Evolution of concept of related parties and related party transactions
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- SEBI issues clarifications on amended RPT framework – https://vinodkothari.com/2022/03/sebi-issues-clarifications-on-amended-rpt-framework/
- Our resources on related party transactions: https://vinodkothari.com/article-corner-on-related-party-transactions/
FAQs on RPT regulatory framework as amended by the 6th LODR Amendment
Presentation on Amended SEBI Framework on Related Party Transactions
Detailed analysis of the amendments in RPT framework pursuant to SEBI LODR (6th Amendment) Regulations, 2021: https://vinodkothari.com/2021/11/sebi-widens-the-sweep-of-related-party-provisions-drastically/
Article explaining the amendments in RPT framework with action points: http://vinodkothari.com/2021/11/sebi-notifies-stricter-norms-for-rpts/
Snapshot of SEBI LODR 6th Amendment Regulations 2021: https://vinodkothari.com/2021/11/snapshot-of-sebi-lodr-6th-amendment-regulations-2021/
Read our other articles on the subject: https://vinodkothari.com/article-corner-on-related-party-transactions/
Other Corporate Law articles: http://vinodkothari.com/corporate-laws/
RPT provisions in India and other countries
RPT-provisions-in-India-and-other-countries
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RPTs and related exemptions in the context of Government companies
Munmi Phukon and Tanvi Rastogi
corplaw@vinodkothari.com
Introduction
Ministry vide its Notification[1] dated 5th June, 2015 issued certain modifications/ exemptions/ exceptions for Government Companies on certain provisions of the Companies Act, 2013. One such exemption was with respect to the provisions pertaining to related party transactions (RPTs). Vide the said Notification, Government Companies were provided relaxation from obtaining the prior shareholders’ approval as required under the first proviso to section 188(1) and consequently, from the restriction on the affirmative voting by the related parties for (a) contracts/ arrangements with other Government Company(ies) and (b) where the Government Company is not a listed company, contracts/ arrangements with related parties other Government companies as mentioned above, if prior approval of the Ministry/ Department of the Central Government (CG) or State Government (SG) administrative in charge of the Company is obtained.
The aforesaid Notification has been revisited by the Ministry by issuing a further Notification[2] dated 2nd March, 2020 (2020 Notification) whereby the said exemptions have been extended to the contracts/ arrangements by the Government Companies with CG/ SG/ any combination thereof.
Before analysing the relevance of the 2020 Notification, one has to understand the related parties from a Government Company’s perspective. This article analyses the provisions of the Companies Act, 2013 (Act) only, considering the Notification has been brought in by the Ministry of Corporate Affairs.
Related parties for a Government Company
As per clause (76) of section 2 of the Act following shall be a related party with reference to a company:
- a director or his relative;
- a key managerial personnel or his relative;
- a firm, in which a director, manager or his relative is a partner;
- a private company in which a director or manager or his relative is a member or director;
- a public company in which a director or manager is a director and holds along with his relatives, more than two per cent of its paid-up share capital;
- any body corporate whose Board of Directors, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager;
- any person on whose advice, directions or instructions a director or manager is accustomed to act: Provided that nothing in sub-clauses (vi) and (vii) shall apply to the advice, directions or instructions given in a professional capacity;
- any body corporate which is—
- a holding, subsidiary or an associate company of such company;
- a subsidiary of a holding company to which it is also a subsidiary; or
- an investing company or the venturer of the company
- a director other than an independent director or key managerial personnel of the holding company or his relative as prescribed under Rules
Accordingly, to consider someone as related party, he/ she/ it shall have to strictly fall under any of the aforesaid sub-clauses. Seemingly, the Government of India or any State Government having controlling stake in the company does not get fit in any of the said clauses as the CG/ SG is neither considered as a person nor an entity/ body corporate. Accordingly, CG/ SG is not a related party to a Government Company as per the aforesaid definition.
