– Team Finserv | finserv@vinodkothari.com
RBI Notification dated December 14, 2021 – https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12208&Mode=0
Our recent write-ups around the financial services sector – https://vinodkothari.com/category/financial-services/
SEBI’s (Third Amendment) Regulations go live!
Anushka Vohra | Manager | corplaw@vinodkothari.com
On August 03, 2021, SEBI (Listing Obligations and Disclosure Requirements) (Third Amendment) Regulations, 2021[1] (Third Amendment Regulations) were notified to become effective from January 01, 2022. The amendment brings changes in the regulatory framework for Independent Directors (IDs) including but not limited to criteria of independence, appointment framework, composition of IDs in committees of the board, etc. The amendment is a move towards protecting the interests of a larger set of shareholders.
In this write-up we will be discussing the revised appointment and re-appointment framework for the IDs.
As per the provisions of law and given the standard practice, the appointment of IDs is done as follows:
The current practice of re-appointment of IDs is as follows:
SEBI Consultation Paper[2]
On March 01, 2021, SEBI came up with a Consultation Paper (‘Paper’) for reviewing the regulatory provisions relating to IDs viz. their independence, appointment, re-appointment and remuneration.
The Paper proposed two significant changes in the process of appointment, re-appointment and removal of IDs i.e. ‘dual approval’ and ‘prior approval’. The relevant extract is quoted herein below:
‘Appointment and re-appointment of IDs shall be subject to “dual approval”, taken through a single voting process and meeting following two thresholds: –
The approval at point (i) above, shall be through ordinary resolution in case of appointment and special resolution in case of re-appointment.’
Further, concerns were raised on the current framework for appointment of IDs, as discussed above. The Paper expressed that the significant gap between the appointment of an ID and approval of shareholders is not in the best interest of the shareholders, especially the minority shareholders. Accordingly, the Paper proposed to take prior approval of shareholders for appointment of IDs. The relevant extract is quoted herein below:
‘Independent Directors shall be appointed on the board only with prior approval of the shareholders at a general meeting.
In case, a casual vacancy arises due to resignation / removal / death / failure to get re-appointed etc., the approval of shareholders should be taken within a time period of 3 months.’
SEBI Board Meeting[3]
Post the receipt of the comments on the Paper, SEBI at its board meeting held on June 29, 2021 reviewed the regulatory provisions related to IDs. It is significant to note that the proposal of ‘dual approval’ and ‘prior approval’ was not approved by SEBI considering difficulties it could impose during implementation including delay in appointment of IDs in case of a deadlock, etc. Thus, SEBI took a balanced view and introduced a process which is simpler to implement and covers a greater set of shareholders. SEBI, therefore, decided that appointment, re-appointment and removal of IDs shall be through a special resolution of shareholders for all listed entities, applicable from January 01, 2022.
Therefore, it is absolutely clear that the proposal for obtaining prior approval of shareholders was dropped by SEBI.
Amended provisions
The Amended Regulations inserted sub-regulation (1C) to Regulation 17 and sub-regulation (2A) to Regulation 25 which requires passing of a special resolution for appointment, re-appointment as well as removal of IDs. Further, another pertinent change brought about by the amendment is that the approval of shareholders is required to be passed within a maximum of 3 months from the date of appointment by the board.
Hence, on a conjoint reading of both Regulations 17(1C) and 25(2A), the following is understood:
Regulation 25(2A) states that the appointment of an independent director shall be subject to the approval of shareholders. Whether the approval required is prior or post-facto has not been specified. However, on understanding the background of the amendment in the Regulation, and by harmonious construction of this Regulation with Regulation 17 (1C) it is clear that the approval may be post-facto. The approval referred to in Reg 25 (2A) does not necessarily mean prior approval. It is a stated law that approval includes post- facto approval too.
In Black’s Law Dictionary (Fifth Edition)[4], the word “approval” has been defined as follows:
Approval. – The act of confirming, ratifying, assenting, sanctioning, or consenting to some act or thing done by another.
Hence, approval to an act or decision can also be subsequent to the act or decision.
