RPTs: Testing Multiyear Contracts for Materiality
– Saloni Khant, Executive | corplaw@vinodkothari.com
It is common for companies to enter into multi-year contracts in its usual business operations, to secure supply of goods or services, access to premises for operations, or for other commercial reasons etc. In the maze of RPT compliances, however, given that the transactions are usually approved by the Audit Committee and/ or shareholders on an omnibus basis, challenges arise on the ideal way of dealing with and taking approval for multi-year contracts.
The relevance of multi-year contracts in the context of RPTs arises for two reasons:
- the value of contract that is required to be taken for the purpose of ascertaining materiality of a contract or transaction, and
- the tenure for which the approval can be taken for such contracts.
Several questions arise:
- Should the entire value of the contract be placed for approval, even if that results in crossing the materiality threshold, and requires going to the shareholders?
- Or can the shareholders’ approval be circumvented by dividing the total contract value into yearly values and taking approval only for the estimated yearly transaction value?
- If so, what happens if the contract is not approved by the AC in any subsequent FY within the tenure of the contract?
- If the total contract value is approved, should the approved value be considered for materiality thresholds again for the next FY?
Divisibility of contracts into smaller relevant units
The crucial point in considering whether a contract requires yearly approval or one single approval valid for the whole contract is based on the “divisibility” of the contract – that is to say, its ability to be divided into smaller units instead of considering the contract as a whole. If it is a single contract for a fixed term, the approval of the contract is approval of the entire exchange of resources/services that takes place over such term.
The divisibility of a contract may be judged against various factors, for instance:
- Tenure of the contract
- Contractual milestones for payment based on performance
- Satisfaction of performance through delivery of goods or services under a contract etc.
We discuss each of these in detail below.
Fixed tenure implies single approval for whole tenure?
Several contracts may have a fixed tenure, but does the fixity of tenure itself implies that such a contract shall be required to be approved through a single approval – valid for the whole tenure of the transaction?
There may be several contracts having a fixed term, but the fixity of term in itself may not be the essential feature in all such contracts. For example, a contract might have been entered into 3 years for supply of certain goods or services. While the tenure of the contract is 3 years, each instance of supply of goods or services constitutes an independent divisible supply in itself. Hence, in such cases, merely based on the tenure of the contract, the indivisibility of such arrangement cannot be argued.
Performance or payment milestones in a contract
In a multi-year contract, there are usually payment milestones based on performance of the contract. For example, a contract for development of software may contain milestones, such as, (i) development of UAT model, (ii) development of final software interface, and (iii) activation of the software etc. While the contract value may be divided based on the three different stages or milestones specified in the contract – it is important to note that the performance of the contract becomes complete only upon activation of the software, and hence, the divisions based on the performance milestones do not have an independent existence. Hence, dividing the contract would not be feasible here.
Performance of contract: delivery of goods or services
The most important factor in considering the divisibility of a contract is the actual performance of the contract. Whether the contract is of such nature that the delivery happens “over a period of time”, or is it such that while the exchange of resources/ services take place over the tenure of the term, the performance may be said to be complete only “at a point of time”.
Period of time v. point of time: drawing reference from Ind AS 115
In order to understand the divisibility of a contract based on ‘period of time’ v/s ‘point of time’- reference may be drawn from its closest equivalent under Ind AS 115 read with its guidance note for the purpose of revenue recognition.
Divisible contracts: satisfaction of performance obligations over a period of time
Ind AS 115 specifies conditions based on which it may be said that the performance obligation is satisfied and revenue is required to be recognised over a period of time: [Para 35]
- The nature of the activity is such that the counterparty is able to enjoy the supply simultaneously as it is made.
- In case an asset is created/ enhanced, it remains within the control of the counterparty during such creation/ enhancement.
- In case the nature of the asset so created is such that it has no alternative use and the payment terms provide that the supplier has a right to payment for supply till date.
Where none of these conditions are satisfied, the performance obligation in the contract is considered to be satisfied at a point in time.
(a) the customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs;
The key question here is if the performance of the contract is stopped midway, would the customer still be considered to have benefitted from the performance already done?