Similarly, to consider another Government Company as a related party for a Government Company, the former shall also be required to fall under the definition. Accordingly, one will have to determine whether the former Government Company is a related party or not, based on its structure i.e. private company, public company, body corporate, and also based on its relationship with the subject Government company i.e. holding company, subsidiary company, associate company etc.
Position before and after 2020 Notification
Transaction between Government companies and CG / SG
The position with respect to transactions between the Government Company and the CG/ SG before and after the 2020 Notification remains same as CG/ SG, as discussed above, does not get covered under the purview of the definition of related party provided under the Act. Therefore, until and unless there is a related party on the other side, any transactions with any other party cannot be considered as RPT. Accordingly, where the transaction itself is not an RPT, exemption from the provisions pertaining to RPTs does not arise.
Transaction between two Government Companies
As discussed above, for considering another Government Company as related party one has to consider the status of such company. Accordingly, for a Government Company, the following Government Companies may be considered as related party:
- A Government Company which is a private company in which a director, manager or relative thereof of the first mentioned Government Company is a member or director;
- A Government Company which is a public company in which a director or manager of the first mentioned Government Company is a director and holds along with his relatives, more than two per cent. of its paid-up share capital;
- A Government Company which is either the holding company or subsidiary or associate company of the first mentioned Government Company;
- A Government Company which is a fellow subsidiary of the first mentioned Government Company;
- A Government Company to which first mentioned Government Company is an associate company
Considering the structure of the Government Companies, it is very unlikely to have related parties covered under point (a) and (b) above. Coming to the position before or after the 2020 Notification, there is no change, as the 2015 Notification already covered transactions between two Government Companies.
Transactions between the Government Companies and other related parties including non- Government Companies
From the definition provided in the Act, the following persons/ entities may also be considered as related parties for a Government Company:
- Individuals who are director, key managerial personnel (KMP), relatives of director/ KMP (s), a director other than an independent director or KMP of the holding company or his relative;
- Firm in which a director or manager or relative thereof is a partner;
- Non- Government Companies such as:
- Private companies in which a director or manager or relative thereof is member or director;
- Public companies in which a director or manager is a director and holds > 2% of its paid-up share capital, singly or jointly with his relatives;
- Body corporate whose Board/ managing director/ manager accustomed to act in accordance with the advice, directions or instructions of a director or manager;
- Any person on whose advice, directions or instructions a director or manager is accustomed to act.
While the parties mentioned in point (d) and (e) above, cannot be determined without analysing the proper facts and considering these are purely circumstantial in nature, it is very unlikely to have such related parties. As regards the position before and after the 2020 Notification, the transactions between these related parties will still require the prior approval of the administrative Ministry in charge, if the company is not obtaining prior shareholders’ approval. Accordingly, there is no change in the position after 2020 Notification.
Conclusion
While the 2020 Notification is an extended version of the 2015 Notification, however, it seems that it does not carry any relevance at all. The reason for the same is that CG/ SG, as discussed above, does not get covered under the purview of the definition of related party provided under the Act. Therefore, until and unless there is a related party on the other side, any transactions with any other party cannot be considered as RPT. Accordingly, where the transaction itself is not an RPT, exemption from the provisions pertaining to RPTs does not arise.
