Managerial Remuneration – Should Promoters Be Disenfranchised?

[Bharat Vasani is Senior Advisor – Corporate Laws and Miloni Mau an Associate in the General Corporate Practice, both at the Mumbai office of Cyril Amarchand Mangaldas. An earlier version of this post was published on the Cyril Amarchand Mangaldas Blog]

The Government of India’s socialistic approach towards controlling managerial remuneration between 1960s and 1990s has been a painful chapter in the history of India’s company law. While the restriction applied only to those on the board of directors, the limits the then Department of Company Affairs had prescribed in its administrative guidelines under the Companies Act, 1956 in November 1969 was as low as INR 7,500 per month and further reduced to INR 5000 per month years later. Any payment beyond those limits required the Central Government’s approval, which was also a very cumbersome and time-consuming process. This led to the unhealthy practice of compensating Managing Directors and Executive Directors (“MD/EDs”) with cash reimbursements and many other inappropriate methods. Some MDs/ EDs also stepped down from the board to accept positions one level below the board. They were designated as presidents and vice presidents despite performing the role of the MD.

Following the economic liberalisation of July 1991, managerial remuneration limits were progressively relaxed. Moreover, from September 12, 2018, the prior Central Government approval is not a requirement either. The only limits applicable now pertain to high percentages of 5%, 10% and 11% net profits of the company, as specified under section 197 of the Companies Act, 2013 (“the Act”). Even the upper limit of 11% of the net profits can be exceeded by passing an ordinary resolution at the shareholders’ meeting.[1][2]

Governance Issues

The Government’s decision to de-control managerial remuneration and leave the decision of remuneration entirely to the shareholders has created different challenges for the regulators and the minority shareholders. According to the provisions of the Act and the regulations of the Securities and Exchange Board of India (“SEBI”) applicable to listed companies, promoters or controlling shareholders are allowed to vote on their own remuneration resolutions because these are not regarded as related-party transactions.

The research reports of the proxy advisory firms have clarified the following important governance aspects:

“In case of director’s remuneration practices, the low scoring companies had skewed remuneration practices or excessive remuneration to certain class of directors’ & non-disclosures of rationale for skewed remuneration. Highest divergence was observed in directors’ remuneration.”[3]

“The level and composition of executive remuneration should be appropriately structured to attract and incentivize the top management. It further believes that remuneration of executive directors should be used to align their focus with the company’s goals and performance. Excessive remuneration, especially in underperforming companies, are a major cause of concern for stakeholders. To promote greater accountability and discipline, companies must ensure that the growth in remuneration for its executive director is in line with growth in profits and revenues. It believes that to align pay with performance, the remuneration structure of executive directors must majorly comprise of variable pay, a sizeable portion of which must be in form of long-term incentives.”[4]

Another issue arises when Indian companies have many subsidiaries in various jurisdictions globally. Directors drawing remuneration from such companies might also earn remuneration from the foreign subsidiaries not subject to regulation, which results in inadequate disclosure of managerial remuneration in the Corporate Governance Report/ Directors’ Report, which forms part of the annual report of the company for the relevant financial year.

Presently, most listed companies seem to be taking a view that there is no restriction on voting by the related parties on the remuneration resolutions of the promoters, either under the Act or under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“Listing Regulations”). However, this does not seem to be SEBI’s view. In fact, the recently published report of the Mohanty Committee[5] [constituted by SEBI  to revise the Listing Regulations and SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (“ICDR”)] has made a specific recommendation for the amendment of  the Listing Regulations to provide that the remuneration and sitting fees paid by the listed entity or its subsidiary to its director, key managerial personnel or senior management, except who is a part of the promoter or promoter group, may be exempted from the requirement of approval by the audit committee provided it is not crossing the materiality threshold stipulated under regulation 23 of the Listing Regulations.  

The proxy advisors, as a matter of good governance practice, are issuing an “against” recommendation on promoters voting on their remuneration resolution. There have also been several recent instances where, based on the recommendations given by the proxy firms, the shareholder resolution for payment of managerial remuneration to promoter executive directors has been rejected. Moreover, such instances have been seen in listed companies where the public shareholding percentage is comparatively high.    

An analysis by the proxy advisory firm IiAS suggests that, in 2022, had promoters not been allowed to vote, of the 211 promoters’ remuneration resolutions, 68 (i.e., 34%) would have been defeated. The investors’ main concerns included the compensation level of promoters, compensation structuring, and disclosure levels. That many promoters are also members of the Nomination and Remuneration Committee adds another layer of conflict of interest to the decision-making process. The regulators are evaluating whether the resolutions for promoter compensation should be subject to a “majority of minority” votes and whether companies must make a minimum set of disclosures while seeking shareholders’ approval.

This has further led to a broader discussion on whether the controlling shareholder owes fiduciary duty (as envisaged in Delaware Corporation Law) and is prohibited to vote on such resolutions. In re Sears Hometown & Outlet Stores, Inc.,[6] the Court held that when a controlling stockholder acts to change the status quo, it owes limited fiduciary duties to the corporation and the minority stockholders. The Court also noted that a controlling stockholder does not owe fiduciary duties when refusing to sell shares or voting against a proposed transaction. The Court stated that in exercising its voting powers as a stockholder, a controller need not meet the higher standard applied to directors, who must act affirmatively to promote the best interest of the corporation.

