Section 197 of the Companies Act, 2013 and its Applicability to Private Companies

Section 197 of the Companies Act, 2013 and its Applicability to Private Companies. The Companies Act 2013 establishes a complete framework for corporate governance, and an important component of this framework is the regulation of managerial remuneration. Section 197 of the Act plays an important role in this regard, setting limits on overall maximum managerial remuneration and addressing remuneration in specific circumstances, such as the absence of a managing director or a full-time director. This article explains the provisions of Section 197, analyses its applicability, and examines the compliance obligations it imposes, with a focus on its applicability to private companies.  
Legislative Framework and Purpose
Section 197 of the Companies Act, 2013, aims to ensure transparency and accountability in the determination of managerial remuneration. The primary principle is to prevent excessive payouts to managerial personnel, thereby safeguarding the interests of shareholders and promoting corporate responsibility. The section establishes ceilings on the overall managerial remuneration payable by a company and provides for specific scenarios, such as the absence or inadequacy of profits.  
Key Provisions of Section 197 of the Companies Act, 2013
1. Overall Maximum Managerial Remuneration (Section 197(1)):
(a) Subsection (1) of Section 197 specifies that the total managerial remuneration payable by a public company to its directors, including managing director, whole-time director, and manager, shall not exceed eleven percent of the net profits of the company for that financial year, except as otherwise provided in the section.  
(b) This provision establishes a critical threshold, ensuring that managerial remuneration remains within reasonable limits relative to the company's financial performance.
2. Remuneration in Case of Absence or Inadequacy of Profits (Section 197(3)):
(a) Subsection (3) addresses situations where a company has no profits or its profits are inadequate. In such cases, a company may, with the approval of its shareholders by a special resolution, pay remuneration in accordance with Schedule V of the Act.  
(b) Schedule V prescribes specific limits and conditions for remuneration payable in cases of absence or inadequacy of profits, taking into account factors such as the company's effective capital.  
3. Specific Components of Managerial Remuneration:
(a) Section 197 encompasses various components of managerial remuneration, including salary, perquisites, allowances, commission, and other benefits.  
(b) It is imperative for companies to ensure that all forms of remuneration are included in the calculation of the overall maximum limit.
4. Disclosure Requirements:
(a) The Act mandates that companies disclose details of managerial remuneration in their directors' report.  
(b) This requirement promotes transparency and enables shareholders to assess the reasonableness of the remuneration paid.  
Applicable Rules and Considerations
(a) Schedule V of the Companies Act, 2013, provides detailed guidance on the limits and conditions for managerial remuneration in cases of absence or inadequacy of profits.  
(b) The Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014, provide further clarity on the implementation of Section 197.
Applicability to Private Companies
It is very important to note that section 197 of the Companies Act 2013, relating to managerial remuneration, is primarily applicable to public limited companies. Private limited companies are generally exempted from the restrictions outlined in Section 197. Therefore, there is usually no statutory limit on the amount of managerial remuneration that can be paid by a private company.
This exemption is a significant distinction between the regulatory treatment of public and private companies. However, even though they are exempt from the limitations of section 197 it is still recommended that private companies manage their managerial remuneration in a way that is reasonable, and that reflects sound business practices.
Even though a private company is not forced to adhere to Section 197, if there are loan or financial agreements, those agreements may have clauses that put restrictions on managerial pay. So Private companies, should always refer to their loan, and financial agreements.
Compliance Obligations under the Companies Act, 2013
1. Determining Applicability and Limits
(a) Net Profit Calculation: Companies must accurately compute "net profits" for the financial year, as defined by Section 198 of the Companies Act, 2013. This calculation determines the 11% ceiling for managerial remuneration.
(b) Identifying Managerial Personnel: The term "managerial personnel," as per Section 197, includes the Managing Director, Whole-Time Directors, Manager, and other Directors. All remuneration paid to these individuals should be aggregated for the 11% calculation.