Also, in the case of Vijay S. Sathaye v. Indian Airlines Ltd & Ors[5], the Hon’ble Supreme Court held that, ‘Approval means confirming, ratifying, assenting, sanctioning or consenting to some act or thing done by another.’Further in the case of Union of India v. Sunny Abraham[6], the Delhi High Court held that, ‘the dictionary meaning of the word “approval” includes ratifying of the action, ratification obviously can be given ex post facto approval.’ The Court also pointed out in this case that if the provision of law requires prior approval, it will specifically prefix the approval by “prior”.
The Allahabad High Court in Shakir Hussain v. Chandoo Lal[7] held that, ‘Of course the expression “subject to approval by the Court” implies that the arrangements which are considered by him to be most convenient and economical must be made by him first and approved by the Court subsequently. It is not necessary for him to submit his proposal beforehand and get approval though such a course is not impossible.’
Hence, we are of the view that provision of Reg 25 (2A) does not deviate from the provisions of Reg 17(1C) giving a time of 3 months or by the calling of the ensuing AGM, whichever is earlier, for shareholder’s affirmation of the appointment of an independent director.
Hence, with effect from 1st Jan., 2022,, the process for appointment of an ID stands as follows:
Concluding remarks
The requirement of special resolution would safeguard and protect the interest of shareholders and the independence of the IDs. Covering a greater set of shareholders would ensure that the composition of ID is not influenced by the whims of the majority shareholders. Hence, this move would increase the participation of shareholders in approving the appointment of a person, whom they want to be represented on the board of directors.
[1] https://egazette.nic.in/WriteReadData/2021/228705.pdf
[2] https://www.sebi.gov.in/reports-and-statistics/reports/mar-2021/consultation-paper-on-review-of-regulatory-provisions-related-to-independent-directors_49336.html
[3] https://www.sebi.gov.in/media/press-releases/jun-2021/sebi-board-meeting_50771.html
[4] https://www.latestlaws.com/wp-content/uploads/2015/04/Blacks-Law-Dictionery.pdf#page=208
[5] https://indiankanoon.org/doc/86328176/
[6] https://indiankanoon.org/doc/152013330/
[7] https://indiankanoon.org/doc/1531761/
[8] Though the Listing Regulations already require the NRC to formulate criteria regarding such appointments, the role of NRC, in practice, does not suffice the intent of law properly. Therefore, vide the Amendment Regulations, SEBI has brought amendment to Para A of Part D of Schedule II of the Listing Regulations thereby specifying the procedure for selection of candidates for the role of NRC. The procedure is in line with the proposal laid down in the Paper.
[9] https://vinodkothari.com/2021/03/revised-regulatory-framework-for-ids/
– Team Finserv (finserv@vinodkothari.com)
Relevant links:
Our write-ups on financial interests – https://vinodkothari.com/category/financial-services/
– Vinod Kothari, Director ( finserv@vinodkothari.com )
Digital technology has disrupted a whole lot of things in our daily lives; slowly but surely, Fintech is changing the way we make payments and remittances, make or monitor investments, store and analyse financial data, and so on. One of the very important aspects of financial services industry – origination of loans, is also being fast impacted by the advent of technology. Financial Technology (Fintech) has impacted both the way lenders originate credit, as also the essential function of financial intermediation. Fintech has brought artificial intelligence to collect data about consumers, their behavior on social networking, the social, financial and personal data about the consumer, and process the same to create completely new algorithms to provide credit scores to individuals, and thereby form the basis of credit decisions. As a result, loan origination, which in traditional system of credit evaluation and underwriting, would have taken weeks, is now completed online, in seconds. The second stage of lending, which is actual disbursal of loans, could have taken another few weeks, but is now done instantaneously by crediting the sanctioned loan to the mobile wallet of the consumer.
Apart from Fintech-assisted lending (which is given a broad term called “alternative lending”), the very function of financial intermediation has also been disrupted by the emergence of P2P technology, or so-called uberisation of lending. P2P lending, also known by various names such as marketplace lending, or platform lending, is also sometimes referred to as “fintech credit”. P2P lending, having passed through some challenges itself, particularly in countries such as China and UK, is now learning to live with moderate regulation, and is strongly poised for growth, and if predictions have it, it may change the face of financial intermediation sooner than one would imagine.