The Supreme Court of India in Sangramsinh P Gaekwad v. Shantadevi P. Gaekwad[7]. held:  

“Such a fiduciary duty would arise inter alia in exceptional situations when the Directors take upon themselves the task of advising the shareholders who may be their family members, or when a transaction of purchase or sale is entered into by and between the Director and the shareholders, wherein the former takes undue benefit or has ill or improper or ulterior motive or mala fide acts solely to make a pecuniary benefit and gain for himself and to the detriment of such shareholders. If a general fiduciary duty of a director vis-à-vis shareholders is laid down, the same would lead the Directors to the risk of multiple legal actions by dissenting minority shareholders”.

Further deliberation and review of the law is necessary to settle this conflict between corporate governance aspects and majority rule.

Since the Companies (Amendment) Act, 2017 (which was pursuant to the Company Law Committee Report of February 2016) eliminated the requirement for prior Central Government approval for payment of managerial remuneration in excess of the Schedule V limits, managerial remuneration has been subject only to shareholder’s approval by a special resolution. If the special resolution is passed, no limit is applicable on the extent of managerial remuneration that can be paid.

While all these changes relate to managerial remuneration, the limits on sitting fees remain the same and are regulated under the Act and the rules framed thereunder (i.e., Rs. 1,00,000 per meeting)[8]. If it is possible to approve and pay the larger remuneration without any limits prescribed in the law by passing a special resolution, then there is no rationale for restricting the amount of sitting fees per board meeting.

Are the Clawback Provisions under Section 199 of the Act Adequate?

In a first, section 199 of the Act has introduced a provision in connection with the recovery of excess remuneration paid upon the re-statement of financial statements. The company would have to re-state its financial statements due to fraud or non-compliance with any requirement under the Act or the rules prescribed. The provision is applicable to the managing director, whole-time director, manager, or chief executive officer but not to the independent directors. The Ministry of Corporate Affairs needs to reassess this provision, and it should include the independent directors as well.

The recovery of excess payments is also mandatory. The aforesaid section is invoked when remuneration paid is more than the profits for the year as per the re-stated accounts. The recovery is without prejudice to any liability incurred under the Act or under any other law. The recovery of remuneration will include stock options.

Concluding Thoughts

The de-control of managerial remuneration has led to instances of some promoter directors drawing excessive remuneration. The Government of India, while uncomfortable with such excessive payment, has consciously chosen not to interfere, given that government control over the remuneration had not proved to be effective and had led to certain unhealthy practices in compensating managerial personnel. Proxy advisory firms have also become active in scrutinising proposals for managerial remunerations. They have advocated that SEBI disenfranchise the promoters from voting on their own resolutions because of the direct conflict of interest. The regulator is yet to introduce any amendments to deprive the promoter of voting rights; however, there are certain restrictions under regulation 17 of Listing Regulations with respect to obtaining the approval of the shareholders. Several advanced jurisdictions recognise the fiduciary duty of controlling shareholders; hence it is high time India introduces this principle under its company law to prohibit promoters from voting on their own remuneration resolutions, particularly in listed companies.

If such a provision is challenged in a court of law, it is very likely that Indian courts will uphold the constitutional validity of this requirement, since there is  a direct nexus with the regulatory objective of avoiding conflict of interest – and Indian courts may likely hold that promoters voting on their own remuneration is a classic case of conflict of interest (as the promoters are effectively acting as a “judge in their own cause”), and taking away the voting rights of the promoter by a law passed by Parliament is within the parameters of proportionality and non-arbitrariness under Articles 14, 19 and 21 of the Constitution of India.

– Bharat Vasani & Miloni Mau

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[1] the remuneration payable to anyone managing director or whole-time director or manager shall not exceed five per cent of the net profits of the company; and if there is more than one such director, remuneration shall not exceed ten per cent of the net profits to all such directors and manager taken together;

the remuneration payable to directors who are neither managing directors nor whole-time directors shall not exceed,–

(A) one per cent of the net profits of the company if there is a managing or whole-time director or manager;

(B) three per cent of the net profits in any other case.

[2] Regulation 17 of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 mentions that “the fees or compensation payable to executive directors who are promoters or members of the promoter group, shall be subject to the approval of the shareholders by special resolution in general meeting, if

• the annual remuneration payable to such executive director exceeds rupees 5 crore or 2.5 per cent of the net profits of the listed entity, whichever is higher; or
• where there is more than one such director, the aggregate annual remuneration to such directors exceeds 5 per cent of the net profits of the listed entity:

[3] SES ESG Research Report

[4] IiAS voting guidelines 2024-25

[5] Report of the Expert Committee on Recommendations for facilitating ease of doing business and harmonization of the provisions of ICDR and LODR Regulations dated June 26, 2024

[6] 2019-0798-JTL,2024 WL 262322 (Del. Ch. Jan. 24,2024)

[7] (2005) 11 SCC 314

[8] Rule 4 of the Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014