Managerial Remuneration Without Profits: Schedule V

Managerial remuneration without profits is not a discretionary payment. Where a company has no profits or its profits are inadequate, section 197(3) of the Companies Act, 2013 bars it from paying its directors any sum by way of remuneration, exclusive of the sitting fees under section 197(5), except in accordance with Schedule V. Schedule V Part II is where the numbers live, and the ceiling there is a rupee figure driven by effective capital, not the percentage of net profits that governs a profitable company.

What are the limits on managerial remuneration without profits?

Schedule V Part II Section II carries the table. Section II itself was substituted by Notification No. S.O. 2922(E) dated 12 September 2016, and Table (A) inside it was substituted again by Notification No. S.O. 1256(E) dated 18 March 2021. The words "without Central Government approval" were omitted from the Section by Notification No. S.O. 4822(E) dated 12 September 2018, which is why the table is now read on its own rather than as the threshold above which a company applied to the Central Government.

Two riders sit on the table. The proviso allows remuneration above these limits if the resolution passed by the shareholders is a special resolution, and that wording was substituted by Notification No. S.O. 4822(E) for "Provided that the above limits shall be doubled". The change matters: the old rule capped the excess at twice the table, the new one does not cap it at all and puts the whole question to a special resolution. The Explanation then pro-rates the limits for a period of less than one year.

The India Code consolidation prints the same notification number two ways on adjacent pages, as G.S.R. 2922(E) in the Part I footnote and as S.O. 2922(E) in the Part II footnote, both dated 12 September 2016. The series letter should be checked against the notification itself before it is relied on.

What is effective capital, and as of when is it measured?

Effective capital is defined by Explanation I to Part II and it is not net worth. It is the aggregate of paid-up share capital excluding share application money or advances against shares, the credit balance of the share premium account, reserves and surplus excluding revaluation reserve, and long-term loans and deposits repayable after one year, excluding working capital loans, overdrafts, unfunded interest due on loans, bank guarantees and other short-term arrangements. From that aggregate you subtract investments, accumulated losses and preliminary expenses not written off. An investment company whose principal business is acquiring shares, stock, debentures or other securities does not subtract its investments.

The measurement date is fixed by Explanation II. Where the appointment is made in the year the company was incorporated, effective capital is calculated as on the date of appointment. In every other case it is calculated as on the last date of the financial year preceding the year in which the appointment is made. Explanation V defines negative effective capital as effective capital below zero, which is what puts a company into the first row of the table.

Which conditions must be met before the limits apply?

The "Provided further" proviso to Section II, the one opening "Provided further that the limits specified under items (A) and (B) of this section shall apply, if", makes the table conditional. All four have to hold. It is not the proviso immediately under Table (A), which is the special-resolution one, and it is not item (B)'s own proviso on employee shareholdings, which is set out below.

1. Payment of remuneration is approved by a Board resolution and, in a company covered by section 178(1), by the nomination and remuneration committee.
2. The company has not defaulted in payment of dues to any bank, public financial institution, non-convertible debenture holder or other secured creditor. Where it has defaulted, the prior approval of that creditor must be obtained before the approval in general meeting is sought.
3. An ordinary or a special resolution, as the case may be, has been passed for remuneration under item (A), or a special resolution for remuneration under item (B), for a period not exceeding three years.
4. A statement accompanies the notice calling that meeting, carrying general information about the business, information about the appointee including past remuneration and any pecuniary relationship with the company, the reasons for the loss or inadequate profits and the steps proposed, and the four remuneration disclosures that must appear under the Corporate Governance head of the Board's report.

Item (B) is the professional-capacity route. A managerial person functioning in a professional capacity may be paid as per item (A) if he holds no interest in the capital of the company, its holding company or its subsidiaries, directly or indirectly or through any statutory structure, has no direct or indirect interest in or relationship with the directors or promoters of those companies at any time in the two years before, on or after appointment, and holds a graduate-level qualification with expertise in the field the company operates in. An employee holding shares under an employee scheme, including an employee stock option plan, not exceeding 0.5 per cent of paid-up share capital is deemed not to have an interest in the capital.

