Compensation for Loss of Office

Companies Act – Compensation for Loss of Office

Companies Act – Compensation for Loss of Office

Companies may decide to pay compensation at the time of discontinuing the services of Key Managerial Personnel (KMP). The Companies Act provides restrictions for companies which are paying compensation to KMP at the time of termination of service. KMP refers to the individuals who have overall responsibility for the functioning of the company. KMP is also responsible for the company’s compliance with the provisions of the Companies Act, 2013. KMP includes the Chief Executive Officer (CEO), Company Secretary, Chief Financial Officer (CFO), Managing Director (MD), Whole-time Director (WtD) and General Manager (GM) of a company. Appointment of KMP is mandatory when the assessee is a listed company. Listed companies are companies whose outstanding paid-up capital is traded in the National Stock Exchange (NSE), Bombay Stock Exchange (BSE) or Calcutta Stock Exchange (CSE). Public companies which have a paid-up share capital of ten crore rupees or more should also mandatorily appoint KMP.

The Government of India (GoI) observed that companies were using the funds of shareholders to pay excessive compensation to KMP. To address the issue, the GoI introduced restrictions on the maximum amount of compensation payable. The restriction is part of an overall initiative by the GoI to prevent misuse of shareholders’ funds. The misuse takes place when public limited companies pay abnormally large amounts as compensation to KMPs. By introducing restrictions on the payment of unusually high compensation to KMP, the GoI ensured that funds invested by the public are efficiently utilised.

Rules for Payment of Compensation

The rules which should be followed by companies that make payment of compensation for loss of office are mentioned in Section 202 of the Companies Act 2013. The rules are explained below:

Eligibility for Compensation

The Companies Act permits compensation for loss of office to be paid to the MD, WtD and GM of a company. Other directors are not eligible to receive compensation. The compensation should be paid as consideration for the retirement of the KMP from the service of the company. However, the retirement should not have been voluntarily made by the KMP. The company should have decided to remove the KMP on account of business-related reasons.

Compensation for Voluntary Resignation

The company may be placed in circumstances of economic difficulty. In such instances, the company may decide to terminate the services of those KMP which are drawing high remuneration. Thus, the initiative to discontinue the services of the KMP has originated from the company. Hence, in such circumstances, the company can pay compensation. However, the company should ensure that it avoids paying compensation over and above the amount determined by the terms of the appointment. Also, the compensation paid to the KMP should not be disproportionately excessive in comparison with the duties and responsibilities undertaken.

Applicability to Reappointed Individuals

The KMP may resign from the service as a result of reconstruction or reorganisation of the company. The reconstruction or reorganisation may take place on account of amalgamation or demerger. The KMP who is working in an organisation may be appointed as a KMP again. The subsequent appointment may be granted in the company, which results from the reconstruction or reorganisation. In such circumstances, the company should not pay compensation.

Liquidation Caused by Negligence

The company may be liquidated voluntarily or by order of the National Company Law Tribunal (NCLT). Circumstances for liquidation are generally caused since the company is undergoing economic hardship. However, liquidation can also be caused by the actions of the officers of the company. The officers in the employment of the company could have committed an act of negligence or error, thus making liquidation necessary. In such circumstances, the KMP is not eligible to receive any compensation. Also, compensation should not be paid concerning the transfer of any property belonging to the company.

Discontinuation of Business

A company may be in the process of discontinuing the business. The assets of the company after deducting the expenses of liquidation may not be sufficient to repay the capital to the shareholders. The insufficiency may arise at the time of termination of the services of the KMP. It may also occur twelve months following the date of termination. In such circumstances, the KMP is not eligible to receive any compensation.

Compensation Limit

The maximum period for compensation should be remaining years of service or three years, whichever is shorter. The maximum per month compensation should be a three-year average remuneration. The average should be calculated by considering the salary drawn during three years preceding the date on which the termination was implemented.

Compensation in Disqualification Cases

When specified disqualification circumstances are attracted, the company should remove the KMP from service mandatorily. In such circumstances, compensation should not be paid. The specified disqualification circumstances are the following:

  • When a court has determined that the individual is of unsound mind
  • When insolvency proceedings are pending against the individual
  • When the individual has been convicted by a court and sentenced to more than six months’ imprisonment
  • When the individual has not paid share call-money even after it has been outstanding for more than six months
  • When the individual has caused the company to enter into related party transactions without informing the shareholders about the nature of interest in the transaction
  • When Form DIR 3 was not filed at the time of appointment of the individual as a GM, MD or WtD in the company
  • When the company has made a default in repayment of public deposits or debentures
  • When the company has made a default in payment of the interest on public deposits or debentures
  • When the company has made a default in a loan-related payment which should be made to nationalised banks or public financial institutions towards interest or principal
  • When the company has made a default in payment of Income Tax, GST or any other statutory obligation
  • When outstanding dues to the employees the company have not been paid
  • When the company has not paid a dividend on preference shares on the due date
  • When the company, being a listed entity, has violated the listing agreements entered into with the NSE, BSE or CSE
  • When the company has failed to redeem preference shares on the due date

Compensation for Transfer of Controlling Interest

  • At a general body meeting of the company, an offer may be made for purchasing the shares of the company. The purchase may result in the availability of controlling interest for the buyer. A controlling interest means the ownership of more than thirty-three percentage in the paid-up capital of a company.
  • An offer of shares made at a general body meeting could result in the transfer of controlling interest to the buyer of the shares. The KMP may receive compensation in connection with the agreement for the transfer. The compensation received in such cases will be governed in the same manner as compensation paid for loss of office.
  • Further, the payment of compensation should also be approved by the shareholders in a general body meeting. To indicate approval, the shareholders should pass a resolution. The resolution should indicate that shareholders have no objection to the payment of compensation to the KMP.
  • The resolution passed by the shareholders for approving the payment should contain the following details:
    • Name and Directors’ Identification Number (DIN) of the KMP
    • The amount which is proposed to be sanctioned
    • Particulars of the event concerning which compensation has become payable and justification for the amount paid
    • Board meeting details for the board meeting which recommended that compensation should be paid
    • The reference number of the Form MGT 14 which was submitted to the Registrar of Companies (RoC) for filing the minutes of the board meeting
    • The fact of whether any of the directors refrained from participating in the proceedings of the meeting although physically present, together with the reason for non-participation
    • In case a director in the company has any financial interest in the resolution, the reference number of the Form MBP 1 which was submitted to the RoC for filing the details of the financial interest
  • The payment may have been made before the shareholders passed the resolution. In such cases, the KMP should hold the money in trust on behalf of the company. In case the resolution is rejected by the shareholders, the funds should be returned. In case the KMP fails to make the repayment within seventy-five days, a fine of one lakh rupees should be paid. The penalty will also be payable in case a default is made in complying with any other legal requirement which applies to the payment of compensation.

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