Identification Of Related Parties Of Subsidiaries

Which law to follow? – Listing Regulations or laws applicable to subsidiaries?

– Aisha Begum Ansari, Manager | aisha@vinodkothari.com

The RPT provisions under the SEBI Listing Regulations were substantially amended by SEBI on November 9, 2021. Pursuant to the amendment, the definitions of related party, RPT, material RPT, requirements of obtaining audit committee, and shareholders’ approval were changed.

The definition of ‘RPT’ was amended to include cross RPTs. Earlier, only transactions between the listed entity and its related parties were covered, but now, the following transactions are also covered:

1. Transaction between listed entity and its related parties;
2. Transaction between the subsidiaries of listed entity and its related parties;
3. Transaction between listed entity and related parties of subsidiaries;
4. Transaction between subsidiaries and related parties of listed entity;
5. Transaction between subsidiaries and related parties of other subsidiaries.

In order to identify the RPTs and to obtain requisite approvals, the listed entity is first required to identify its related parties and share them with its subsidiaries. Similarly, the subsidiaries are required to identify their related parties and share them with the listed entity and other subsidiaries. The subsidiaries are also required to track the RPTs at their level on an ongoing basis, to check if the value of their RPTs exceeds the threshold limits requiring audit committee or shareholders’ approval of the listed entity. Therefore, to carry out the implementation of RPT framework at holding company level, the subsidiaries are also required to identify their related parties.

Now, the question here arises is which definition of related party should be followed by the subsidiaries? The subsidiary can be a listed subsidiary or an unlisted subsidiary – as is known, an unlisted subsidiary prepares its list of related parties as per section 2(76) of the Companies Act as the Listing Regulations do not apply to them. However, for the purpose of compliance of reg. 23 by the listed parent, should the unlisted subsidiary continue providing the list of related parties as per only Companies Act, or should it prepare another holistic list of related parties as per each of the clauses of reg. 2(1)(zb) of the Listing Regulations? Further, if the subsidiary is in a foreign jurisdiction, should it follow the law of the Indian holding company or the law of the country in which it is incorporated?

The law, as of now, is not clear on this. Hence, there is a possibility of varied interpretations. One interpretation is identifying related parties as per the law applicable to the Listing Regulations. However, on the other side, it might be possible to say that related parties should be identified as per the law applicable to them.

In this article, we have tried to analyse the highlights and challenges of each of the above options.

Option 1: Identifying related parties as per the Listing Regulations

Option 1 applies an entity-agnostic definition, across the parent as well as all its subsidiaries. The subsidiaries may be Indian unlisted companies, or overseas entities.

The definition of related party under reg. 2(1)(zb) of the Listing Regulations is quite comprehensive and means:

1. Related parties defined under section 2(76) of the Companies Act, 2013;
2. Related parties defined under the applicable accounting standards;
3. any person or entity forming a part of the promoter or promoter group of the listed entity;
4. any person or any entity, holding equity shares of 20% or more (10% or more, w.e.f. April 1, 2023) in the listed entity either directly or on a beneficial interest basis as provided under section 89 of the Act, 2013, at any time, during the immediately preceding financial year.

Merits

If the subsidiary follows the laws as applicable to the listed parent entity i.e., Listing Regulations, it will be required to identify the related parties applying the definition given in Reg 2(1)(zb) of the Listing Regulations.

The advantage of following the Listing Regulations definition by the subsidiary is that there is a consistency of definition used by both entities. There is a common template, consisting of items (a), (b), (c) and (d) which is circulated to all the subsidiaries. The subsidiaries fill the common templates, and that is how the RPTs at the level of the subsidiaries are identified. In essence, for the identification of related parties as well as RPTs, there is a common group-wide definition. As such, there will be consistency in the law followed by the entire group, making the implementation of the RPT framework, right from the identification of related parties to approval and disclosure requirements, easier at the parent level.

Demerits

• If we closely examine the definition of related parties under reg 2(1)(zb), we get a different view. The parties covered under the proviso (i.e., promoter and promoter group or entities holding shares on a beneficial interest basis) specifically refer to listed entities – therefore, these are not relevant for unlisted subsidiaries, or subsidiaries outside India.

• As for applicable accounting standards – it very clearly seems to be referring to standards applicable to the entity in question, and therefore, an entity-agnostic approach does not seem implied there. In case of overseas entities, “applicable accounting standards” will obviously mean accounting standards as may be applicable to the entity, therefore, entity-specific accounting standards.

• The only clause which is, therefore, left to be applied is the definition under the Companies Act, 2013. That definition applies to both listed and unlisted companies in India. However, such an extension by exported jurisdiction may create complexity for the subsidiaries incorporated outside India. At times, the terminologies used in foreign jurisdictions are not the same as that used in India. For example, terms such “relative” (a part of the definition of related party) may have completely different meanings in different jurisdictions. There may be nothing such as “private company”. Further, the definition of “subsidiary” or “associate’ may also be different.

• As a result, there is a strong possibility of inaccuracy or irreconcilability in the list of related parties provided by such foreign subsidiaries.

Option 2: Identifying related parties as per the applicable laws

Option 2 lets each company define related parties based on the definition applicable to it. There may or may not be analogous controls on RPTs, but clearly, accounting standards are almost the same all over the countries that matter. Since, a part of the definition of related party even under the Listing Regulations refers to “applicable accounting standards”, if we are using the definition as per accounting standards of the jurisdiction, we are serving the requirement of the law. Besides, going by the respective law as applicable to the subsidiaries would be more convenient for the subsidiaries as it would anyways maintain the list of related parties to comply with its applicable law.

Closing remarks

Basis the analysis above, it can be said that there can be two possible approaches – one, the listed entity requires the subsidiaries to maintain and provide the list of related parties as per Listing Regulations; alternatively, subsidiaries may be allowed to share the list of related parties maintained as per their respective local laws. Listing Regulations, at present, do not provide ample clarity on the approach to be followed. Neither is there any guidance issued by the regulator so far. Therefore, neither of the said approaches can be said to be non-compliant. Hence, the listed entities may take a considered call to go by any of the options. In our view, allowing subsidiaries to prepare the list by their local laws may be more convenient.

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Read our related articles on Related Party Transactions here:

Related Party Transactions- Resource Centre