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Regulating Un-related Party Transactions under RPT provisions – An Analysis of Report of SEBI’s Working Group

SEBI Portfolio Managers - RPT provisions - SEBI - Taxscan

In November 2019, SEBI had constituted a Working Group to review the provisions relating to Related Party Transactions (‘RPTs’). The terms of reference of the Working Group were to make recommendations to SEBI on issues relating to reviewing scope of ‘related party’ and ‘related party transactions’, approval process, thresholds for classification of RPT provisions as ‘material’, review of provisions under SEBI’s Listing Regulation vis-à-vis the Indian Accounting Standards and the Companies Act, 2013, format of disclosure of RPTs by listed entities, strengthening the monitoring and enforcement of regulatory norms, etc. This article is an analysis of key recommendations of the Working Group.

  • Scope of ‘Related Party Transactions’: Working Group noted that companies have used certain innovative structures to avoid classification of transactions as RPTs and then avoiding the associated regulatory compliance and disclosure requirements. Such instances include the use of complex structures, transactions undertaken by the listed entity with seemingly ‘unrelated parties’ and instances of loans being given to an ‘unrelated party’ which in turn gives such loan to a ‘related party’. According to the extant provisions, ‘RPT’ means a transaction involving a transfer of resources, services or obligations between a listed entity and a related party. Now, the Working Group has suggested inclusion of following parties for a transaction involving the transfer of resources, services or obligations between:
  • A listed entity or any of its subsidiaries on the one hand and a related party of the listed entity or any of its subsidiaries on the other hand and
  • The listed entity or any of its subsidiaries on the one hand, and any other person or entity, on the other hand, the purpose and effect of which is to benefit a related party of the listed entity or any of its subsidiaries

By the proposal, the scope of RPT is significantly widened. For example, transaction by a listed entity and with a related party of a subsidiary company would also be a ‘related party transaction’. If a subsidiary company is incorporated outside India, then determining the ‘related party’ of such a subsidiary company would be difficult as laws of that country would apply. Further, if the subsidiary company is a step-down subsidiary (whether in India or elsewhere), then such a transaction would also fall under the proposed amendments. If the subsidiary company is a private company under the Companies Act then certain parties are not ‘related parties’ under section 2(76) of the Companies Act read with the MCA Notification dated June 5, 2015 (as amended). In such cases, whether related parties under Ind AS is to be applied for such companies. Based on the recommendation – the question is whether a transaction by listed entity’s subsidiary company (whether in India or outside India) with a related party of listed entity’s subsidiary company – is a related party transaction for a listed entity? Interestingly, the listed company is not a party to the transaction. However, based on the recommendation of the Working Group, it seems that such a transaction will fall under the purview of RPT provisions under the SEBI Listing Regulations.

The above compliance (and the confusion) of the transactions gets further compounded in the next clause, i.e. reference of ‘benefit to related party of listed entity or any of its subsidiary’, i.e. listed entity or any of its subsidiaries on the one hand, and any other person or entity, on the other hand, the purpose, and effect of which is to benefit a related party of the listed entity or any of its subsidiaries. This is much complex provision and the repercussions are quite wide to cover any kind of transaction.

Interestingly, certain transactions are proposed to be excluded from the purview of related party transactions. Such transactions include – an issue of securities on preferential basis, corporate actions (e.g. payment of dividend, sub-division of securities, issuance of securities on rights basis, bonus issue, buy-back of securities) by the listed entity which are uniformly applicable/offered to all shareholders in proportion to their shareholding). For such a transaction, there is a separate approval and disclosure process that would not be detrimental to unrelated parties.

