Remuneration & Independency

Remunerating Independent Directors had always been a big question mark for the Companies. The
immediate doubt which arises as soon as the remuneration of an Independent Director is spelt out is
whether the Director’s Independency still stands good. Although remuneration is not the only factor
which determines the Independency of a Director, it is one important factor which needs consideration.
In this note, a brief attempt is made to explain the various ways to get the best people on to the Board
as Independent Directors and the various ways to remunerate such Directors without violating the law.
The meaning of the term remuneration becomes relevant in considering the payments to i) managing
director, ii) whole-time director; iii) manager, collectively called managerial personnel; iv) non-executive
director, and v) non-executive independent directors. The remuneration payable to non-executive
directors is governed by sub-section 4 of Section 309, which permits different modes of payment to
such categories of directors. The Companies Act, 1956 limits the remuneration payable to directors to
11 per cent and then there is a sub-limit of 10 per cent for the remuneration payable to managerial
personnel. Therefore remuneration to such directors (all put together other than managerial personnel)
is limited to 1 per cent of the net profit of the company where there is a manager or a whole-time
director or 3 per cent of net profit of the company where there are no managerial personnel.
On the other hand, the law envisages talented persons to be inducted on the board and yet does not
make any specific provisions for payment of remuneration or, for that matter, does not even give the
company the freedom to do so. All public companies are mandatorily required to appoint audit
committees. And in the case of Listed Companies, the Board should comprise of a healthy balance of
Executive and Independent Directors. This necessitates the appointment of independent directors. This
is impossible except in companies where the margin of profit is huge to ensure the best available talent
is hired and paid commensurate remuneration within 1 per cent of the net profit. A Herculean task,
indeed.

In simple terms, remuneration is a reward for services. Company law has not defined the term
`remuneration'; but it attempted to control the payment of remuneration to managerial personnel —
directors and their relatives — through the operation of Sections 198, 269, 308, 309, and 310 read with
Schedule XIII together.

The general clause of "definition" did not contain any specific meaning of the term "remuneration".
Nevertheless, the explanation to sub-section 4 of Section 198 makes a reference to the meaning of
remuneration for the purpose of operation of Sections 198, 310, 311, 381 and 387. The explanation
reads thus: "For the purposes of this section and Sections 309, 310, 311, 381 and 387, "remuneration"
shall include: any expenditure incurred by the company in providing any rent-free accommodation or
any other benefit or amenity in respect of accommodation free of charge, to any of the of the persons
specified in sub-section (1); "any expenditure incurred by the company in providing any other benefit or
amenity free of charge or at a concessional rate to any of the persons aforesaid; "any expenditure
incurred by the company in respect of any obligation or service which, but for such expenditure by the
company, would have been incurred by any of the persons aforesaid; and "any expenditure incurred by
the company to effect any insurance on the life of, or to provide any pension, annuity or gratuity for, any
of the persons aforesaid or his spouse or child."

Definitions of Non Executive Director and Independent Director.

Non- Executive Director
The term NED is not defined in the Act. In fact, it does not a find a place therein. The Act defines
director as “director includes any person occupying the position of director by whatever name called”.
However, from a reading and construction of relevant sections, one can conclude that NEDs are
directors other than managing or whole-time directors i.e., NEDs are directors who are not in the
whole-time employment of companies. The listing agreement has a new term in it which introduces a
new set of Directors called “independent directors” and proceeds to define them as `those directors,
who apart from receiving directors' remuneration, do not have any other material pecuniary relationship
or transaction with the company, its promoters, its management of its subsidiaries, which in the
judgment of the board, may affect independence of judgment of the directors’.
The revised clause 49 lays down tighter qualification criteria for independent directors. It not only
disqualifies material suppliers and customers from acting as independent directors but also disallows a
shareholder with more than two per centum (2 %) stake in the company from being an independent
director as well as a former executive who left the company less then three years ago. Partners of
current legal, audit and consulting firms, as well as partners of such firms that had worked in the
company in the preceding three years, cannot be independent directors. A relative of a promoter, or an
executive director or a senior executive one level below an executive director, cannot be an
Independent Director.
 
Who is an Independent Director?
‘Independent Directors’ means a non-executive director who:
o apart from receiving director’s remuneration, does not have any material pecuniary relationships
or transactions with the company, its promoters, its directors, its senior management or its
holding company, its subsidiaries and associates which may affect independence of the director;
o is not related to promoters or persons occupying management positions at theboard level or at
one level below the board;
o has not been an executive of the company in the immediately preceding three financial years;
o is not a partner or an executive or was not partner or an executive during the preceding three
years, of any of the following:
i) the statutory audit firm or the internal audit firm that is associated with the company, and
ii) the legal firm(s) and consulting firm(s) that have a material association with the company.
o is not a material supplier, service provider or customer or a lessor or lessee of the company,
which may affect independence of the director; and
o is not a substantial shareholder of the company i.e. owning two percent or more of the block of
voting shares.
Where a director has any material pecuniary relationships or transactions with any of the parties
mentioned in the first point, such director is not to be considered to be independent. But even such
director shall be considered to be independent if he is able to show that any such relationship or
transaction has not affected his independence as a director. Affecting the independency of Director is
nothing but the ability to influence his decision making capacity. By giving remuneration to Directors we
cannot always say that their independency is being affected. If we are to get the real expertise services
from a Director we should also ensure that he is being properly remunerated. The popular adage which
says “If you pay peanuts you get monkeys”, is true even in the case of independent directors. Without
attractive remuneration, the best persons will not offer themselves as independent directors. It is
erroneous to say that attractive remuneration will erode the independence of independent directors In the following paragraphs we shall see the amounts that can be paid to as remuneration and the various
ways by which these amounts can be paid to Independent Directors.
Let us now understand the limits prescribed by the Companies Act, 1956 for
remunerating Directors:

What is the maximum remuneration which can be paid to all the Directors?
The maximum remuneration which can be paid to all the directors of the Company is 11% of the net
profits of the Company.

