Friday, 31 October 2014

Appointment of key Managerial personnel under Section 203 of the Companies Act,2013- Some perspectives

Much water has flowed down the bridge since the substantive provisions in the  Companies   Act, 2013 (herein after referred to as “the Act”) became operational from April 1,2014.The Act has been a subject of wide spread criticism from the Industry and the professional fraternity alike as it contains certain provisions which are regressive and retrograde and can hardly pass muster as an appropriate and contemporary substitute for the 1956 Act which  , it was felt, was an anachronism and had outlived its utility. The Ministry of Corporate Affairs has since soft-pedaled on some of the provisions as a typical knee jerk reaction to assuage the feelings of all and sundry and come out with a slew of    notifications and Rules , some of which are doubtful of legal scrutiny and sustainability, given the fact that they travel beyond the contours of the mother legislation. Be that as it may,   the  Act , to its credit does have several provisions which are intended to elevate the level of professionalism and corporate governance.

Section 203 of the Act which provides for the appointment of Key Managerial Personnel (KMPs) in Companies of a certain genre is one such provision in the right direction. The purpose of this exposition is to   capture   the  nuances of the provision and bring to the fore certain contentious issues that arise for consideration which provide considerable food for thought..For this purpose we shall dissect the section for the sake of clarity and understanding.

Applicability of Section 203

Section 203 (1) makes it clear that it   shall apply to such class or classes of companies as may be prescribed. Pursuant to the above,  Rule 8 in the companies (Appointment and Remuneration ) Rules,2014 lays down  that  every listed Company and every other public company having a paid up capital of Rs 10 Crore or more shall have whole-time KMPs. 

Public Company includes a Subsidiary private Company

A private Company which is a subsidiary of a public company is considered as a public company u/s 2(71) and therefore such a company will also come  within the ambit of the above requirement , provided it has the threshold paid –up share capital as above.

What constitutes paid up Share Capital for the purposes of Section 203

Section 2(64) provides a restrictive definition to the term “Paid-up share capital” and   it refers to the aggregate (emphasis supplied)amount of money credited as paid-up as is equivalent to the amount received as paid-up in respect of shares issued. As the Section does not  refer to any specie of shares in respect of which money has been paid –up and in addition it refers to an aggregation of  the amount of money credited against shares issued, in our view,  paid-up capital would include both Equity as well as preference capital.

Key Managerial personnel defined

Section 2(51) provides that in relation to a company, a KMP means:

i)  the chief Executive officer or the Managing director or the Manager ;

ii)  the company secretary;

iii) the whole-time Director;

iv)  the chief financial officer; and

v)  such other officer as may be prescribed.

Through the residual clause in the definition, the Central government has reserved its right to extend the contours of the above definition. The above   extension clause is yet to be invoked by the MCA.

A CEO need not be a Director of the Company

In addition to the above, it is pertinent to note that the Act also contains specific definitions to the terms ”Chief Executive Officer” and “Chief Financial Officer”.

As per Section 2(18) a   CEO , refers to an officer of the company who has been designated as such by it. From the above definition it follows that a person designated by the company as CEO need not be a Director of the Company although in Section 203 he is equated with Managerial persons such as the Managing Director, the Manager or in their absence, the Whole time Director. The remuneration payable to the CEO shall not be subject to regulation under Section 197 of the Act read with Schedule V in the Act , unless he is part of the Board or he is appointed as a Manager in addition to his designation as CEO.

MCA does a flip-flop - of the right type

The immediate fall-out of Section 203 as it stood on the date it was notified   was that   it had  made redundant  the appointment of Company Secretaries in all private Companies which have a paid-up share capital   less than  Rs 10 Crores. Readers are aware that under Section 383 A in the 1956 Act, every company whether public or private, having a paid-up share capital of Rs 5 crore or more has to employ a full time company Secretary. As Section 203  originally had no application to a private company which is not a subsidiary of a public company, the provision understandably caused an uproar in the fraternity of company secretaries many of whom would have been rendered  jobless if they were associated with private companies having  a paid up capital below the specified bench mark. In an  endeavor   to ameliorate the feelings   and not to endanger the futures ,particularly,   of  young  company secretaries ,MCA bowed down to the pressures and came up with a Notification  on June,9,2014 through the Companies (Amendment and Remuneration of Managerial Personnel) Rules,2014  to clarify that private companies having a capital of Rs 5 crore or more but below Rs 10 Crore would still have to appoint full time company Secretaries .However ,they  would not, for the purposes of Section 203 be considered as KMPs. Thus the shadow of uncertainty which hung over the futures of young   Company secretaries like the proverbial sword of  Damocles  has been lifted mercifully and thankfully.

