Dissecting RPT controls in a corporate restructuring

Saket Kejriwal, Assistant Manager | corplaw@vinodkothari.com

Background

The identity of a corporate entity may undergo various changes, either pursuant to merger, demerger, sale of one or more divisions or undertakings, conversion into LLP etc. Usually, in corporate restructuring, the assets and liabilities forming part of an undertaking are shifted to another undertaking, say, the successor entity. Generally, these kind of transactions are covered under the ambit of Related Party Transactions (“RPTs”)  under the provisions of Companies Act, 2013 (“Act”) and SEBI Listing Regulations given that the restructuring involves related party(s) and RPTs have always been an evergreen and ever-evolving aspect of corporate functioning that has been put to guardrails by the law makers by involving specific disclosures and approvals.

However, MCA vide its General Circular No, 3O/2O14 dated July 17, 2014 has provideda relaxation to unlisted companies from the applicability of section 188 of the Act for the transactions arising out of corporate restructuring since the same are  being dealt under the specific provisions of the Act. On the other hand, for listed companies Regulation 23 of Listing Regulations requires seeking prior approval of Audit Committee/Shareholders, as applicable, for RPTs and no relaxations have been granted by SEBI to listed companies in this specific regard. This gives rise to doubt whether a transaction under a scheme of corporate restructuring will qualify as an RPT or not.

Accordingly, in the present write-up, the following issues have been dealt with:

• Identification of a transaction under a corporate restructuring as an RPT;
• Rationale for segregation of an RPT from a scheme; and
• Process for approval and disclosure of RPTs arising out of corporate restructuring.

Identification of a Transaction

Definition of RPT is not the subject matter of this write-up as the same has been dealt with by us in several of our write-ups along with FAQs which can be accessed at https://vinodkothari.com/article-corner-on-related-party-transactions/. Instead of diving into the details, let’s simply understand that any transaction involving a transfer of resources, services or obligations between parties falling under the following matrix will be considered as an RPT.

• Dilution of shareholding under a Scheme

• A Limited^[1] (‘A’) is a Listed Company;
• A and B Limited (‘B’) are related parties with A holding a 51% stake in B’s share capital;
• B holds a 20% stake in C Limited (‘C’); and
• A holds 0.33% in C.

A scheme of arrangement has been proposed between these companies, under which an undertaking of Company A will be transferred to Company C. As consideration for this transfer, shares of Company C will be issued to the shareholders of Company A.

This arrangement involves two distinct transactions:

1. Transfer of Undertaking:
   The first transaction involves the transfer of an undertaking (a bundle of assets and its related liabilities) from Company A to Company C, in exchange for shares of Company C. This constitutes a “transfer of resources” as defined under Regulation 2(zc) of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, and therefore qualifies as an RPT.
   
2. Issuance of Shares and Dilution of Shareholding:
   A key aspect of the scheme is the issuance of shares by Company C to the shareholders of Company A. As a result of this issuance, the shareholding of Company B in Company C will be diluted, falling below the 20% threshold.

This raises a question: Does such dilution constitute an RPT?

For a transaction to be classified as a related party transaction, there must be a transfer of resources, services, or obligations between related parties. In this case, while Company B and Company C are related parties, there is no actual transfer of resources, services, or obligations between them as part of this transaction. The dilution of shareholding occurs as a consequence of the share issuance, not due to a direct transaction between B and C.

Conclusion:

Therefore, while the transfer of the undertaking qualifies as an RPT, the dilution of Company B’s shareholding in Company C does not constitute a related party transaction and hence does not require separate approval under the SEBI Listing Regulations.

• Transfer of an undertaking under a scheme of demerger

A Limited (“A”), a diversified conglomerate with operations across multiple sectors, owns B Limited (“B”), its wholly owned subsidiary engaged in automobile manufacturing. Recently, B expanded into the electric vehicle (EV) segment. Following a strategic review, B has decided to demerge its EV business from its core automobile operations.