What is the maximum remuneration which can be paid to Managerial Personnel (i.e.,
Managing Director, Whole-time Director, Manager etc)?
The maximum remuneration which can be paid to Managerial Personnel (a Managing Director or a
Manager or a Whole time Director) is 5% of the net profits of the Company.
The above is the case, where there is only one Managerial Personnel.
The maximum remuneration which can be paid to all such managerial personnel shall not exceed 10% of
the net profits of the Company.
This is the case where there is more than one managerial Personnel {(i.e., 1 Managing Director and one
or more whole time director(s) or a manager and one or more whole time director(s)}.
The above are the limits prescribed for Managerial Personnel, subject to the remunerations which can
be paid pursuant to Schedule XIII.

What is the maximum remuneration which can be paid to all the non-whole time
Directors?
If the company has Managing Director or whole time director or a manager:
1% of Net Profits
If the company has no Managing Director or whole time director or a manager:
3% of Net Profits
Because of the presence of Section 269, it is mandatory for most of the Companies to have a Managerial
Personnel. Therefore, the maximum remuneration that can be paid to all the non-whole time directors
is generally one percent of the net profits of the Company.

The various ways for the Companies to remunerate their Directors (Non-Whole time)
can be enumerated as follows:
1. In the form of Sitting Fee
2. In the form of Incidental Expenses for attending the meeting
3. In the form of Commission on net profits
4. In the form of monthly, quarterly or annual payment
5. In the form of Fee for Services rendered in Professional Nature
6. In the form of ESOPs

Sitting Fee:
A director may receive remuneration by way of a sitting fee for each meeting of the Board, or a
committee thereof, attended by him. By virtue of sub-section (2) of Section 198, such sitting fee paid to
directors shall not be reckoned for the purpose of calculating Directors Remuneration.
What are the ceiling limits for sitting fee?
Rule 10-B of Companies (Central Governments) General Rules and Forms, 1956 provides that
companies having a paid-up capital and free reserves of Rs. 10 crores or above or companies having a
turnover of Rs. 50 crores or above can pay sitting fees not exceeding Rs. 20,000 and other companies
can pay sitting fees up to Rs. 10,000.

Approvals Required
No approval is required to pay the above said sitting fee.

Incidental Expenses for attending the meetings
This does not form part of the remuneration of the Director but is provided to the Directors in order
to facilitate them to attend the meeting. Only the actual amounts spent by the Directors in this regard
will be reimbursed to them.

Commission on net profits
Sub-section 4 (b) of Section 309 of the Companies Act, 1956 allows the Companies to pay a commission
of 1% of its net profit to its Directors. Therefore the Companies can remunerate their directors by
paying an amount upto 1% of their profits to its Directors.

Approvals Required
This commission of 1 % can be paid to its Directors by taking the approval of members by means of a
Special Resolution in a General Meeting of the Company.

Can non-whole time Directors be paid Remuneration in excess of 1%?
Yes, the Company can pay remuneration in excess of 1% to its directors, provided:
• A separate approval of the Central Government is required for paying such higher remuneration.
• Such higher remuneration should be authorised by the Company in its General Meeting.
Remuneration by means of monthly, quarterly or annual payment
Remuneration can also be paid in the form of monthly, quarterly or annual payment to its Directors.

Approvals Required
In order to pay such remuneration by way of a monthly, quarterly or annual payment the Company has
to obtain the approval of Central Government.

Fee for Services rendered in Professional Nature
The provisions of Companies Act provide a mechanism for the Companies to remunerating their
Directors for the Services, if any received n professional nature. As to what are the professional
Services and whether a director possesses them or not is left to the opinion of Central Government.
The Company has to seek the opinion of the Central Government as to whether a director is qualified
for payment of professional remuneration. Once the Central Government is satisfied that the Director
in question possesses the requisite qualification to render professional services, it is then not open to
the Government to put any restriction on the amount of remuneration payable to him for his
professional work.

Remuneration by way of ESOPS (Employee Stock Options)
Rule 4.3 of the Securities and Exchange Board of India (Employee Stock Option Scheme And Employee
Stock Purchase Scheme) Guidelines, 1999 provides that “A director who either by himself or through
his relative or through any body corporate, directly or indirectly holds more than 10% of the
outstanding equity shares of the company shall not be eligible to participate in the ESOS.”
Therefore, an independent director is eligible for allotment of shares under the ESOPs scheme. Care has
to be taken to see that such Director’s Share-holding in the Company does not exceed 2% of its share
capital, by which the Director loses his status of Independent Director.
                Thus the above are the various ways, in brief in which we can remunerate the Independent.