(c) Applying the 11% Ceiling: The total managerial remuneration must be compared to 11% of net profits. If it exceeds the limit, corrective actions, including shareholder approval, are required.
2. Remuneration in Cases of Absence or Inadequacy of Profits
(a) Assessing Profit Adequacy: Companies must assess if their profits are "absent" or "inadequate" with due diligence.
(b) Adherence to Schedule V: If profits are insufficient, companies must comply with Schedule V of the Companies Act, which outlines permissible remuneration based on factors like effective capital.
(c) Shareholder Approval via Special Resolution: If the remuneration exceeds the limits under Schedule V, shareholder approval via a special resolution (75% majority) is necessary. This requires a general meeting with clear justifications for the proposed remuneration.
3. Components of Remuneration
(a) Comprehensive Inclusion: All forms of remuneration must be included in the total calculation, such as salary, allowances (e.g., HRA, DA), perquisites (e.g., company car, medical benefits), commission, retirement benefits, stock options, and other payments in cash or kind.
(b) Valuation of Perquisites: Perquisites must be properly valued, following prescribed rules if applicable.
4. Disclosure Obligations
Directors' Report: Companies must disclose detailed managerial remuneration in the Directors' Report as part of the annual report, including remuneration paid to each director, commission details, perquisites, and justification for remuneration, particularly in cases of inadequate profits and a comparison of remuneration to company performance.
5. Record Keeping
Companies must maintain accurate records of all managerial remuneration for the prescribed duration, ensuring compliance with Section 197 and Schedule V.
Consequences of Non-Compliance
Non-compliance with Section 197 can result in (a) Penalties for the company and its officers, (b) Directors being liable to repay excess remuneration, and (c) Legal action from shareholders or regulators.
Conclusion
Section 197 of the Companies Act, 2013, plays an important role in regulating managerial remuneration, promoting transparency, and protecting shareholder interests. Public Companies must stringently adhere to the act, and it related schedule. However, private companies do not have the same restrictions. Therefore, they have greater freedom in determining managerial remuneration. Even though private companies have that freedom it is still a very good practice to follow reasonable business practices. Continuous monitoring of regulatory developments and professional support are important for ensuring compliance. You can connect with Compliance Calendar experts through mail info@ccoffice.in or Whatsapp/Call at +91 9988424211.
Frequently Asked Questions (FAQs)
Q1. What is the primary purpose of Section 197 of the Companies Act, 2013?
Answer: The primary purpose of Section 197 is to ensure transparency and accountability in the determination of managerial remuneration. It aims to prevent excessive payouts to managerial personnel, thereby safeguarding the interests of shareholders and promoting corporate responsibility.
Q2. What is the overall maximum managerial remuneration allowed under Section 197(1) of the Companies Act, 2013?
Answer: According to Section 197(1), the total managerial remuneration payable by a public company to its directors, including managing directors, 1 whole-time director, and managers, shall not exceed eleven percent of the net profits of the company for that financial year, except as otherwise provided in the section.  
Q3. How does Section 197 address remuneration in cases where a company has no profits or inadequate profits?
Answer: Section 197(3) addresses such situations. In cases where a company has no profits or inadequate profits, it may, with the approval of its shareholders by a special resolution, pay remuneration in accordance with Schedule V of the Act. Schedule V prescribes specific limits and conditions for such remuneration, considering factors like the company's effective capital.
Q4. What components are included in the calculation of managerial remuneration under Section 197?
Answer: Section 197 encompasses various components of managerial remuneration, including salary, perquisites, allowances, commission, and other benefits. It is imperative that all forms of remuneration are included in the calculation of the overall maximum limit.
Q5. Does Section 197 apply to private companies, and if so, how?
Answer: Section 197 primarily applies to public companies, setting limits on their managerial remuneration. Private companies are generally exempt from the restrictions outlined in Section 197. However, even though they are exempt from the limitations of section 197 it is still recommended that private companies manage their managerial remuneration in a way that is reasonable, and that reflects sound business practices.

