This article has been authored by Indranil Chakravorty who is a fourth-year law student studying at the National University of Study and Research in Law, Ranchi.
Related party transaction can be defined as a transaction by a party related to a company in any other way besides companies' very own transactions. The current Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (hereinafter referred to as “LODR 2015”) is quite clear on its stance regarding ‘related party’. It includes within its ambit any persons or entities holding 20% or more shares of a specifically listed company as per Regulation 2(1)(zc). This can be in the capacity of a promoter or part of the promoter group of the concerned company. This is a clear indication towards a special relationship existing between the parties prior to the transaction taking place.
The pertinent risk of an inclination towards the related party with terms that could harm the interests of the company’s shareholders cannot be overlooked. Consequently, the SEBI Working Group on Related Party Transaction vis-à-vis its Report dated 22nd January, 2020 has suggested certain modifications in the provisions as per Related Party Transactions (hereinafter referred to as “RPTs”) with reference to Listing Regulations, 2015.
The Need for Amendment
Related party transactions (hereinafter referred to as “RPTs”) have always been regulated but owing to the major corporate scandals coming into light, the need for an amendment still exists. The SEBI Listing Regulations played a major role in bringing a substantive change in regulating the RPTs with reference to Section 297, Companies Act 1956. However, as per recent trends there is a dire need for amendments in the ‘approval, review and disclosure of RPTs’. The modern day complicated corporate structures are also one of the impetuses behind the call for such amendment in regularisation of RPTs. The misuse of power to influence transactions and lending is one of the most significant obstacles that the amendments need to tackle.
The major intent behind widening the definition of Related Party Transaction by the Working Group is to try and keep a check on transactions where there may be possibilities of an unrelated party being only a pretext or merely for name sake. In those cases, there is a clear requirement to lift the veil and determine the actual beneficiaries from the transaction and their relations with any executive or promoter of the company. The nexus may be immediate or buried in the past but it is the duty of the listed entity to scrutinize and to investigate such transactions.
Widening of “Related Party”
In order to tighten the related party regulatory framework, the Working Group has proposed certain modifications in LODR 2015. Firstly, the definition of “Related Party” needs an immediate inclusion of any individual or entity belonging to the promoter group of the listed company, irrespective of the shares they hold. The current requirement of holding 20% or more shares needs to be amended with a view of enlarging the scope of Regulation 2(zb) of LODR, 2015.
The Working Group further went on to propose some other modifications in Regulation 2(zc) of LODR relating to , the transactions between the listed entity or any of its subsidiary and a related party or its subsidiary on the other side. This modification has basically called for including transactions which have a hidden purpose or effect of benefitting a related party or its subsidiary.
The impact of these amendments in the Indian corporate scenario would be of great significance. However, this modification also makes it burdensome on the part of the companies to identify such transactions. This is mainly due to the upfront complications of identifying the purpose and effect of such transactions and whether such information is enough to classify them in the category of related party transaction or providing benefits to the related party/its subsidiary. This, in turn, would also make procedural compliance tougher on the part of the Audit Committee. The reason is that the identification of such transactions would not be easy at all, especially where the listed company has a large number of subsidiaries.
Materiality Thresholds with regard to prior approval from shareholders
Material Related Party Transaction can be defined as a transaction with a Related Party where the parties entering the transaction individually or in combination with previous transactions exceeds the 10% of Annual Consolidated Turnover as per Regulation 23(1) of LODR .
The Working Group has taken into consideration the above-mentioned regulation and decided to amend the regulation. The proposed amendment is to consider the transaction to be material related party transaction, if the consideration exceeds Rs 1,000 crore or 5% of annual total revenue/ net worth. But this needs to be subjected to approval of shareholders. Such an amendment is aimed to augment the regulatory ambit with respect to approval of shareholders. However, this could increase the burden of compliance on part of the listed entities.
Approval by the Audit Committee
The present regulation for constituting an audit committee for listed entities is provided under Regulation 18 of the LODR 2015. The Regulation demands the listed entities to provide information before the audit committee but is completely silent on the kind of information which needs to be provided for approval of the committee. Consequently, a new format has been proposed by the Working Group that specifies the kind or nature of information required to be put before the audit committee with a view of seeking approval for the concerned related party transaction.
As per the new format, the Working Group also suggested that the parties undertaking related party transactions should disclose the precise time period within which the concerned transactions would be completed. This has been proposed in order to lessen the burden on the part of the audit committee by diminishing the scope for any concealment of information on the part of such parties.
The recommendations put forth by the Working Group, are truly a sincere attempt to tighten the grip around related party transactions. However, identifying such apparent related party transactions is way easier in theory than implementing it in the actual market scenario. The Working Group clearly needs to set some parameters vis-à-vis identification of purpose or effect of transactions by listed companies. This would also make things clearer for the Audit Committee to categorize the concerned transaction as related party transaction which would eventually result in reduction of disputes arising in future.