Context
A managing director (“MD”) is the principal executive officer of a company, serving on its Board in an executive capacity and is at the helm of its affairs. He is primarily responsible for managing the day-to-day affairs of the company under the overall ‘superintendence, control and direction’ of the Board.
Section 2(54) of the Companies Act, 2013 (“CA 2013”), defines a MD as “a director who, by virtue of the articles of a company or an agreement with the company or a resolution passed in its general meeting, or by its Board of Directors, is entrusted with substantial powers of management of the affairs of the company and includes a director occupying the position of managing director, by whatever name called”. The Companies Act, 1956 (“CA 1956”), also had a proviso to clarify that a MD exercises his powers subject to the superintendence, control and direction of its Board, but it has been omitted from CA 2013 without any justification.
An MD, therefore, wears two hats ˗ one, as the senior most employee of the company and two, as the director of the company, where he acts in a fiduciary capacity and can be removed from his office only by the procedure laid down in Section 169 or if he vacates his office for any of the reasons stated in Section 167 of CA 2013. This position was also clarified by the Apex Court in Ram Pershad v. The Commissioner of Income Tax, New Delhi [1]. It was observed that an MD may operate in a dual capacity. He may be regarded as both, a director and an employee and hence, as an MD, he may personify a director or an employee or an agent, depending on the nature of his work and the terms of his employment. It was held that it is a ‘contract of service’ and not a ‘contract for service.’
Unfortunately, due to a drafting lacuna in the CA 2013, the termination of an MD from his executive capacities does not automatically result in him being removed as a director. Hence, many companies in India have started appointing CEOs instead of a MD so that he/she can be removed from their position without seeking shareholder approval. This blog will analyse the legal provisions of CA 2013 in comparison with their CA 1956 counterparts, and the practical challenges that arise due to the drafting gaps.
CA 1956
Section 283(1)(l) of the erstwhile CA 1956, stated that,
“(1) The office of a director shall become vacant if –
…
(l) having been appointed a director by virtue of his holding any office or other employment in the company, he ceases to hold such office or other employment in the company.”
A bare reading of this provision makes it amply clear that if an individual is appointed as a director by virtue of his holding any other office or employment, the director seat shall become vacant immediately after he ceases to hold such office. The Bombay High Court in Sunil K. Alagh v. Britannia Industries Limited[2] alsoweighed in on whether a director shall vacate its directorship if he/ she is appointed by virtue of employment in the company. The brief facts were that the Plaintiff held approximately 850 shares of the Respondent company and was promoted from position to position till his appointment as a general manager. Thereafter, the Board appointed him as a whole-time director in 1984 and MD in 1989. Certain events transpired, and in 1992, his powers as MD were revoked and withdrawn. Soon, the Plaintiff was also informed that he was no longer a director by virtue of Section 281(1)(l) of CA 1956 and a resolution was passed terminating his services. The Plaintiff then challenged this removal. The Bombay High Court, in their assessment, while relying on Sastri Committee’s Report, held that, “the plaintiff, by virtue of his employment, was appointed as a director of the company and on the employment coming to an end would automatically cease to be a director under the said provisions.”
CA 2013
With the introduction of CA 2013, the position changed. Section 167(1)(h) of CA 2013, states that,
“(1) The office of a director shall become vacant in case—
…
(h) he, having been appointed a director by virtue of his holding any office or other employment in the holding, subsidiary or associate company, ceases to hold such office or other employment in that company.”
The Standing Committee on Finance, which presented the Companies Bill, 2011 (now CA 2013), made an error by extending the provision to holding, subsidiary, or associate companies but not including the company itself. This creates a unique situation, as it would mean that a person is appointed as a director of a Company A by virtue of being a MD of any holding, subsidiary or associate company, upon parting ways with such holding, subsidiary or associate company, the individual shall vacate their office of director in the Company A as well; but if a person is appointed as a director of Company A by virtue of being the MD of Company A, he would not have to vacate the office of director under Section 167 of CA 2013.
A suggestion to revisit this lacuna was also made to the Companies Law Committee set up in 2015 to review issues arising out of the implementation of CA 2013. In para 11.16 of the Report of the Company Law Committee, dated February 1, 2016, they observed that, “the Committee considered and did not agree to the suggestion to amend Section 167(1)(h), because in the Committee’s opinion, the provision was clear, and referred to an automatic vacation of the office of a Director where a person was appointed as such a Director, by virtue of his holding any office, or other employment in the holding, subsidiary or associate company.”
