Learning No. 13Month: June 2021
RELATED PARTY TRANSACTIONS – AN ANALYSIS
Introduction
When a Company becomes publicly held entity, its
members expect better return, transparency in its operations and compliance in
letter and spirit. The leakage of funds is the main concern which every company
is facing and normally happens through the Related Party Transactions. In turn,
it will affect return to its members. Hence it is pre-requisite that the transactions
with related parties must be tightened. It doesn’t mean it must be totally
prohibited. But such transactions shall be executed on arm’s length basis. In this
article, an attempt has been made to analyze the various provisions of Companies
Act, 2013 and Listing Regulations connected to the Related Party Transactions.
Normally, when a transaction takes place between two parties, there exists market mechanism. That means, demand and supply (Transaction takes place at Market price (MRP)). On the other hand, when a transaction is executed with related parties, they may get preferred facilities in form of payment at discount rate, extending credit period which unrelated parties are not getting. In order to prevent misuse of such type of transactions, company should maintain caution and arm’s length relationship while executing contract or arrangement.
As the name suggests, Related Party Transactions means any transaction, deal or arrangement between two and more parties who have any relationship before such transaction is executed.
REGULATORY FRAMEWORK
The concept was introduced for the first time under
the Companies Act, 2013 (“the Act”) and it got inherence from the erstwhile
Companies Act, 1956, the details of old provisions are as given below:
Ø Section 297: Board approval was required for entering into any contract or arrangement with the related parties w.r.t. sale, purchase or supply of any goods, materials and services or for underwriting the subscription of any shares in, or debentures of, the company. Further, there was a requirement to get central Government approval for above mentioned contract if the company has more than Rs. 1 Cr. paid up capital. The said section also mentioned about various exemption under sub section (2).
Ø Section 299: directors to disclose their interest in other concerns to the Board of Directors before entering into any contract with the related parties. Only exception is where directors of one company taken together have less than 2 % of paid up capital of another company.
Ø Section 300: Directors not to participate in voting when the board resolution is passed relating to any business in which such person is interested.
Ø Section 314: Office or Place of profit
Currently, regulatory framework governing the Related
Party Transactions is given as follows:
Following points must be followed to treat AS Related
Party Transactions
Before entering into any transactions by the reporting company, compliance
officer must look into following factors. If it is satisfied, such transactions
will be treated as Related Party Transactions.
But if transaction is in “Ordinary Course of Business” and “arm’s length basis”, then provisions of Sec 188 (1) shall not applicable.
PROCESS INVOLVED IN IDENTIFICATION OF RELATED PARTY TRANSACTIONS
Let us now understand how we can treat transactions as Related Party Transactions based on the following:
Step no. 1 - IDENTIFICATION OF RELATED PARTY
The word “related party” is defined under Section 2(76) of the Companies
Act, 2013 are as follows along with illustrations:
Following are the related parties w.r.t. ABC Ltd and let’s take, Mr.
V, W, X, Y, and Z are directors and Mr. U as MD of this company. The
related parties to the reporting company are as under:
|
Sl. No |
Related parties |
|
i. |
A director or his relative (For eg: Mr. V, Mr. W, Mr. X, Mr. Y and Mr. Z and the
relatives of them.) |
|
ii. |
Key managerial personnel or his relative (For eg: Mr. U along with his relatives.) |
|
iii. |
A
firm in which a director, manager, or his relative is a partner
(For
eg: Mr. X is a partner at PQR & Co, firm. Hence PQR & Co will be
treated as related party) |
|
iv. |
a private company in which a director or manager or his relative is a member or director; (For eg: Mr. Z is also a director in MNO Pvt Ltd and Mr.