This article is structured as follows: we start with the broader definition of fintech credit and briefly discuss its evolution and current state of development and regulatory framework across the world, and then move to specifics of P2P lending, the various types of P2P lending models that have emerged. We then discuss P2P regulations in different countries, before focusing on India. We now turn focus to India to talk about RBI regulations, and the current state of the market in India and the way forward. Finally, we deal with its prospects in global as well Indian context. Before closing, we deal with the role that company secretaries may have in the field of Fintech credit.
The article has been published in the March, 2020 edition of Chartered Secretary and can be read here Page 48 onwards.
– Vinod Kothari, Managing Partner (corplaw@vinodkothari.com)
You may also like to read:
Rendering effective legal opinions: https://vinodkothari.com/2021/12/rendering-effective-legal-opinions/
– Vinod Kothari, Managing Partner ( corplaw@vinodkothari.com )
In profession as in life, one has the choice of either being a face in the crowd, or be identifiable with distinction. The latter clearly requires the ability to do different things, or common things differently. For company secretaries in practice, while handling compliances and attestations functions such as certification of forms and secretarial audit are common things, but several professionals have earned special recognition by abilities such as advocacy, legal research, rendering of legal opinions, arbitration, etc. This article deals with the art of opinion writing, written specially for company secretaries in practice.
The article has been published in the March edition of Chartered Secretary (Pg. 139 onwards) and can be read here
– Aanchal Kaur Nagpal, Assistant Manager | Sharon Pinto, Manager | finserv@vinodkothari.com
| 10th Securitisation Summit, 2022:
The tenth edition of the Indian Securitisation Summit will be held on May 27, 2022 at The LaLiT Hotel, Mumbai as well as virtually (through Zoom). This edition will include panel discussions, expert interviews, Chakra-view: Huddling of ideas, Securitisation-samman and much more. Read more here. |
Our write-ups on related topics:
We have attempted to collate all major regulatory amendments notified throughout the year, with our resources on the same. Below we present a regulatory round-up for the year 2021, be it for MCA, SEBI, RBI or the like, along with the links to our major articles/ FAQs on the same.
Our youtube video giving a quick view on the same can be accessed at – https://www.youtube.com/watch?v=WJbJx2jgK9A
This version: 4th December, 2021
Vinita Nair and Sikha Bansal
Related Party Transactions (RPTs) are perceived as potential tools for unjust enrichment of those in fiduciary capacity. Hence, the stock market regulator has recently revamped RPT norms (most of which are to take effect from 1st April, 2022 though) intending to have a greater scrutiny on RPTs. Among all the measures, one is revision in threshold for ‘materiality’, and second is, ‘prior’ approval of shareholders for all such material RPTs. Materiality is now fixed as a value above – (i) INR 1000 crores, or (ii) 10% of annual consolidated turnover of the listed entity, whichever is lower. For all such contracts which cross the threshold, the listed entity would need to have prior shareholder consent. Additionally, the scope of RPTs now also covers cross-RPTs, that is, transactions of listed entity with related parties of subsidiary, transactions of subsidiary with related parties of listed entity, and transactions of subsidiaries with its own related parties.
Given the above, all companies which have annual consolidated turnover exceeding INR 10000 crores, alongside contracts exceeding INR 1000 crores, are now faced with a quizzical issue: Do the amendments impact only future contracts or even past contracts? The question becomes perplexing as to continuing contracts because of the wide ramifications which can possibly occur if the contract fails to get favour from shareholders (which of course, would be unrelated shareholders). Further, there would be questions, relating to scope of transactions to be included to determine the threshold limit (especially because of expanded scope of RPTs), and the computation and aggregation of values thereof.
We intend to address these nagging questions in our write up below.
SEBI has made amendments to the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘LODR’), vide the SEBI (Listing Obligations and Disclosure Requirements) (Sixth Amendment) Regulations, 2021 (‘amendment’).