As part of this restructuring, the EV undertaking will be transferred to C Limited (“C”), a newly incorporated, wholly owned subsidiary of A. Post-demerger, C will become the Resultant Company, focusing exclusively on the EV business.

RPT Implication

The transfer of the EV business from B to C constitutes a transaction between two wholly -owned subsidiaries of the same listed entity (A) and hence, there cannot be said to be any effective transfer of resources so as to be considered as an RPT.

However, since company C will be incorporated after the approval of the scheme by the shareholders a question may arise as to when the approval needs to be placed between the shareholders for RPT. Since, a pre approval of RPT is mandatory the approval has to be taken beforehand from the shareholders

Exemption from Approval

Since both B and C are wholly owned subsidiaries of A, there is no effective change in ownership or effective transfer of resources. Accordingly, this transaction falls under the exemption provided in Regulation 23(5) of the SEBI Listing Regulations, which exempts RPTs between wholly owned subsidiaries of a listed entity from the approval requirements.

Conclusion

While the transfer qualifies as an RPT under the SEBI Listing Regulations, it is exempt from the approval process due to the continued ownership within the same shareholders thereby resulting in no change of resources. This allows the company to realign its structure without involving regulatory hindrances. Also refer to our write up on  RPTs: Wholly-owned but not wholly-exempt to understand the application of RPT Controls for transactions with Wholly Owned Subsidiary.

• Scheme of arrangement involving Creditors

• A Limited (‘A’) is a Listed Company;
• A Limited (‘A’) and B Limited (‘B’) are related parties with A holding a 51% stake in B’s share capital;
• B holds  20% stake in C Limited (‘C’); and
• A holds 0.33% in C.

C is facing a severe liquidity crunch and thereby, C is unable to service/ settle the o/s debt obligations. As a result, a scheme of arrangement has been proposed in which an undertaking of C will be transferred to B. Further, the consideration for the present arrangement as is required to be disbursed by B shall be used for servicing the remaining creditors of C (i.e., the creditors belonging to the remaining undertaking of C)

This arrangement involves two distinct transactions:

1. Transfer of Undertaking:
   The first transaction involves the transfer of an undertaking from Company C to Company B, in exchange for shares of Company B used to discharge its liability. This constitutes a “transfer of resources” as defined under Regulation 2(zc) of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, and therefore qualifies as a RPT.
   
   
2. Issuance of Shares to creditors:
   A key aspect of the scheme is the issuance of shares by Company B to the creditors of Company C against their outstanding loans to C. The transaction is between two unrelated parties, However, one may argue that the purpose and effect of this is to benefit C (by way of reducing its outstanding debt obligations) which is a related party of B and from A’s perspective this will be a transaction between a subsidiary (B) and a person,  the purpose of which is to benefit a related party of the subsidiary (C).

There will be two kinds of creditors in the above scenario:

• Creditors pertaining to the demerged undertaking: After the transfer of undertaking to company B all the liabilities pertaining to the undertaking will also be transferred, as a result, the creditors of company C will become creditors of company B, thereby removing the doubts of C being benefited by this transaction.
• Other Creditors: At the time of receiving the consideration, these creditors will still be creditors of company C, thereby benefiting C by reducing its outstanding debt obligations and accordingly will constitute an RPT. However, separate approval can be avoided and clubbed alongside approval sought under point 1 above.

• Dilution of director’s shareholding under a Scheme

• A Limited (‘A’) is a listed company;
• A and B Limited (‘B’) are related parties with B being a WOS of A;
• Mr. X (Independent Director of B) holds a 2% stake in C Limited (‘C’); and
• A and C have entered into a scheme of arrangement whereby an undertaking of C is transferred to A.

The transaction between A and C will qualify as an RPT because:

• The first party to the transaction is the listed company itself (A), and
  
  
• The second party (C) qualifies as a related party of the subsidiary (B) in terms of Section 2(76)(v) of the Companies Act, 2013.

With respect to the dilution of Mr. X’s shareholding in C, as a result of the scheme, it is clarified that this will not pose any concern, as already discussed earlier in this article.