Z’s relative is a member in MNO Pvt ltd, MNO Pvt. ltd becomes a related
party.) |
|
v. |
A public company in which a director or manager is a
director and holds along with his relatives more than 2% of its paid-up
capital
(For eg: Mr. Y along with his relatives holds more than 2%
of the paid-up capital of HIJ Ltd. In such case, HIJ Ltd will be considered
as a related party) |
|
vi |
Any body corporate whose board of directors, MD or manager
is required to act in accordance with the advice, directions or instructions
of a director or manager (NA in cases when these directions are followed in
professional capacity)
(For eg: When JKL Ltd acts on the directions of Mr. V, JKL
Ltd will be a related party.) |
|
vii |
Any person on whose advice, directions or instructions a
director or manager is required to act. (If it is done in a professional
capacity, they are not considered as related party)
(For eg: Mr. R on whose advice Mr. W has to act will be
considered as a related party.) |
|
8 |
Holding, Subsidiary or Associate of such company These all will be considered as related parties: · EFG Ltd holding 72% in ABC Ltd (EFG Ltd is a Holding
Company) · ABC Ltd is holding 65 % in RTS Ltd (RTS is a Subsidiary
Company) · ABC Ltd is holding 23% in JAQ Ltd (JAQ Ltd is an Associate
Company) |
|
9 |
Any company which is subsidiary of a holding company to which it is also a subsidiary. (KQJ Ltd & RTS Ltd is both subsidiaries of EFG Ltd.
Thus, KQJ Ltd. also becomes a related party) |
|
10 |
As per Rule 3 of Companies (Specification of definitions
details) Rules, 2014 for the purposes of above-mentioned sub-clause (ix), a
director [other than an independent director] or key managerial personnel of
the holding company or his relative with reference to a company, shall be
deemed to be a related party. |
Whereas “Relative” (Sec 2(77)) means
· a member
of the same HUF;
· husband
& wife;
· one
person is related to the other like father (including step father) mother
(including step mother), son (including step son), son’s wife, daughter,
daughter’s husband, brother (including brother), sister (including step sister).
As per Regulation 2(1)(zb) of the SEBI (Listing Obligations and
Disclosure Requirements) Regulations, 2015 as amended from time to time, the
term “Related Party” means related party as defined under Section 2(76) of the
Companies Act, 2013; or Such entity is a related party under the applicable
accounting standards. Please note that if any person or entity belonging to the
promoter or promoter group of the listed entity and holding 20% or more of
shareholding in the listed entity, such entity/ person shall be treated as a
related party. The definition shall not be applicable to the units issued by
Mutual funds which are listed on recognized stock exchange.
Step no. 2: TRANSACTIONS
INVOLVED IN THE RELATED PARTY TRANSACTIONS
|
Sl. No. |
Transactions considered as
Related Party Transactions |
|
1 |
Sale, purchase or supply of any goods or materials; |
|
2 |
Selling or otherwise disposing of, or buying, property of any kind; |
|
3 |
Leasing of property of any kind; |
|
4 |
Availing or rendering of any services; |
|
5 |
Appointment of any agent for purchase or sale of goods, materials,
services or property; |
|
6 |
Such related party's appointment to any office or place of profit in
the company, its subsidiary company or associate company |
|
7 |
Underwriting the subscription of any securities or derivatives
thereof, of the company |
OFFICE OR PLACE OF PROFIT
Meaning: It means any office or place:
i. which is held
by a director, if the director holding it receives from the company anything by
way of remuneration over and above the remuneration to which he is entitled as director,
by way of salary, fee, commission, perquisites, any rent-free accommodation, or
otherwise;
ii. which is
held by person connected to the directors ie an individual other than a
director or by any firm, private company or other body corporate, if the individual,
firm, private company or body corporate holding it receives from the company
anything by way of remuneration, salary, fee, commission, perquisites, any
rent-free accommodation, or otherwise;
Purpose: To prevent a Director/ person connected to the directors from
being placed in the inconsistent position without proper selection procedure/
approval.
Step no. 3: APPROVAL STRUCTURE
LEVEL 1 approval: Audit Committee approval
As per Sec 177 of the Act, for every transaction with the related
parties, the prior approval of Audit Committee is required. But in case of
transaction, other than transactions referred to in section 188, and where
Audit Committee does not approve the transaction, it shall make its
recommendations to the Board. The approval structure is as follows:
The Committee shall consider 2 factors while
specifying the criteria for making omnibus approval, namely,
(i) Repetitiveness of the transactions; and
(ii) Justification for the need of omnibus
approval.
