KMP norms: Do they apply to private companies?
In 2005, the Government of India had constituted an expert committee headed by Dr. J.J. Irani to advise on revising and modernizing the Companies Act, 1956. The committee in its report (JJ Irani Report)[i] gave its views on various issues including on appointment, duties and obligations of the Key Managerial Personnel (KMP). Pursuant to the recommendations in the JJ Irani Report, the Companies Act, 2013 (Act) introduced the concept of KMPs. Section 203 of the Act provides that every listed company and every other public company having a paid-up share capital of INR 100 million or more shall have: (a) a managing director (MD), or chief executive officer (CEO) or manager and in their absence, a whole-time[ii] Director; (b) a company secretary (CS); or (c) chief financial officer (CFO), as whole-time KMP. It also provides that a whole-time KMP shall not hold office in more than one company at the same time (expect in a subsidiary, except that of a director if the board of directors of the company permits him in this regard). Section 203 further provides for punishment in case of contravention.
It should be noted that Section 203 does not mandate a private company to appoint a KMP, nor does it prohibit the voluntary appointment of KMPs by private companies for efficient management of their businesses. This puts to question whether Section 203 will apply in the event a private company voluntarily appoints a KMP. In Hamlin Trust & Ors. vs. LSFIO Rose Investments & Ors., the National Company Law Appellate Tribunal (NCLAT) has held that Section 203 of the Act should be followed where a private company voluntarily chooses to appoint KMPs.
Brief facts
Hamlin Trust and members of Rattan Family Group (Hamlin Trust) held 50% shares in Rattan India Finance Private Limited (Company), with LSFIO Rose Investment S.a.r.l (Rose Investment) being the other 50% shareholder. As per the Article of Association (AoA) of the Company, the right to appoint a CFO was with Rose Investments, however Hamlin Trust had the right to reject two such candidates of Rose Investment, post which the third candidate will stand appointed.
The third candidate proposed by Rose Investments as CFO of the Company was an individual already associated as KMP with another entity and not available whole time for the Company. Therefore, Hamlin Trust objected to the appointment of the CFO on the grounds that it is contrary to Section 203 of the Act. The appointment of the CFO 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.
NCLAT’s ruling
The NCLAT observed that Section 203 of the Act provides rational and reasonable norms for eligibility of a KMP which are relevant in conducting the affairs of a company in a transparent, independent, and unbiased manner, while keeping the interest of the company foremost. The NCLAT ruled that the NCLT had erred in hold that the provisions of the AoA of the Company for appointment of CFO are absolute and no contention on the basis of eligibility under Section 203 of the Act can be made a ground for rejection. The NCLAT ruled that provisions of the AoA cannot override the provisions of the Act and whenever 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. The NCLAT further held that all suggested candidates should satisfy the basic conditions of eligibility as required under Section 203 of the Act.
Accordingly, the NCLAT quashed the NCLT’s order and directed the shareholders of the Company to appoint a CFO in the manner provided under the AoA, while also complying with Section 203 of the Act.
Our thoughts
The NCLAT’s order has established that the appointment of KMPs by private companies as per the provisions of their AoA, will be illegal if it is in violation of Section 203 of the Act. It should be noted that earlier this year, the Registrar of Companies, Karnataka had levied a penalty on Landomus Reality Private Limited[iii] which had appointed its director as a CFO in violation of Section 203. It can be inferred that by applying Section 203 to private companies appointing KMPs voluntarily, the NCLAT and the ministry of corporate affairs intend to ensure proper compliances are met by a company for all its employees who are vested with the most important roles. This may be akin to the application of Section 177 of the Act to private companies that voluntarily set up an audit committee. Such private companies are then required to have their related party transactions approved by the audit committee, similar to listed companies.
However, it is important to consider that higher level of regulation is envisaged under the Act for public companies, having regard to the public interest in such companies. As opposed to this, private companies are closely held, and thus, governed largely by the constitution documents such as the AoA. A private company may choose to undertake voluntary actions, such as appointment of KMPs, to ensure good governance. Given the high costs associated with complying with rules and regulations, one may argue that subjecting such private companies to the same level of regulation and compliance as larger public companies may be an unnecessary compliance burden impacting business productivity. We are of the view that it is important to minimize unnecessary compliance requirements for private companies, while maintaining the effectiveness of the regulatory regime under the Act.