• Transfer of undertaking under a scheme of amalgamation

A and B are peer entities, with A being backed by foreign promoters who wish to divest one of their business verticals. Scheme of amalgamation has been proposed for both entities to merge their operations, with the business being run through a newly incorporated entity i.e. C. All of A’s resources related to this vertical will be transferred to C and both A and B will become shareholders in the newly formed company with A holding 40% and B holding 60%. B will be dissolved as a result of this scheme.

In the above scenario, C will be an associate company of A and accordingly will be considered as a related party of A. However, if we take a broader view this transaction is between A and B with both being an unrelated party. This scheme will definitely affect the shareholders of A and approval of shareholders for the scheme will be a prerequisite for this transaction. However, from the RPT angle this does not seem to fundamentally affect the shareholders as the transaction is between two unrelated parties.

Despite the above facts, this transaction will be governed by the provisions of regulation 23 and will have to follow a separate approval process, independent of the scheme approval, as this falls under the RPT matrix. Alternatively this transaction would not have been required to take a separate approval if the transfer of undertaking was between A and B removing C from the scenario.

• Transfer of undertaking in a Scheme of Merger

A Limited and B Limited are related parties, with B forming part of the promoter group of A. A Limited operates in the Agriculture sector, while B Limited is primarily engaged in marketing and logistics services, assisting A in distributing and promoting its agricultural outputs globally. A proposal has been placed to merge the operations of B into A.

Since the transfer of resources occurs between A and B, which are related parties, the transaction qualifies as an RPT as there is transfer of resources of B into A.

Decoding the underline basis for considering the RPT angle in scheme of arrangements

The first checkpoint for a transaction to be categorised as an RPT is transfer of resources, services and obligations with the involvement of a related party either at the level of the listed entity or of its subsidiary. Further, the following takeaways can be understood from the casses discussed above:

1. A scheme of arrangement can involve transactions that qualify as RPTs for one or more parties directly participating in the scheme.
2. Even if a listed company is not a direct party to the scheme, it may still be subject to RPT regulations if its subsidiary is a party to the scheme and is transacting with a related party of the listed entity or its subsidiary.
3. Under a scheme of Corporate Restructuring resources are generally transferred from the transferror company to the transferee company. For instance, in a scheme of merger, both assets and liabilities, which qualify as “resources” and “obligations” respectively, are transferred from one entity to another, typically in exchange for shares of the transferee company and/or for a cash consideration.
4. It is important to carefully consider the meaning of “transfer” in the context of a scheme of arrangement. The concept should not be limited to the  movement of assets and liabilities between two separate legal entities but also the receipt of consideration which results in a change in shareholding or even control.
5. In a scheme involving two WOS of a listed company, there may be a transfer of resources from one WOS to another. However, since both entities are ultimately owned by the same parent, there is no real change in the ownership or even an effective transfer of resources. Hence, these cases remain outside the purview of an RPT.
6. In the case of a transfer of an asset by a subsidiary, which is not a WOS, in which the listed entity holds a 51% stake to an associate company in which the listed entity holds only a 20% stake, the transaction results in a change in partial ownership of the asset outside the listed entity’s structure. Although the transfer may occur between two investee entities of the listed company, it effectively leads to divestment of a portion of economic interest. Hence, results in a transfer of resources. Therefore it is suggested that the RPT implications must be independently evaluated for each party, including listed entities with indirect exposure through subsidiaries.
7. Once a transaction is identified as a RPT the primary concern that arises is whether it has been undertaken on an arm’s length basis. A natural question that follows is whether the fair valuation requirement under Section 230(2) of the Companies Act, 2013 is sufficient to satisfy this test. While the section mandates the submission of a valuation report covering all properties, assets, and shares involved in a scheme, it is important to note that a scheme of arrangement is structurally distinct from a plain bilateral transaction. A scheme often involves strategic, composite, or long-term considerations that may justify deviations from pure fair value. Therefore, the assessment of arm’s length nature, both in terms of properties transferred and the consideration offered, must be undertaken in the context of the terms and conditions of the scheme as a whole, rather than simply putting the share exchange ratio for approval under the RPT agenda.