Such approval for the RPT shall be obtained on
annual basis (Rule 6-A of the Companies (Meetings of Board and its Powers)
Rules, 2014) and shall be valid for a period not exceeding 1 financial year (requires
fresh approval after expiry of such FY). Omnibus approval shall not be made for
transactions in respect of selling or disposing of the undertaking of the
company.
As per third proviso to Sec 177 (4) of the Act, in
case any transaction involving any amount not exceeding Rs. 1 Crore is entered
into by a director or officer of the company without obtaining the approval of
the Audit Committee and it is not ratified by the Audit Committee within 3
months from the date of the transaction, such transaction shall be voidable at
the option of the Audit Committee.
level – 2 approval: BOARD OF
DIRECTORS’ APPROVAL
As per Sec 188(1) of the Act, no company shall enter into any contract
or arrangement with related parties except with the consent of the Board of
Directors. The provisions of this sub-section shall not apply
to any transactions entered into by the company in its ordinary course of
business and at an arm’s length basis.
Such meeting can be held in person or through virtual means as may be
prescribed. The Approval of the Board of Directors cannot be obtained by
passing a circular resolution or by any other mode (as prescribed in SS-1 on
Board meeting).
As per Section 188(3) of the Act, where any contract or arrangement is
entered into by a director or any other employee, without obtaining the consent
of the Board or approval by a resolution in the general meeting under
sub-section (1), such transaction required to be ratified by Board and General
Meeting within 3 months from the date on which such contract or arrangement was
entered into. It is clear from sub section (3) that requirement of prior
approval shall not required.
Where there is any interested director in any contract/ arrangement with
related party, such director shall not be present at meeting during discussions
on subject matter of resolution relating to such contract/ arrangement. Interested
Director shall not be counted for quorum and shall not allow participating in the
voting. But in case of private companies, interested director may participate
in such meeting after disclosure of his interest.
Board meeting’s resolution shall contain the following details:
1. Name of
related party and nature of relationship;
2. Nature,
duration of contract and particulars of contract/ arrangement;
3. Material
T&C of contract/ arrangement including value, if any,
4. Any
advance paid/received for contract/arrangement, if any;
5. Manner of
determining pricing and other commercial terms, both included as part of
contract and not considered as part of contract;
6. Whether
all factors relevant to contract have been considered, if not, details of
factors not considered with rationale for not considering those factors; and
7. Any other
info. Relevant/ important for Board to take a decision on proposed transaction.
level – 3 approval: SHAREHOLDERS’
APPROVAL IN THE GENERAL MEETING:
As per first proviso to Sec 188 of the Act read with Rule 15 of
Companies (Meeting of Board and its powers) Rule, 2014, prior approval of
shareholders by way of ordinary resolution required in cases of contract/
arrangement entered into with the related party exceeds the following threshold
limit:-
|
Sl. No. |
Contract/ Arrangement with related party with
respect to: |
Revised Threshold |
|
i |
Sale,
purchase or supply of any goods or materials |
10% or
more of its turnover |
|
ii |
Selling
or otherwise disposing of, or buying, property of any kind |
10% of
its net worth |
|
iii |
Leasing
of property of any kind |
10% or
more of its turnover |
|
iv |
Availing
or rendering of any services |
|
|
v |
Appointment
of any agent for purchase or sale of goods, materials, services or property |
|
|
vi |
Such
related party’s appointment to any office or place of profit in the company,
its subsidiary company or associate company |
Monthly
remuneration exceeding Rs. 2.50 lakhs |
|
vii |
Remuneration
for underwriting the subscription of any securities or derivatives thereof,
of the Co. |
Exceeding
1% of its networth. |
Ø It is hereby clarified that the limits specified in sub-clause (i) to
(iv) above shall apply for transaction(s) to be entered into either
individually or taken together with the previous transactions during a
financial year.
Ø The turnover or net worth referred in the above sub-rules shall be computed on the basis of the audited financial statement of the preceding financial year.