The Companies Act 2013 establishes a complete framework for corporate governance, and an important component of this framework is the regulation of managerial remuneration. Section 197 of the Act plays an important role in this regard, setting limits on overall maximum managerial remuneration and addressing remuneration in specific circumstances, such as the absence of a managing director or a full-time director. This article explains the provisions of Section 197, analyses its applicability, and examines the compliance obligations it imposes, with a focus on its applicability to private companies.

Legislative Framework and Purpose

Section 197 of the Companies Act, 2013, aims to ensure transparency and accountability in the determination of managerial remuneration. The primary principle is to prevent excessive payouts to managerial personnel, thereby safeguarding the interests of shareholders and promoting corporate responsibility. The section establishes ceilings on the overall managerial remuneration payable by a company and provides for specific scenarios, such as the absence or inadequacy of profits.

Key Provisions of Section 197 of the Companies Act, 2013

1. Overall Maximum Managerial Remuneration (Section 197(1)):

(a) Subsection (1) of Section 197 specifies that the total managerial remuneration payable by a public company to its directors, including managing director, whole-time director, and manager, shall not exceed eleven percent of the net profits of the company for that financial year, except as otherwise provided in the section.

(b) This provision establishes a critical threshold, ensuring that managerial remuneration remains within reasonable limits relative to the company's financial performance.

2. Remuneration in Case of Absence or Inadequacy of Profits (Section 197(3)):

(a) Subsection (3) addresses situations where a company has no profits or its profits are inadequate. In such cases, a company may, with the approval of its shareholders by a special resolution, pay remuneration in accordance with Schedule V of the Act.

(b) Schedule V prescribes specific limits and conditions for remuneration payable in cases of absence or inadequacy of profits, taking into account factors such as the company's effective capital.

3. Specific Components of Managerial Remuneration:

(a) Section 197 encompasses various components of managerial remuneration, including salary, perquisites, allowances, commission, and other benefits.

(b) It is imperative for companies to ensure that all forms of remuneration are included in the calculation of the overall maximum limit.

4. Disclosure Requirements:

(a) The Act mandates that companies disclose details of managerial remuneration in their directors' report.

(b) This requirement promotes transparency and enables shareholders to assess the reasonableness of the remuneration paid.

Applicable Rules and Considerations

(a) Schedule V of the Companies Act, 2013, provides detailed guidance on the limits and conditions for managerial remuneration in cases of absence or inadequacy of profits.

(b) The Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014, provide further clarity on the implementation of Section 197.

Applicability to Private Companies

It is very important to note that section 197 of the Companies Act 2013, relating to managerial remuneration, is primarily applicable to public limited companies. Private limited companies are generally exempted from the restrictions outlined in Section 197. Therefore, there is usually no statutory limit on the amount of managerial remuneration that can be paid by a private company.

This exemption is a significant distinction between the regulatory treatment of public and private companies. However, even though they are exempt from the limitations of section 197 it is still recommended that private companies manage their managerial remuneration in a way that is reasonable, and that reflects sound business practices.

Even though a private company is not forced to adhere to Section 197, if there are loan or financial agreements, those agreements may have clauses that put restrictions on managerial pay. So Private companies, should always refer to their loan, and financial agreements.

Compliance Obligations under the Companies Act, 2013

1. Determining Applicability and Limits

(a) Net Profit Calculation: Companies must accurately compute "net profits" for the financial year, as defined by Section 198 of the Companies Act, 2013. This calculation determines the 11% ceiling for managerial remuneration.

(b) Identifying Managerial Personnel: The term "managerial personnel," as per Section 197, includes the Managing Director, Whole-Time Directors, Manager, and other Directors. All remuneration paid to these individuals should be aggregated for the 11% calculation.

(c) Applying the 11% Ceiling: The total managerial remuneration must be compared to 11% of net profits. If it exceeds the limit, corrective actions, including shareholder approval, are required.