Practical Challenges
A few practical challenges arise due to the drafting lacuna as discussed above. The first is increased compliance, as the only option available with the company is to follow procedure to remove the director under Section 169 of CA 2013. This comes with its own challenges, for example:
- There are situations where the person turns hostile and makes it more difficult for the company to comply with procedure for removal. For example, Section 169(3) provides for the right to being heard by the director; in case the individual turns hostile, they request for innumerable confidential documents to make effective representation, almost making it impossible for the company to furnish it. It also occurs that the said individual leaks information from such confidential documents, cause irreparable reputational damage to the company.
- The company now requires an ordinary resolution to remove a director, enhancing compliance compared to the previous CA 1956 regime where the individual immediately vacated their office upon being fired as MD.
- Section 179(3) mandates a Board resolution at a Board meeting for removal of any key managerial personnel, and not through a circular resolution. This involves its own challenges, as the Secretarial Standards – 1 require circulation of agenda and notice seven days prior to the meeting, etc., thereby providing sufficient time to the MD to move the Court for a stay and/or leak such information.
- Section 178(2) also requires the Nomination and Remuneration Committee (“NRC”) to recommend to the Board, the appointment and removal of each director, and also carry out evaluation of their performance. However, the Division Bench of the Bombay High Court in Invesco Developing Markets Fund v. Zee Entertainment Enterprises Limited[3], while overturning the decision of the Single Judge, held that the intention of the CA 2013 was not to restrain the shareholders from appointing/removing a director without the recommendation of the NRC and hence, there are no fetters on the power of shareholders under Section 169 of CA 2013 to appoint/remove a director.
- In case of listed entities, SEBI often seeks for reasons or grounds for removal of a MD. This however is in conflict with the judgement of the five judge bench of the Supreme Court in Life Corporation of India v. Escorts[4] where it was held that LIC, being a shareholder of Escorts Limited, had the right to remove any director and they cannot be restrained from doing so nor is it bound to disclose its reasons for moving the resolutions. It was also clarified that the reasons for removal, if provided, are not subject to judicial review.
Another issue that arises is that a director is not liable to compensation if he/ she automatically vacates office by virtue of Section 202(2)(c) of CA 2013. However, since the drafting lacuna requires the company to initiate procedure for removal under Section 169, the MD can claim remuneration of the director, under Section 202, viz. the remuneration the director would have earned had he completed his term or the next three years, whichever is shorter, calculated basis an average remuneration actually earned by him during the preceding three years. However, since Section 202(4) does not prohibit payments by the company to the MD, in any other capacity, it provides the company flexibility to determine the severance package of an exiting MD, as an MD is appointed as a consultant or an equivalent position. This, however, is nowhere close to the hefty severance packages received by the top management in the US, which range from $10 million to $40 million, on a case-to-case basis.
Since the legislative backing for automatic vacation is done away with, private companies often include a clause in the employment agreement with the MD to the effect that in case of removal as MD, they will cease to be a director of the company. However, the same is not the case with public companies, as the language of Section 167(4), when read while applying rule of construction of necessary implication, precludes public companies from providing any grounds for vacation of office except those stated in Section 167(1) of CA 2013. This position was affirmed in the context of the erstwhile CA 1956 by the Bombay High Court in Cricket Club of India Ltd. v. Madhav L. Apte[5], where in its analysis of determining the implication of Section 274, it held that Section 283(3) of CA 1956 precluded public companies from including any grounds for vacation besides those prescribed in law.
Conclusion and the Way Forward
In our opinion, Section 167 needs to be amended to correct this drafting lacuna as otherwise it leads to companies continuously being forced to adopt the cumbersome procedure for removal under Section 169, which often ends in litigation. Moreover, Section 167(4) prohibits a public company from including a contract clause that automatically removes a director if they stop being the managing director.
This anomaly needs to be rectified in the next round of amendments to CA 2013.
[1] AIR 1973 SC 637
[2] [1993] 1 CLA 68
[3] 2022 SCC OnLine Bom 630
[4] (1986) 1 SCC 264.
[5] 1974 SCC OnLine Bom 40.