Compliance with requirements of Section 203 is not prospective

A plain reading of Section 203 makes it obvious that its compliance is not from a prospective date and that  it is effective from the date on which it was notified for application namely   from April 1,2014. Readers will recall that the notification with regard to the date of application of the substantive provisions of the Act was issued in late  March ,2014 and it was therefore well neigh impossible for companies to ensure compliance of the requirements as early as  on April 1.2014.Appointmant of a CEO or CFO is not an activity which happens in a trice!. A decision as crucial as this is preceded by a considerable thought process involving identification of potential candidates, their selection, so on  and so forth. That the provision is not prospective in application is also clear from a plain reading of the second proviso to Section 203(3) which reads as under:

“Provided further that whole –time Key Managerial personnel holding office in more than one company at the same time on the date of commencement of this   Act…..”

From the above it is obvious that the Act postulates that the whole-time KMP would be associated with the company   from the date on which the Act came into operation.

It would have been appropriate and in the fitness of things if compliance of this provision were triggered off as of a prospective date. However, as per the law as it stands today potentially the whole of corporate India   could   be guilty of non compliance of the provision in some form or the other   as of April 1, 2014. In a procedural law such as the present Act, compliance provisions should inevitably be made applicable prospectively  so that the users get the time to assimilate the law and embrace it for future application. There should be , as they say a  ”grandfathering “clause in every  procedural legislation to facilitate compliance from a future date. This is not to suggest that there are no ”grand fathering “provisions in the present Act. For reasons which are bereft of logic, Section 203 has been   kick started from April 1, 2014. It remains to be seen as to how MCA responds to the spate of non-compliances which are inevitable on this score.

Status of persons occupying the position of KMPs prior to the introduction of Section 203 and action necessary for regularization of procedure

The terminology   of a KMP is a novelty   in the Act. Although companies have appointed persons for   the position of MD, Whole time Director and Manager in the past also  , in deference, in many cases, to the requirements of Section 269 in the 1956 Act,  such functionaries  have been bracketed as KMPs under the Act  for the first time. The question that   is   uppermost in the minds of the fraternity relates to   the nature of action to be taken under the Act in respect of persons occupying such positions prior to the inception of the new Act. Although there is lack of full clarity on the subject, our view is that   to bring  such functionaries within the ambit of the terminology  of KMPs and to ensure compliance with the provisions of  Section 203 ,companies impacted by the requirements ,will have to, at the first meeting of their  Boards  held post April 1,2014 propose the appointment of such persons as KMPs. Their appointments by the Board   will have to be preceded by recommendations for their appointment to be made by the Nomination and Remuneration committee of the Board to be set up pursuant to the requirements of Section 178 of the Act. As the thresholds   laid down under Section 203 and 178 are identical   , it follows that companies which have to be compliant with Section 203 will have to willy-nilly follow the procedure laid under Section 178 as well. Sub-sections (2) and (3) of Section 178 , make it abundantly clear that before appointing the KMPs ,the Board must seek the recommendation of the Nomination and Remuneration Committee  for their appointment, remuneration , terms and conditions thereof.

The procedure that we have advocated above may appear to be  convoluted and contrived, given the fact that calling a person who was hitherto i. e, before April 1,2014 a CEO, ,CFO,MD or CS as a Key Managerial personnel would be only analogous to pouring  old wine in a new bottle. In our view, the above procedure will have to be gone through    ,just  the same ,for a company  to be truly compliant , albeit belatedly ,with the requirements of Section 203.

Chairperson of the Company cannot be Managing Director or CEO

In all the advanced   Economies of the World there is a clear demarcation in the responsibilities of the Chair person of the Company in that he is expected to occupy only a non-executive position on the Board. This philosophy has also been advocated in the voluntary guidelines on corporate governance issued by the Department of Company Affairs in the year 2010.Taking a cue from the above, legal sanction to this   ethos has been accorded   in Section 203 of the Act. Except in cases where the Articles of the Company ordain otherwise or where the company   carries   on multiple businesses,   the chairperson of the company should not be appointed as the Managing Director or the CEO of the company. This is a welcome provision as it will ensure that there is no conflict of interest arising out of the same person acting as the Chairman and Managing Director of the company.