The changes, which we are discussing here, are three-fold, as below:
First, SEBI felt that it is prudent to obtain “prior” approval of shareholders for material RPTs; this is on account of the practical difficulties which the listed entity may face in case the transaction is rejected by the shareholders at a later stage. Further, this would ensure consistency with the requirement of obtaining prior approval of the audit committee for all RPTs as specified in the regulations.
Second, and rather more importantly, as the threshold for determining materiality has changed (many companies would have transactions falling in the the bracket of INR 1000 crores), one is left to think if ongoing RPTs need to be reclassified as material and non-material; and if such classification is required, whether the RPT now classified as material RPT would need ‘prior’ shareholder approval.
The question of retrospective application to ongoing contracts arises because of reg. 23(8), which states, “All existing material related party contracts or arrangements entered into prior to the date of notification of these regulations and which may continue beyond such date shall be placed for approval of the shareholders in the first General Meeting subsequent to notification of these regulations.” Of course, reg. 23(8) has been in place right from the time LODR was notified; however, the expression ‘these regulations’ would refer to LODR as amended from time to time. The regulation, so far, has not been omitted.
Pursuant to the same, if it is concluded that a reclassification is required and consequently, all RPTs categorised as material RPTs have to pass shareholders’ nod before proceeding further, the same may have wide ramifications. The company would have entered into an ‘agreement’; the agreement would require both parties to execute their part of obligations under the agreement. The agreement would also include, as a part of default covenants, damages, etc. for breach of agreement. Hence, failure to have shareholders’ approval may have commercial implications on the company, along with ancillary consequences.
Here, note that there are certain other provisions in LODR which seem connected and may be relevant – one is proviso to reg. 1(2) which says that provisions of reg. 23(4) shall come into force on the date of notification of these regulations, and the other is reg. 23(6) which says that the provisions of this regulation shall be applicable to all prospective transactions. All these provisions, at the first stance, seem to be conflicting and overlapping (however, see below).
Thirdly, as regards expanded scope of RPTs to cover cross-RPTs, it might be possible that threshold limits get crossed because of cross-RPTs not considered earlier. While it is likely that the listed entity may have an existing approval in place for the transactions undertaken with its own related parties, but there is a rare probability of an approval being in place for cross-RPTs (considering the cases where there are no overlaps between the related parties of the listed entity and those of the subsidiary). Further, there would be ‘aggregation’ issues for such cross-RPTs, as we discuss further.
One would note that regs. 23(1), 23(4), and 23(6), all use the expression ‘transaction/s’; however, reg. 23(8) uses the word “contracts or arrangements’. What could be the relevance of such different usages? Essentially, ‘transaction’ and ‘contract’ are not one and the same. There may be a single transaction or a series of transactions pursuant to a contract or arrangement. As per the definition of RPT in LODR, a “transaction” with a related party shall be construed to include a single transaction or a group of transactions in a contract. Therefore, the term ‘contract’ is wider or an umbrella term within which there can be a single transaction or even a series of transactions resulting in transfer of resources, service or obligation by a listed entity. For instance, A sells goods to B at a certain price – this is a transaction; and this can as well be a contract. In another example, A agrees to supply goods to B over a period of 3 years at a predetermined price. This is a contract, which can have multiple transactions (multiple supplies of goods to B).
Hence, reading the provisions of LODR, one can have the following conclusions –
Therefore, if there is a contract, transactions under which run beyond the effective date, such contracts need to be taken before shareholders with respect to transactions yet to be initiated. In that case, acts already performed under transactions previously concluded under the same contract should not be hampered. However, transactions which are pending execution shall only begin once shareholder approval is received.
Thus, in the context of effective date for the present amendment to take over, there can be various scenarios, and the treatment would accordingly depend as noted below –
| Scenarios | Possible implication under present amendment (assuming the transactions/contracts attain materiality limits) | |
| Case 1 | The entity enters into single transactions, where one transaction is equivalent to a contract | This is a simplistic case. No implication under present amendment if transaction is done and completed. However, the company would need shareholder approval to undertake fresh transactions. |
| Case 2 | The entity has entered into a contract for multiple transactions, and has completed all such transactions
|
This is a simple scenario too – past transactions in a past contract. The contract stands ‘executed’. No transaction remains to be fulfilled. Hence, no impact under present amendment. |
| Case 3 | The entity has entered into a contract for multiple transactions, and has completed only some transactions, while some transactions are yet to be executed | This is a case of executory contract. As a part of the transactions contemplated under the contract remains to be fulfilled, the contract might need to be placed before shareholders.