When can a company pay more than Section II allows?

Section III lists the special circumstances in three lettered clauses, the middle one of which carries three separate cases.

• Clause (a), the other-company route: the excess is paid by another company that is a foreign company or has the approval of its shareholders in general meeting, and that company treats the amount as managerial remuneration within its own section 197 limits.
• Clause (b), three cases of a company in an early or a distressed state: a newly incorporated company for seven years from incorporation, a sick company under a Board for Industrial and Financial Reconstruction revival scheme for five years from sanction, and a company whose resolution plan has been approved by the National Company Law Tribunal under the Insolvency and Bankruptcy Code, 2016, for five years from approval.
• Clause (c), different in kind from both: remuneration that exceeds the Section II limits but has been fixed by the Board for Industrial and Financial Reconstruction or the National Company Law Tribunal, so the excess is one an authority has already set rather than one the company proposes.

Clause (b) was substituted by Act 31 of 2016, section 255 and the Eleventh Schedule, with effect from 15 November 2016, and the words allowing "any remuneration" replaced "remuneration up to two times the amount permissible under Section II" by Notification No. S.O. 4822(E) with effect from 12 September 2018.

Section III comes with its own conditions on top of Section II's, and there are three of them. Condition (i) is that the managerial person receives no remuneration from any other company, except under clause (a). Condition (ii) is a certificate by the auditor or company secretary, or a secretary in whole-time practice where none is appointed, that all secured creditors and term lenders have stated in writing that they have no objection to the appointment and to the quantum of remuneration, and the Act requires that certificate to be filed along with the return under section 196(4). Condition (iii) is a separate certificate by the same persons that there is no default on payments to any creditors and that all dues to deposit holders are being settled on time. The filing requirement sits inside condition (ii) only: the Section states none for condition (iii).

Section V handles the two-company case: a managerial person may draw from one or both companies provided the total does not exceed the higher maximum admissible from any one of them.

Why the 18 March 2021 change matters to a reader of a filing

Two things happened on the same date. Notification No. S.O. 1256(E) inserted "or other director" into Sections I, II and III of Part II and gave Table (A) its second column, and Act 29 of 2020, section 32 inserted the proviso to section 149(9) allowing an independent director at a company with no or inadequate profits to receive remuneration in accordance with Schedule V. Before that date a loss-making company had a Schedule V answer for its managing director and no clean answer for its non-executive board. After it, both sit in the same table at different ceilings, and the Explanation inserted by the same notification defines "or other director" as a non-executive director or an independent director.

Part III of the Schedule keeps the shareholder gate on both Parts: appointment and remuneration under Part I and Part II are subject to approval by a resolution of the shareholders in general meeting, and the auditor or secretary certifies compliance in the return filed with the Registrar under section 196(4). Part IV lets the Central Government exempt classes of companies by notification.

Where managerial remuneration without profits shows up in a filing

The special or ordinary resolution is the visible artefact. A loss-making company paying under Schedule V has to put the item to members, and the statement accompanying that notice carries the appointee's past remuneration, the comparative remuneration profile, any pecuniary relationship with the company, and the company's stated reasons for the loss. The Board's report then carries the four disclosures under its Corporate Governance head, including the split between fixed pay and performance-linked incentives and the service contract, notice period and severance terms.

Where this sits in the disclosure picture

• Managerial remuneration under section 197 covers the percentage ceiling that applies when the company does have profits.
• Calculation of profits under section 198 covers the computation that decides whether profits are inadequate in the first place.
• Appointment of a managing director under section 196 covers the appointment that Schedule V Part I gates and Part II prices.
• Schedule IV, the code for independent directors covers the separate Schedule that governs an independent director's appointment terms.
• The nomination and remuneration committee covers the committee whose approval that proviso requires.

Flock reports the filings themselves, each stamped with its date and linked back to the exchange or regulator that published it. What any of it means for you is your call to make.