In case of a company which has multiple lines of business in respect of which CEOs have been appointed for each line, the chairperson can play the dual role of being the CEO of the company as well. MCA has vide its notification dated July 25, 2014 clarified that those public companies   which have a paid up share capital of Rs.100 Crore or more and an average turnover of Rs 1000 Crore or more and which are engaged in multiple businesses and have appointed chief Executive officers for each such business can   have a chairperson who is also holding the position   of the CEO in the  company.

Can the same person hold office of CFO / Managing Director

The question that is repeatedly being asked is whether the same person can occupy the position of the CS and CFO in the same company or whether as certain companies have done,   the same person can be the MD and CFO. There is nothing in the Section which expressly debars such an arrangement. In fact, a positive   inference can be drawn from a reading of sub-section (3) and the third proviso under the same  sub-section that the Act does contemplate such a situation.

Sub-Section (3) under Section 203   provides that a  whole-time key Managerial personnel shall not hold office in more than one company except in its subsidiary company at the same time.

The third proviso under Sub-Section (3) which corresponds to Section 316 in the 1956 Act allows the Managing director of a company to hold the position of the Managing director or Manager of   another company   subject to the appointment being approved unanimously by the entire Board of the other company as a meeting of the Board duly convened in this behalf.

Our submission is that when the Act   itself contemplates that a whole time KMP can be associated as a KMP in another subsidiary or as a Managing director or Manager of another company  ,albeit, after compliance with the required procedure  ,we do not see why the same person cannot double up as the CS/Manager or as CS/CFO or even as MD and CFO in the same company. The moot point is that it should be ensured that he is associated with the company in a full time capacity.

Another fall out of Section 203(3) would be that the same person can be the Company Secretary of the Holding company as also that of its subsidiary Company, a consequence which cuts across the logic that every company with the requisite capital base should have a full time Company secretary.

It is also pertinent to note that the threshold laid down for appointment of full time KMPs is abysmally low- a paid up capital base of Rs 10 Crore. That being so, it would not be fair to impose on marginal players the additional cost burden by stipulating that the Company should appoint separate persons for each of the positions to be carved out as KMPs. While making the same person   wear three different hats   as the CFO/CS and Manager  in the same Company would lead to dilution of the quality of governance  , we do not see why the same person cannot hold two different  designations simultaneously.

We would also state that companies were confronted with a similar predicament when Section 383A was introduced in the 1956 Act with effect from 1.2.1975 calling for the compulsory appointment of a “whole-time company secretary” in case of those companies which had a paid-up share capital beyond the prescribed threshold. The question arose as to whether the same person could be appointed as the “Financial Controller and Company Secretary” in the same Company. It is pertinent to note that both Section 203 and 383A carry the same terminology of “whole-time “ association  with a company where it comes to appointment of such functionaries. The consensus that emerged at that point in time was that by designating the same person  as “Financial controller and Company Secretary ’ ,the company would not be in any way making a compromise in so far as appointing a person in a whole time capacity as the company Secretary is concerned.. Strength  , it is often said,” does not always lie in numbers”. If the company finds a person   of competence to don the mantle of both a Company Secretary and say CFO or   as Manager ,we do not say how the company could be held guilty of violating the spirit of Section 203.

Our submission on the above stands fortified by the following views expressed in page no. 3990 in A. Ramaiya’s 17th Edition:

“There is no bar under section 383 A to appoint a qualified company secretary as Financial controller –cum-company secretary. The same person can discharge both the functions.

The object of clause (b) of sub-section (2) is that the Secretary of a company should be a whole-time officer.”

Appointment of KMP to be approved at a Meeting of the Board

Sub-section (3) of section 203 makes it clear that the appointment of a whole-time KMP should be approved by  a resolution of the Board. The Board should also settle the terms and conditions of the appointment including the remuneration payable to the KMP. That the above decision should be taken only at a Meeting of the Board and not through circulation becomes apparent when one reads Section 179 conjointly with Rule 8(2) of the companies (Meetings of Board   ) Rules ,2014.The removal of the KMP shall also be preceded by the similar process. There is also no scope for ratification of the appointment and approval should be accorded prior to the appointment becoming effective.

