Compensation for Loss of Office Under Section 202 of the Companies Act, 2013

The companies can decide to pay compensation for loss of office to the Key Managerial Personnel (KMP) when discontinuing their services. Compensation for loss of office means a payment made by a company to their senior executive, manager or director who is forced to retire before the expiry of their service contract due to a merger, takeover or any other reason. Section 202 of the Companies Act, 2013 (‘Act’) contains provisions regarding compensation for loss of office of a KMP.

Eligibility for Receiving Compensation for Loss of Office

As per Section 202 of the Act, a company can make payment for loss of office to the following KMPs:

• A managing director.
• A full-time director.
• A manager.

A company can give compensation for loss of office or consideration for retirement from office to only the KMPs mentioned above and not to any other director. The company cannot pay compensation for loss of office or consideration for retirement from office to the KMPs who retire voluntarily. Further, the company can pay compensation under Section 202 of the Act only when it decides to remove the KMP for business-related reasons such as a merger or takeover.

As per the Act, a manager means an individual who manages the whole or substantially the whole of the company affairs subject to the Board of Directors’ control, superintendence and direction. A manager includes a director or any other person occupying a manager’s position, by whatever name called, whether under a service contract or not.

The Act defines the whole-time director as a director who is in the whole-time employment of a company. A managing director means a director who is entrusted with the substantial powers of the management of the company’s affairs by virtue of either of the following:

• Articles of a company. 
• An agreement with the company. 
• A resolution passed in the company general meeting. 
• Entrusted by the Board of Directors. 

Who Cannot Receive Compensation for Loss of Office?

As per the Act, a company cannot make a payment or give compensation for loss of office in the following cases:

• Where the director resigns from his office due to the reconstruction of the company or amalgamation with another body corporate and is appointed as the whole-time director, managing director, manager or another officer of the reconstructed company or the amalgamated body corporate.
• Where the director resigns from his office for reasons other than the reconstruction of the company or its amalgamation.
• Where the company is being wound up due to the default or negligence of the director, either by order of the Tribunal or voluntarily.
• Where the director is guilty of breach of trust or fraud relating to gross negligence or mismanagement of the conduct of company’s affairs or affairs of any subsidiary or holding company.
• Where the director instigated or took part indirectly or directly in bringing about the termination of his/her office.
• Where the office of the director is vacated due to the below reasons: 
  • The director absents himself from all Board of Directors meetings held during a year either without or with seeking leave of absence of the Board.
  • The director acts in contravention of Section 184 of the Act relating to entering into arrangements or contracts in which he/she is indirectly or directly interested.
  • The director fails to disclose his/her interest in any arrangement or contract in which he/she is indirectly or directly interested.
  • The director becomes disqualified by order of a court or the Tribunal.
  • The director is convicted by a court and sentenced to imprisonment for not less than six months, whether involving moral turpitude or otherwise. 
  • The director is disqualified under the Act to act as a director.

The director will be disqualified under the Act to act as director in certain circumstances and will not be eligible to get compensation from the company for the loss of office due to the disqualification. The circumstances where the director is disqualified for appointment as a director are as follows:

• The director is of unsound mind and is declared unsound by a competent court. 
• The director has applied to be adjudicated as an insolvent, and the application is pending.
• The director is an undischarged insolvent.
• The director has not paid any calls relating to any shares of the company held by him/her, whether jointly or alone, and six months have elapsed from the last day fixed for the payment of the call.
• The director is convicted of the offence dealing with related party transactions under Section 188 of the Act at any time during the preceding five years.
• The director has not complied with Section 152(3) of the Act. 

Further, Rule 17 of the of the Companies (Meeting of Board and its Power) Rules, 2014 provides that a company will not make payment as compensation for loss of office to a KMP in the following cases: 

• The company defaults in repayment of public deposits or payment of its interest.
• The company defaults in the redemption of debentures or payment of its interest. 
• The company defaults in repaying any liability (secured or unsecured) payable to any public financial institution, bank, or other financial institution.
• The company defaults in paying any dues towards VAT, income tax, service tax, excise duty, or any other tax/duty payable to the Central or State Government, statutory authority or local authority. 
• The company has outstanding statutory dues which have not been paid towards its workmen or employees. 
• The company has not paid dividends on preference shares or not redeemed preference shares on the due dates.

Payment Limit on Compensation for Loss of Office

The Act provides that the payment made to the eligible KMP as compensation for loss of office should not exceed the remuneration which the KMP would have earned if he/she were in the office for the remaining term, or three years, whichever is shorter. Thus, the compensation for loss of office made to the KMP will not exceed the remuneration which he/she would have earned during the following period, whichever is shorter:

• The remaining term of office.
• Three years.

The compensation for loss of office is calculated based on the average remuneration earned by the KMP during three years immediately preceding the date on which he/she ceased to hold office or where he/she held the office for a lesser period than three years. 

The company will not make the payment for compensation for loss of office to the director upon the commencement of the winding up of the company, and the assets of the company after deducting the expenses are not sufficient to repay the shareholders, including the premiums contributed by them.

Procedure for Payment of Compensation for Loss of Office

As per Rule 17 of the Companies (Meeting of Board and its Power) Rules, 2014, a company’s director will receive any payment as compensation only after passing a resolution at a general meeting approving the payment of such amount. The resolution should disclose the following details: 

• The name of the director.
• The amount proposed to be paid.
• The event due to which compensation is payable.
• Date of board meeting recommending the payment. 
• The basis for the determined payment amount. 
• The justification or reason for the payment. 
• The manner of payment, i.e. payable in cash or another mode.
• The sources of payment.
• Any other particulars as the Board may think fit.

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