Ø Members of the company shall not vote on such resolution to approve any contract or arrangement which may be entered into by the company, if such member is a related party. The said provision shall not be applicable to the company in which 90% or more members, in number, are relatives of promoters or are related parties:
Ø In case of private company, second proviso to Sec 188(1) shall not apply.
Ø First and second proviso to Section 188 (1) shall not apply to:-
a. Government company in respect of contracts or
arrangements entered into by it with any other Government company;
b. a Government company, other than a listed company,
in respect of contracts or arrangements other than those referred to in clause
(a), in case such company obtains approval of the Ministry or Department of the
Central Government which is administratively in charge of the company, or, as
the case may be, the State Government before entering into such contract or
arrangement.
Ø The requirement of passing the resolution under first proviso shall not be applicable for transactions entered into between a holding company and its wholly owned subsidiary whose accounts are consolidated with such holding company and placed before the shareholders at the general meeting for approval:
ADDITIONAL PROVISIONS IN THE CASE OF LISTED
COMPANIES
As per Reg 23 of the SEBI (LoDR) Regulations, 2015, All Material Related
Party transactions shall require approval of the shareholders through
resolution and no related party shall vote to approve such resolutions whether
the entity is a related party to the particular transaction or not.
Here, “Material Related Party Transactions” means
Ø A
transaction with a related party shall be considered material if the
transaction(s) to be entered into individually or taken together with previous
transactions during a financial year exceeds 10% of the annual consolidated
turnover of the listed company as per the last audited financial statements of
the listed entity.
Ø A
transaction involving payments made to a related party with respect to brand
usage or royalty shall be considered material if the transaction(s) to be
entered into individually or taken together with previous transactions during a
financial year, exceed 5%
of the annual consolidated turnover of the listed entity as per the last
audited financial statements of the listed entity.
All related party transactions require prior approval of Audit Committee
either through omnibus approval route or ordinary approval route.
The
provisions of Reg 23 (2), (3) & (4) shall not apply in the following:
Ø transactions
entered into between two government companies;
Ø transactions
entered into between a holding company and its wholly owned subsidiary
whose accounts are
consolidated with such
holding company and
placed before the shareholders at the general meeting for
approval
COMPLIANCE
I. Disclosure/Reporting Requirements under Companies Act, 2013
|
Provision/ Section |
Requirement |
|
188(2)
|
Every
contract or arrangement entered into under sub-section (1) shall be referred
to in the Board’s report to the shareholders along with the justification for
entering into such contract or arrangement. |
|
129
|
Financial
Statements to Comply with Accounting Standards -
Disclosure of Related Party Transactions in Financial Statements of a company to be made as per Applicable Accounting
Standard |
|
134(3)(h)
|
Board’s Report to
include Particulars of
Contracts or Arrangements with Related Parties referred to in Sec 188(1) in
AOC-2 |
|
Rule
15(2) |
Where
any Director is interested in any contract with Related Party, such director shall not be present at meeting during discussion |
|
184 |
Form
MBP - 1 (General Notice of Disclosure) helps to evaluate the details of
entities in which directors are interested. |
|
189 |
The
company shall maintain a register (Form MBP-4) for related party
transactions. After entering the particulars in the register, such register
shall be placed before the next Board meeting and signed by all directors
present at the meeting. |
II. Disclosure/Reporting Requirements under SEBI (LODR), 2015
|
Provision |
Requirement |
|
23(9) |
The listed entity shall submit within
30 days from the date of publication of its standalone and consolidated
financial results for the half year, disclosures of related party
transactions on a consolidated basis, in the format specified in the relevant accounting standards for annual
results to the stock exchanges and publish
the same on its website. |
|
34(3) read
with Sch. V |
Annual report shall contain RPT disclosures
as specified in Para A of Schedule V
of these regulations |
|
46(2)(g)
|
Listed Entity to disseminate on its Website
Policy on dealing with RPTs. |
|
Sch
V. Para C Disclosure 10(a) |
Report on Corporate Governance shall
disclose disclosures on materially significant
related party transactions that may have potential conflict with the interests of listed entity at large |
|
Sch
V para C Disclosure 10(f) |
Report on Corporate Governance shall
disclose web link where policy on dealing with related party transactions is disclosed.
|
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