If the contract fails before shareholders, the ‘to-be executed’ transactions may need to be aborted (with possible commercial implications, as discussed above). For example, say A has agreed to deliver 5 lots of products to B over a period of 1 year. While 3 lots have been delivered and paid; 2 lots are pending (neither delivery nor payment has taken place). In such a case, the shareholder approval would be required for the pending 2 lots. |
| Case 4 | The entity has entered into a contract for multiple transactions, and all transactions thereunder are just partly fulfilled.
|
The contract too, is continuing. But this is a case where each transaction may have been partly fulfilled. For example, A might have delivered goods, but is yet to receive payments from B in tranches, or vice-versa. In such a case the transaction has been initiated, and should not come under shareholders’ radar. |
| Case 5 | The entity has entered into a contract for multiple transactions (say 10 sale transactions), out of which –
– 3 are complete as to delivery and payment – 2 have been delivered on credit sale basis, payment is awaited – in 5 sale transactions, goods are yet to be delivered |
Going by the interpretation and logic applied –
– 3 transactions are fulfilled, shall not need any approval – 2 transactions have been initiated already, and thus the transactions are not ‘prospective’ – remaining 5 transactions are prospective in nature, and thus would need shareholder approval. |
Understandably, the examples above are basic ones; in reality, contracts may be quite complicated and each contract has to be read with all its dimensions to understand the implications with respect to the present amendments.
Hence, reg. 23(8) cannot be read dehors reg. 23(6). On a harmonised reading, it can be deduced that, where there are no prospective transactions, there is no question of applying reg. 23(8) and consequently, reg. 23(4) is not attracted. However, shareholder approval for ‘existing contracts/arrangements’ which are continuing shall be required for prospective ‘transactions’ under those contracts.
An interpretation that the amendment applies only to prospective contracts but not to existing contracts will provide leeway to errant entities/controlling shareholders to have their way well before the amendment takes effect. Also, to say that prospective transactions under past contracts and those under future contracts should be treated differently, will lead to anomalies and discrimination, and would thus be incorrect. Therefore, the scope of RPTs to be considered for shareholder’s approval should be for all prospective transactions (including under continuing contracts) after the effective date.
There is another dimension to the issue, that is, aggregation, as discussed below.
As is clear from the language of the proviso to reg. 23(1), a ‘transaction’ has to be adjudged as ‘material’ or ‘immaterial’ in relation to ‘a related party’. Now, the revised definition of RPT includes cross-RPTs, that is, transactions by the listed entity and the subsidiary with – (i) their own related parties, and also, (ii) each other’s related parties[1]. Hence, all transactions which either the listed entity or the subsidiary(ies) enter with ‘a related party’ (that is, a particular related party) shall be aggregated to see if the value of the transactions is breaching the threshold limit. The intent is to regulate ‘the consolidated entity as a whole’, where a ‘network of entities’ may be used as conduit to benefit related parties[2]. Hence, irrespective of whether the transaction is undertaken by the listed entity or the subsidiary, if the counterparty is the same related party, aggregation has to happen. Otherwise, the easiest way to avoid materiality threshold will be to route the RPTs through various subsidiaries to ensure that the threshold is not breached. Note that, the aggregation shall exclude transactions entered into by a listed subsidiary with a related party, where the listed entity is not a party – as in that case, such transaction will have to be separately assessed under reg. 23 for the listed subsidiary. As proviso to reg. 23(4) also says, such transactions by listed subsidiary shall not require approval of shareholders of listed entity.
Also note that the coverage does not include associate companies. However, an interesting question is – whether any transaction entered into by the holding company of a listed entity with a related party (of its own or of the listed entity) needs to be considered? Assuming that the holding is an unlisted entity, there is no provision for aggregation of transactions at the holding level. On the other hand, if both holding and subsidiary are listed entities, question of aggregation does not arise (as explained above).
