NED in companies which make loss or inadequate profit. This regime is what the new 2020 amendment seeks to fix. The amended Schedule V prescribes the scale of remuneration which can be followed to pay the IDs and NED in relation to the effective capital or the aggregate of the paid-up share capital of the company in question. It is included in the revised Schedule V that when the effective capital is less than 5 crores, 5 crores and above but less than 100 crores, 100 crores and above but less than 250 crores and, 250 crores and above then the limit on yearly remuneration to be paid i.e, Rs.12 Lakhs, Rs. 17 Lakhs, 24 Lakhs, and 24 lakhs plus the 0.01% of the effective capital over Rs. 2500 crores, respectively, shall not exceed in case of other directors i.e the independent directors. Plainly speaking, the remuneration rates for IDs and NEDs will be one-fifth of the total amount that can be paid to the managerial persons or executive directors, according to the amendments.

Also, on 1^st March, 2021, SEBI has published a Consultation Paper on, “Review of Regulatory Provisions Related to ID” and through it, it has proposed to remunerate the IDs with Employee’s Stock Options Plan with a long vesting period of 5 years in place of profit linked commission. [3]

If we take a look at the global sphere, there are other countries across the world, which have taken a step to recognise the need to pay remuneration to independent directors based on the valuable time they invest in the company’s Board and not on the profits made by the company.  According to the UK Corporate Governance Code, 2018, the payment of remuneration to non-executive directors is decided in accordance to the Articles of Association (AOA) of the company or the company’s Board. The International Corporate Governance Network (ICGN) through its “Guidance on Non-Executive Director Remuneration” [4]stated that performance based remuneration scheme in any organisation has potential to come in conflict with a NEDs role as an independent representative. Thus, they do not uphold performance based remunerations for non-executive directors.

Conclusion

In Conclusion, it maybe stated that the new remuneration regime for NEDs and IDs who do not get involved in the daily management of the company but provide valuable policy making and planning guidance, introduced through the 2020 Amendment Act is a constructive and reasonable measure. The need for IDs in companies arose to ensure that there was a presence of someone who would bring in a fair balance between the opinions of promoters and other stakeholders during board meeting. If such a member of the board is not compensated satisfactorily, companies will miss out on valuable recommendations which would serve as essential in a company’s long term growth. Hence, in order to satisfactorily remunerate the IDs and NEDs and to aid in the development of companies the Companies (Amendment) Act, 2020, will serve as an essential but the limit on the extent to which remuneration can be paid to IDs provided under Schedule V should be followed so as to not corrupt the IDs. A large pay-cheque to Independent Directors could defeat the reason behind their appointment which is why the implementation of the 2020 Amendment Act in its true sense is of prime importance.  Many experts in the field of company law have welcomed this change as a step in the right direction and stated that it should have been made earlier just like it has been in some other international actors. Even though it took some time, with the necessary amendments now in place, it is now expected that more people with expertise and interest will come forward as independent directors and guide companies in need without fear of no or insufficient returns.  

References:

[1] Ministry of Corporate Affairs S.O 1256(E) (Notified on March 18, 2021)

[2] Report of Company Law Commission 2019, November 14, 2021

[3] SEBI’s Consultation Paper In Re. Review of Regulatory Provisions Related to Independent Directors available at https://www.sebi.gov.in/reports-and-statistics/reports/mar-2021/consultation-paper-on-review-of-regulatory-provisions-related-to-independent-directors_49336.html

[4] ICGN’s Guidance on Non-Executive Director Remuneration (Issued on June.27, 2016) available at https://www.icgn.org/sites/default/files/Item%2013_ICGN%20Non-Executive%20Director%20Guidelines.pdf