Board to approve continuance of KMP as Director of any company

It may well be that the person holding the position of a KMP is a Director in any other company. The   proviso to sub-section (3) makes it incumbent on the KMP to seek the permission of the Board in case he   wishes to continue his association as a Director in any other company. It would be good secretarial practice while recording the grant of the Board’s approval to the continuance of the KMP as a Director to note whether the KMP is in receipt of any pecuniary benefits other than sitting fees from the companies with which he is associated as director.

KMP to abdicate office held  as KMP in any other company

The second proviso to Section 203 (3) makes it necessary for the person holding the position of whole time KMP in  more than one company as on April 1,2014 to abdicate his office in one of the two companies within six months from the date of commencement of the Act. This proviso would not however come in the way of a KMP holding the position of KMP in a Subsidiary company as this is specifically permitted by Section 203(3) as discussed above.

No bar to appointing Managing Director or Manager of one Company as Managing Director  in another company

The third proviso under Section 203(3) runs on the lines of Section 316 in the 1956 Act. It provides that   any person holding the position of   Managing Director or Manager in one company can be appointed as  Managing director in another provided that such appointment is approved unanimously by all the Directors of the Company at a meeting convened for the purpose. It is necessary that the notice for the meeting convened for the appointment  should be issued to all the directors then in India.

From a plain reading  of  the above proviso one  can observe  an obvious flaw in the drafting of the Section 203(3). By   definition u/s 2(51)   a    Managing   Director or Manager of a company is a KMP. When the above proviso visualizes a person holding the  office of Managing Director in two companies , Subsection (3) ought to have been redrafted as under:

“Subject to the third proviso hereunder, a whole time key Managerial personnel shall not hold office in more than one company except in its subsidiary company at the same time”.

The above insert would have facilitated harmonious reading of the third proviso with Section 203(3).

Vacancy in the office of KMP to be filled up in six Months

Sub-section (4) recognizes that the appointment of a KMP is an elaborate process, given the onerous   responsibilities that the incumbent has to shoulder. The company has to select the   suitable candidate with the right credentials which are compatible with its requirements. With this end in view, sub-section (4) provides that in the event there arises a vacancy in the office of the KMP , the company will be allowed a cool-off period of six months within which to fill up the vacancy.

Stiff penalties for non-compliance

Sub-section (5) provides for a stiff penalty which is extendable up to Rupees five lacs  in the event of any non-compliance. This impost will be on the company. In addition, every director and KMP who is in default shall be liable to a fine which may extend up to Rs 50000.In the event that the contravention is continuous in nature a penalty of Rs 1000/ per day shall be imposed.

In our view, the penal provisions are stiff enough to make it imperative for a company to comply with the requirements of the Section.

Conclusion

In the above exposition we have tried to encapsulate the content of the law, brought to the fore some vexatious  issues which engage attention. One aspect which is conspicuous by its absence in the provision is   that, given the important role that the KMPs are expected to play in the company, there should have been some stipulation as regards their educational qualifications, to determine their eligibility to such office .In our view the Act should have provided a pre-requisite by way of professional qualifications for any one aspiring to be a CFO on the lines applicable for appointment as a company Secretary. The positions of an MD or WTD are not arguably specialist positions, in the same vein as a CS or a CFO and perhaps the existence of domain knowledge more than the existence of professional qualifications would be the predominant factor that would decide the suitability of the candidate for such positions. The other improvement that could have been brought about is that given the low threshold by way of paid up  capital, Marginal companies may have been given some concession in the matter of compliance. It is also inexplicable as to why private limited companies  which are not subsidiaries of public companies and which have a capital base of Rs 10 Crore or more have been exonerated from the requirements of appointing KMPs save and except for the requirement of appointing a Company Secretary where the threshold of Rs 5 crore is exceeded. Surely there is a case for appointing CFOs and other professionals in private Companies which have a  capital base above Rs.10 Crore ,given the complexities of modern business. Notwithstanding, the provision will usher in ,we hope,  better governance and  bring in the desired element of professionalism, traits  which are the cornerstone for India Inc  to stand shoulder to shoulder with the best of Corporations in the developed Economies.

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