2. Remuneration in Cases of Absence or Inadequacy of Profits

(a) Assessing Profit Adequacy: Companies must assess if their profits are "absent" or "inadequate" with due diligence.

(b) Adherence to Schedule V: If profits are insufficient, companies must comply with Schedule V of the Companies Act, which outlines permissible remuneration based on factors like effective capital.

(c) Shareholder Approval via Special Resolution: If the remuneration exceeds the limits under Schedule V, shareholder approval via a special resolution (75% majority) is necessary. This requires a general meeting with clear justifications for the proposed remuneration.

3. Components of Remuneration

(a) Comprehensive Inclusion: All forms of remuneration must be included in the total calculation, such as salary, allowances (e.g., HRA, DA), perquisites (e.g., company car, medical benefits), commission, retirement benefits, stock options, and other payments in cash or kind.

(b) Valuation of Perquisites: Perquisites must be properly valued, following prescribed rules if applicable.

4. Disclosure Obligations

Directors' Report: Companies must disclose detailed managerial remuneration in the Directors' Report as part of the annual report, including remuneration paid to each director, commission details, perquisites, and justification for remuneration, particularly in cases of inadequate profits and a comparison of remuneration to company performance.

5. Record Keeping

Companies must maintain accurate records of all managerial remuneration for the prescribed duration, ensuring compliance with Section 197 and Schedule V.

Consequences of Non-Compliance

Non-compliance with Section 197 can result in (a) Penalties for the company and its officers, (b) Directors being liable to repay excess remuneration, and (c) Legal action from shareholders or regulators.

Conclusion

Section 197 of the Companies Act, 2013, plays an important role in regulating managerial remuneration, promoting transparency, and protecting shareholder interests. Public Companies must stringently adhere to the act, and it related schedule. However, private companies do not have the same restrictions. Therefore, they have greater freedom in determining managerial remuneration. Even though private companies have that freedom it is still a very good practice to follow reasonable business practices. Continuous monitoring of regulatory developments and professional support are important for ensuring compliance. You can connect with Compliance Calendar experts through mail info@ccoffice.in or Whatsapp/Call at +91 9988424211.

Frequently Asked Questions (FAQs)

Q1. What is the primary purpose of Section 197 of the Companies Act, 2013?

Answer: The primary purpose of Section 197 is to ensure transparency and accountability in the determination of managerial remuneration. It aims to prevent excessive payouts to managerial personnel, thereby safeguarding the interests of shareholders and promoting corporate responsibility.

Q2. What is the overall maximum managerial remuneration allowed under Section 197(1) of the Companies Act, 2013?

Answer: According to Section 197(1), the total managerial remuneration payable by a public company to its directors, including managing directors, 1 whole-time director, and managers, shall not exceed eleven percent of the net profits of the company for that financial year, except as otherwise provided in the section.

Q3. How does Section 197 address remuneration in cases where a company has no profits or inadequate profits?

Answer: Section 197(3) addresses such situations. In cases where a company has no profits or inadequate profits, it may, with the approval of its shareholders by a special resolution, pay remuneration in accordance with Schedule V of the Act. Schedule V prescribes specific limits and conditions for such remuneration, considering factors like the company's effective capital.

Q4. What components are included in the calculation of managerial remuneration under Section 197?

Answer: Section 197 encompasses various components of managerial remuneration, including salary, perquisites, allowances, commission, and other benefits. It is imperative that all forms of remuneration are included in the calculation of the overall maximum limit.

Q5. Does Section 197 apply to private companies, and if so, how?

Answer: Section 197 primarily applies to public companies, setting limits on their managerial remuneration. Private companies are generally exempt from the restrictions outlined in Section 197. However, even though they are exempt from the limitations of section 197 it is still recommended that private companies manage their managerial remuneration in a way that is reasonable, and that reflects sound business practices.