  • Audit Committee’s Approval process: Working Group has suggested the Audit Committee’s prior approval for certain types of transactions, wherein the listed entity is not a party to the RPT. According to the suggestion, RPT to which the subsidiary of a listed entity is a party but the listed entity is not a party shall require prior approval of Audit Committee of listed entity if the value of such transaction (individually or taken together with previous transactions during the FY) exceeds 10% of the Annual Total Revenues, Total Assets or Net Worth of the subsidiary company, on a standalone basis, for the immediately preceding FY, whichever is lower. Here the compliance level and monitoring level by the listed entity on its subsidiary companies (in India or abroad) would be quite high. It is also quite absurd that the listed entity’s Audit Committee is required to approve RPTs of its subsidiary company i.e. the basic feature of separate legal entity and corporate personality of the company is diluted in such case.
  •  Shareholders’ Approval process: With an objective to align with the related provisions of the Companies Act, the Working Group has suggested prior approval of all material RPTs;
  • Monetary threshold for obtaining shareholders’ approval: As per the extant provisions of SEBI Listing Regulations, a transaction with related party shall be considered ‘material’ if transaction(s) to be entered into individually or taken together with previous transactions during FY, exceeds 10% of the annual consolidated turnover of the listed entity (as per the last audited financial statements of the listed entity). The Working Group has proposed to revise the thresholds, whereby the RPT shall be considered ‘material’ if the transaction(s) to be entered into individually or taken together with previous transactions during an FY, exceeds Rs. 1,000 crore or 5% of annual consolidated turnover total revenues, total assets or net worth of listed entity on a consolidated basis as per the last audited financial statements of the listed entity., whichever is lower. Monitoring so many parameters for all RPTs is quite challenging. The next challenge is obtaining ‘prior approval’ for such material RPT.
  •  Disclosures to stakeholders: The Working Group has suggested additional disclosures for Audit Committee approval and shareholders. This is to bring in more accountability and transparency by the company towards its stakeholders.
  •  Tenure & Value of RPTs: The Working Group has suggested that the RPT provisions – SEBI – Taxscan should have a particular tenure or term and should not be indefinite or open-ended. In my view, it would be desirable that such maximum tenure would be prescribed, e.g. 5 years or 10 years. The Working Group has suggested that an upper limit should be provided and in case of a recurring or continuous transaction, the aggregate value and time period within which such limit will be exhausted. These recommendations are based on many recent cases, wherein listed entities had obtained shareholders’ approval for many open-ended RPTs (in terms of value & tenure). Therefore, this suggestion, if accepted, would bring in transparency.
  •  Disclosures in Corporate Governance Report: The Working Group has suggested that the disclosure of ‘Loans and advances in the nature of loans to firms/companies in which directors are interested in the name and amount’ for a listed entity and its subsidiaries’ – shall be part of the Corporate Governance Report.

The amendments suggested by the Working Group would bring significant change in the compliance mechanism for RPTs by listed entities. Considering the wide definition of RPT provisions – SEBI – Taxscan (as suggested), the listed entity’s Audit Committee and shareholders would be ultimately monitoring ‘un-related party transactions’ under the garb of ‘RPTs’. It is also interesting to note that MCA is relaxing the provisions of RPT provisions – SEBI – Taxscan under the Companies Act, 2013, whereas SEBI is tightening the said provisions. There needs to be some uniformity in policies as listed entities would invariably comply with SEBI Listing Regulations which would include compliance of Companies Act. Complex Regulations for complex transactions would not serve the ultimate purpose as not all RPTs are bad in law, some RPTs are for genuine business purposes. Further, the Working Group ought to have deliberated and discussed whether granting of the loan, guarantee or security by a listed entity to its related party amounts to ‘RPT’ and whether appointment and payment remuneration to directors (executive & non-executive) amounts to ‘RPT’ and whether approval of Audit Committee is required.

Gaurav Pingle is a Practicing Company Secretary and visiting faculty for Company Law, Investment and Securities Laws and Telecom Law. He has authored a book on Companies (Amendment) Act, 2017 and Related Party Transactions. His areas of practice are Corporate Laws, Corporate Compliance Management, SEBI Listing Regulations, and Transaction Advisory Services. He conducts internal training programs and workshops for companies, law firms, CA firms & CS firms on topics relating to Corporate Laws and Corporate Governance.

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