Another crucial question pertains to the manner of computing amounts for determining materiality. The answer depends on the type of transaction. For example, in case of a subsisting loan, payments of interest or even repayment of loan being reciprocal to the entire transaction of loan, should not be counted for the purpose of material thresholds. However, in case of incremental loans or renewal of loan or extending fresh loans, the entire amount will be required to be considered.
Regulations require clubbing of all transactions to be undertaken with a particular related party for determining material RPT. However, the transactions may be of varied kinds – sale, purchase, loan, etc. Should shareholder approval be obtained separately for each kind of transaction? The regulations do not require separate resolutions. However, there is a possibility, that shareholders may be in favour of one transaction but not for others. Hence, the risk is that in case the shareholders intend to turn down one transaction, they will have to vote against the resolution covering several transactions.
Since, the amended provisions mandate prior approval of material RPTs, it is important to ascertain the time within which the listed entity shall approach shareholders, especially for ongoing transactions.
The requirement to seek approval of shareholders for material RPTs was first inserted under Clause 49 (VII) of the equity listing agreement w.e.f. October 1, 2014. When LODR superseded the listing agreement, reg. 23 (8) of the LODR provided a timeline for seeking shareholder’s approval and mandated (permitted) placing the same in the first general meeting subsequent to notification of LODR. Hence, companies were saved from the hassle of convening an extraordinary general meeting solely for the purpose of reg. 23(4).
As regards the present amendment, there are three possibilities:
In the first case, one may argue that provisions of reg. 23(8) were only relevant at the time of commencement of the regulations and will not be relevant in case of commencement of further amendments under the said regulation. However, the intent of the provision, in our view, remains in effect that a reasonable time should be made available post enforcement of a provision to be able to approach the shareholders.
In the second case, it may be argued that material RPTs are required to be determined on the basis of the annual consolidated turnover for the immediately preceding financial year. The immediately preceding financial year prior to the effective date is March 31, 2022 and the annual consolidated turnover as on March 31, 2022 will be available only when the financial statements are audited and approved by the Board. However, if 10% of the existing consolidated turnover as on March 31, 2021 was already above Rs. 1000 crores and it is reasonably expected that the situation will continue; in that case, it will be futile to wait for the audited numbers for consolidated turnover of March 31, 2022.
The third case seems most suitable as the provisions mandate prior approval for material RPTs, therefore, listed entities are free to undertake RPTs until the said threshold is breached. However, given the broad definition of RPT, it is not just sufficient to track the RPTs undertaken by the listed entity itself but also the transactions undertaken by the subsidiaries with that particular related party. This tracking may be difficult at a group level and therefore, it is prudent to avoid seeking approval at the last hour.
As per SEBI Circular dated November 22, 2021, an array of information is required to be placed before shareholders, including a summary of information provided by the management of the listed entity to the audit committee. All the ongoing contracts which are taken to the shareholders pursuant to the amendments, shall be accompanied by all such information as mandated in the aforesaid SEBI Circular.
Also, if the transactions were not placed before the audit committee earlier, then the same will be first required to be placed before the audit committee, along with the information prescribed in SEBI Circular and approved only by the independent directors in the audit committee, in terms of requirement under the proviso to reg. 23 (2) effective from January 1, 2022.
For discussion on the information requirements, refer our earlier article on the same.
The amendments are to be take effect from April, 2022; as such it is possible that the regulator comes up with further clarifications or literature on the amendments. The discussions above have been made keeping in view the framework as it appears today. Needless to say, RPT framework has been constantly evolving. While the intent of law is to reach out to undesirable transactions, there is a simultaneous compliance burden on the companies, which also percolates at the group level.
[1] Regulation 2(1)(zc)(i) includes a transaction involving a transfer of resources, services or obligations between a listed entity or any of its subsidiaries on one hand and a related party of the listed entity or any of its subsidiaries on the other hand.
[2] See discussions in pgs. 19-20 of Working Group Report on Related Party Transactions