A key managerial person (“KMP”) plays a significant role in the conduct of affairs of the company and is responsible for adhering to the governance norms mandated under the Companies Act, 2013, (“Act”) and other applicable laws.
Under the Act, the term ‘KMP’ is defined under Section 2 (51) to mean – (i) the Chief Executive Officer or the managing director or the manager; (ii) the company secretary; (iii) the whole-time director; (iv) Chief Financial Officer; (v) such other officer, not more than one level below the Directors who is in whole-time employment, designated as key managerial personnel by the Board; and (vi) such other officer as may be prescribed.
In 2004, the Government of India constituted the JJ Irani Committee to give suggestions to the Government for improving existing regulations inter alia in relation to resolving issues arising under the Companies Act, 1956. The committee in its report dated 31 May 2005, suggested the identification of independent professionals who have a significant role to play in the conduct of affairs of a company, and determining the quality of its governance. The report identified the following professionals as KMP – Chief Executive officer (CEO) / Managing Director (MD), Company Secretary (CS), and Chief Finance Officer (CFO).
The recommendations of the JJ Irani Committee report find their place in Section 203 of the Act, which requires every listed company and every other public company having a paid-up share capital of ten crore rupees or more to have a whole-time KMP. Further, sub-section (3) mandates that a whole-time KMP shall not hold office in more than one company except in its subsidiary company at the same time. However, it is relevant to note that the private limited companies are exempt from the rigors of Section 203.
In the above background, this article seeks to analyze a situation where if a private limited company appoints a KMP, whether the restrictions and conditions stipulated under Section 203 of the Act apply to such a company.
In a recent decision of Hamlin Trust & Ors. Vs. LSFIO Rose Investments & Ors, the National Company Law Appellate Tribunal (NCLAT) held that if a private limited company appoints a CFO, which falls under the definition of KMP under Section 2(51) of the Act, it must follow the mandate of Section 203.
Brief facts of the case were that the shareholding of RatanIndia Finance Private Limited’s (RFPL) was held by Hamlin Trust and Rose Investments equally. The articles of association (AOA) of RFPL permitted appointment of a CFO, however, no procedure was prescribed for such an appointment.
Rose Investments appointed an individual as CFO, who was already associated with another entity as KMP. The appointment of the CFO by Rose Investments was challenged by Hamlin Trust before the National Company Law Tribunal (NCLT), which allowed such appointment. The NCLT’s order was then challenged before the NCLAT.
The NCLAT held that provisions of Section 203 would apply to RFPL as CFO is a KMP under Section 2(51) of the Act, and hence, all candidates should satisfy the eligibility criteria laid down under Section 203. Given that sub-section (3) mandates that a KMP should be engaged in a full-time capacity with the company, the NCLAT held that the appointment of CFO by Rose Investments is invalid and contrary to the provisions of Section 203. Further, the NCLAT held that provisions of AOA cannot override the provisions of the Act, and wherever the provisions of the AOA are silent, it is perfectly logical and rational that reference be made to the Act to consider the eligibility criteria of KMPs.
Further, in proceedings pertaining to Landomus Realty Private Limited, the Registrar of Companies (ROC) has levied a penalty on the company, which had appointed CEO and Chairman without requisite approvals and filings, and in violation of Section 203 of the Act.
From the foregoing judicial precedents, it appears that by bringing private limited companies within the fold of Section 203, even if such companies have appointed KMPs voluntarily, the intent of NCLAT and ROC appears to ensure that the private companies comply with the mandated requirements for the employees who are vested with important roles (such as CEO/CFO).
It is relevant to note that Section 177 of the Act, which provides for the audit committee, is not applicable for private limited companies. However, if a private limited company voluntarily constitutes an audit committee, then such company is required to have related party transactions approved by such audit committee, which is similar to requirement for listed companies.
Another illustration may be that of Section 197 of the Act which provides a cap on the remuneration of MD, whole-time director, and is not applicable to private limited companies. Hence, if the rationale upheld by NCLAT in the Hamlin Case, is applied here as well, then a private limited company would be required to follow the cap on directors’ remuneration as prescribed under Section 197.
Hence, if the decision of the NCLAT is read into other provisions of the Act, which per se are not applicable for private limited companies, then it may lead to increased compliance burden and costs over such privately held companies, which may not be the intention of the legislature. The prime intention of the legislature to differentiate a privately held company from that of public, is to ease compliance burden in conduct of their day-to-day affairs. However, the NCLAT’s view appears to be in contrast to the legislative intent of the Act.
Bharat Sharma is a Partner, Niyati Shroff and Manish Parmar are Associates at Naik Naik & Company.