One of the major reasons for evaluation of a scheme from RPT perspective is its separate approval.  This ensures that the scheme is not used as a turnaround for an RPT approval which would not have been approved, had it been proposed outside the framework of scheme. Following are two key reasons supporting the requirement of separate shareholders approval for a RPT:

1. Exclusion of Related Parties from Voting:

The law prohibits related parties from voting on RPTs. If we assume that approval of the overall scheme automatically includes approval of the RPT, it would allow related parties to influence the vote—undermining the very purpose of this restriction.

2. Exclusion of Related Parties from Voting:

The minimum information required to be presented to shareholders for approving an RPT may not be adequately disclosed if the approval process is merged with that of the scheme. This compromises transparency and does not ensure that shareholders are fully informed about the transaction.

Approval of transactions qualified as RPT

SEBI vide its master circular no. SEBI/HO/CFD/POD-2/P/CIR/2023/93 dated June 20, 2023 has specified the requirements that listed companies have to comply before submission of any scheme of arrangement to NCLT for its approval. However, an issue which goes unanswered in the aforesaid circular is whether a separate approval of Audit Committee/Shareholder is required for an RPT arising out of a scheme or will the approval of a scheme from the shareholders which includes a RPT will suffice and be considered as a due compliance of Regulation 23 of SEBI Listing Regulations.

This matter was placed before SEBI for Discussion in its Board meeting dated September 28, 2021, However, no decision has been notified yet.

For listed companies, the following are two key reasons supporting the requirement of separate shareholders approval for a RPT:

• Exclusion of Related Parties from Voting:

The law prohibits related parties from voting on RPTs. If we assume that approval of the overall scheme automatically includes approval of the RPT, it would allow related parties to influence the vote—undermining the very purpose of this restriction.

• Disclosure Requirements:

The minimum information required to be presented to shareholders for approving an RPT may not be adequately disclosed if the approval process is merged with that of the scheme. This compromises transparency and does not ensure that shareholders are fully informed about the transaction.

The position of unlisted companies is clear in this regard as the Ministry has already issued a clarification, However, SEBI has not  provided any relaxations of similar nature to the listed entities.  Therefore, it can be said that RPTs under a scheme of arrangement will require a separate approval of the Audit Committee or/and shareholders, as applicable, independent from the  approval  of the scheme by the shareholders.  

• Audit Committee: Under the provisions of Regulation 23 of the SEBI Listing Regulations and the relevant sections of the Companies Act, the Audit Committee must approve any transaction involving related parties before it is executed. This ensures transparency and compliance with regulatory requirements.

It is important to note that even if a transaction is not directly entered into by the listed entity but occurs as part of a corporate restructuring scheme involving a subsidiary and it’s the subsidiary who is entering into a transaction with any related party, the prior approval of the listed entity’s Audit Committee is still required. Specifically, if the transaction exceeds the threshold limits defined in Regulation 23(2) of the SEBI Listing Regulations, the Audit Committee’s approval must be obtained before proceeding.

The approval of the committee in case a transaction is not material may be taken in the same meeting which is held for consideration of the scheme before it is submitted to the stock exchanges.

• Shareholders’ Approval: In case the transaction under a scheme of arrangement reaches the materiality threshold of Regulation 23 of Listing Regulations, the same will have to be approved by the shareholders of the Company before submission of scheme to NCLT.

A pertinent point to note is that in this case the company has to seek shareholders approval two times, one before submission of scheme to NCLT for RPT and the other for the Scheme at the meeting called by NCLT.

Conclusion

In schemes involving corporate restructuring, especially when related parties are involved, the primary legal considerations are fairness, transparency, and ensuring that the rights of minority shareholders and creditors are not prejudiced. It is crucial for the entities to provide independent fairness opinions, detailed disclosures, and valuations. 

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^[1] A being a listed company all the RPTs have to be identified from A’s perspective

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