[1]http://ebook.mca.gov.in/notificationdetail.aspx?acturl=6CoJDC4uKVUR7C9Fl4rZdatyDbeJTqg3XHmN4i4mFb+v2wWhMvQoFsXKgJTHtRr9VmNjj/XQUFc9vZ6tRKIi2gIhxfNI2SOK
[2]http://www.mca.gov.in/Ministry/pdf/Notification_02032020.pdf
Our other articles on related party transactions:
http://vinodkothari.com/2020/02/proposed-changes-in-rpts-ppt/
http://vinodkothari.com/2017/09/presentation-on-related-party-transactionrpts-an-overview/
Majority of minority to ensure economic interest in transactions with related parties
SEBI’s proposal–came late, came correct
-CS Nitu Poddar, Tanvi Rastogi
corplaw@vinodkothari.com
Financial assistance to related entities is a quite a regular transaction. Considering the transfer of obligations, such transactions are subject to certain regulation under the Companies Act, 2013 (Act, 2013) and SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR). However, despite the prohibitions and restrictions, there are several areas within the periphery of transactions with related parties which remain out of the ambit of law and therefore is beyond required checks. Following the proposal of changes in the provisions of RPT vide the report of the working group[1], SEBI has floated a consultative paper[2] on 06-03-2020 proposing certain changes to corporate guarantees being provided by a listed party on behalf of its promoter / promoter related entities, without deriving any economic benefit from such transaction.
In this article, we discuss the coverage of the current provisions, gap therein, need for the proposal and the proposed regime to bridge such gap.
Unrelated-related parties – remains unregulated
As compared to the Act, 2013, LODR has a wider definition of related party where it additionally covers related parties under AS-18 / IND AS-24 and also such member of promoter and promoter group which holds 20% of the total shareholding of the listed entity. Despite such wide definition, practically speaking, there may be several interested entities of the promoter which gets excluded from the technical criteria of being a related party due to absence of required shareholding and consequently transactions with them can easily sail through without being subject to required approvals. As such, currently, a listed entity can grant loan, give guarantee / security in connection of loan to / on behalf of an entity, which technically is not a related party, but either is a promoter or an entity in which the promoter has vested interest against the interest of stakeholders of the lending company.
Existing provisions regulating financial transactions
Currently, section 177, 185 and 186 of Act, 2013 are the major provisions governing any financial transactions. Section 188 of the Act, 2013, does not cover financial transaction within its coverage and therefore the same get ruled out anyway. Section 177 provides for scrutiny of inter-corporate loans as well as approval and modifications of all related party transactions. The challenge of this section are that firstly, transactions with interested unrelated party gets ruled out and consequently the committee is left with the duty of a post mortem scrutiny and not a prior scanning of the transaction. Sec 186 provides for limits of financial transaction i.e giving of loan, investment, guarantee, security in connection with loan and also keeps a check on minimum rates to be charged in case of loan. Transactions beyond the limits require approval by special majority of the shareholders. Sec 185 talks about granting of loan to directors and director-interested entities. While there is complete prohibition of granting of such loan to the director himself or his relative / firm, loan can be granted to interested-companies, subject to approval by special majority of shareholders of the lender company.
To get such approval is not a tough task in a company with high promoter-holding, and the promoters can easily get their transaction through. Unlike sections 188 and 184 where the voting rights of the interested parties are restricted in the general meeting and board meeting respectively, section 185 and 186 does not provide for any such restrictions.
As per Reg 23 of LODR, related party transactions, which includes financial transactions as well, requires approval of shareholders by majority. This approval is by the majority of the minority as all entities falling under the definition of related parties cannot vote to approve the relevant transaction irrespective of whether the entity is a party to the particular transaction or not.
Proposed amendment – need and proposal
It is to be noted that whenever there is a transaction with a promoter related entity, there may be a potential threat to the interest of the non-promoter group / minority shares. Accordingly, approval of the majority of such minority is to be essentially sought to ensure that the resources of the company are not been siphoned away / wrongly used / alienated by the promoters and that the interest of such minority is secured. As mentioned above, in the existing regime, question of approval from such majority of minority arise only for material RPTs under LODR.
Hence, all such transactions which does not fall under the category of “RPT” and / or “material” remains unguarded and thus putting the corporate governance of the company at stake. SEBI, in its report on working group of RPT[3], has clearly put forward its intent to curb such influential transactions by the promoter / promoter group and to revise the definition of related party itself. Once the said proposal is made effective, all transactions with promoter / promoter group will be a RPT. However, inspite of such revision in the definition of RPT, only material transactions will require approval of minority shareholders.
Through the proposal in the consultative paper, SEBI intends to move a step ahead of what the working group discussed. SEBI now proposes to require all guarantee transactions, irrespective of the materiality to be approved by the majority of minority shareholders. Additionally, the directors of lending company are required to establish and record “economic interest” in granting of such guarantee.
Essence of voting by majority of minority
It is no approval, if the person seeking approval and granting approval is the same. In corporate democracy, approval is essentially ought to be sought from the class of people whose rights seem to be prejudiced from transaction proposed in the interest of another class. Reg 23 of LODR and sec 188 of Act, 2013 already recognises such majority of minority approval wherein all the related parties of the company refrain from voting.
Significance of “economic interest”
Any prudent mind would require risk and reward, benefit and burden to be shared proportionately. It is absolutely irrational to say that a listed company is extending guarantee / security in connection with loan but has no benefit in return.
It is to be noted that charging of guarantee commission or charging of interest is not to be misunderstood as presence of economic interest. There are charged only to keep the transaction at arm’s length. However, the exposure of the lender company is the amount of loan / amount guaranteed.
Few examples of embedded economic interest in a transaction can be as follows:
- A holding company extending loan to its wholly-owned subsidiary for funding acquisition of land for building of plant may be benefitted by the figures of such subsidiary at consolidated level;
- A listed company guaranteeing on behalf of another unrelated-related entity which is the customised raw material provider of the lending company
Different scenarios of financial transaction considering the proposal of SEBI:
| S. No. | Transaction between | Existing provision | Proposed amendment | Analysis |
| 1
|
Two unlisted companies | Section 186 / 185, if applicable | Unlisted companies are not covered | No Impact |
| 2 | Listed company with its related party – beyond materiality threshold | Section 186 / 185, if applicable and Reg 23- shareholders’ approval through resolution where no related party shall vote to approve | Ensuring the economic interest + Prior approval from the shareholders on a “majority of minority” basis | Irrespective of the materiality, where there is any transfer of financial obligation, prior approval of unrelated shareholders will be required |
| 3 | Listed company with related party not within materiality threshold | No requirement for shareholders’ approval | Ensuring the economic interest + Prior approval from the shareholders on a “majority of minority” basis | Irrespective of the materiality, where there is any transfer of financial obligation, prior approval of unrelated shareholders will be required |
| 4 | Listed company with unrelated related party[4] | No requirement prescribed under law |
Open issues
- While the proposed amendment is absolutely on-point and timely amendment in the wake of several corporate scams in the recent past being witnessed by the country, however, it will achieve its intent if the same is not kept limited to guarantee / security in connection with loan, but also extended for granting of loan to such unrelated-related entities;
- Also, the list of entities is kept vague in the Paper (promoter(s)/ promoter group/ director / directors relative / KMP etc) and may be better clarified in the amendments, however, the intent seems to be quite clear to include any promoter / promoter group / management related entity;
- Lastly, it is not clear as to who should refrain from voting for majority of minority voting – all promoter / promoter group entities / all related parties of the listed entity;
[1] https://www.sebi.gov.in/reports-and-statistics/reports/jan-2020/report-of-the-working-group-on-related-party-transactions_45805.html
[2] https://www.sebi.gov.in/reports-and-statistics/reports/mar-2020/consultative-paper-with-respect-to-guarantees-provided-by-a-listed-company_46234.html
[3] SEBI Report on working group of RPT dated 27th January, 2020 ibid
[4] Includes promoters which may not fall under definition of related party – like promoter not holding any shareholding in the company
Read our article on proposed changes by working group of SEBI on Related Party Transactions here: http://vinodkothari.com/2020/01/expanding-the-web-of-control-over-related-party-transactions/
Read our articles on the topic of related party transactions here: http://vinodkothari.com/article-corner-on-related-party-transactions/