For e.g., in a rental agreement, the tenant takes the benefit of the premises simultaneously. Even if the tenancy is terminated midway, it does not take away the benefits already enjoyed by such tenant during the period of the contract, he would remain benefitted for the fulfilled period of tenancy.
This may be compared with a construction agreement, where, in the event of an early termination of the contract, the performance obligations would remain incomplete, with no benefits to the customer for the period of time during which the service has been performed prior to its termination. Even where the work is rerouted to another supplier, it would require substantial rework.
(b) the entity’s performance creates or enhances an asset (for example, work in progress) that the customer controls as the asset is created or enhanced;
The renovation of an office building owned by the customer would amount to a contract over a period of time. The service may be terminated midway and can be completed by another service provider since the control of the asset remains with the owner at all times.
(c) the entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date.
The term ‘an alternative use’ must be considered from the perspective of practical limitations and contractual restrictions. Where the nature of the asset is such that it cannot be redirected to another contract, for example – machinery with unusual specifications cannot be sold to another customer, it is said to not have an alternative use. Even where the resources are portable, but the contractual terms restrict such redirection, there is no alternative use.
In such cases, where a contract is terminated midway, the service provider must have the right to receive payment on quantum meruit basis i.e. the work is sufficiently divisible to assess the payment due to the supplier.
When a contract fulfills any of the three conditions, it satisfies one principle criteria:
Any exit from the contract may require the contractual parties to replace the party, and may have penal consequences, but it is not as if the contract was not performed at all.
Manner of seeking approval
Where the transaction is a single indivisible contract i.e. takes place over a period of time, the IND AS recognises revenue over time by measuring the progress in the performance of the contract[1]. Accordingly, the transaction must be placed in its entirety with its full value for approval before the audit committee, the board of directors and the shareholders (if the materiality threshold is crossed). The transactions placed before all the three bodies must be aligned. Once approved, the actual implementation of the transaction shall come merely for review before the audit committee on a yearly basis in terms of section III.B.5 of the SEBI Master Circular dated January 30, 2026.
An interesting question arises here. Once approved, shall this amount be aggregated with new proposed transactions in the next year? Let us consider an illustration here. The materiality threshold for A Ltd. (listed entity) is Rs. 2000cr. In FY 25-26, A enters into a construction contract (single indivisible multiyear contract) and in FY 26-27, a contract for purchase of goods (one off transaction) with B Ltd for various amounts as tabulated below:
| S. No. | FY 25-26 | FY 26-27 | |||||
| Construction Contract Amt (Rs.) (I) | Whether I is material and approved by shareholders? | Purchase Contract Amt (Rs.) (II) | Whether II is material and needs shareholders’ approval? | Whether (I) and (II) shall be aggregated for materiality threshold? | Does the aggregate of (I) and (II) cross the materiality threshold? | Whether (I) shall be placed for noting before shareholders? | |
| 1 | 1000cr | No | 500cr | No | Yes | No | No |
| 2 | 1000cr | No | 1500cr | No | Yes | Yes | Yes |
| 3 | 1000cr | No | 2300cr | Yes | Yes | Yes | Yes |
| 4 | 3000cr | Yes | 1 | No | No | No | Already approved by the shareholders |
| 5 | 3000cr | Yes | 2500cr | Yes | Not required | Yes | |
For the first 3 cases, the transactions are aggregated for testing the material threshold since transaction (I), even though ongoing in FY 26-27, has never been placed before the shareholders. In effect, in case 2, the actual transactions ongoing with B in FY26-27 are crossing the materiality threshold and thus, must be placed for approval before the shareholders.
In case 3, while Transaction (II) crosses the threshold independently, it is only logical for the shareholders to be apprised of the other ongoing transactions (Transaction I) with the same RP to understand the true position of the transactions between the RP and the listed entity. The Industry Standard Note on RPTs (ISN), anyways, requires this disclosure. [Part A(3)] Read our latest article on the ISN: Repetitive Overhaul: RPT regime to get softer
In case 4, Transaction (I) has already been placed before the shareholders for approval. If its value is aggregated with Transaction (II), even a Rs. 1 transaction will require the approval of the shareholders. The essence of the materiality thresholds is seeking approval for material contracts. Such aggregation would defeat the very intent of the law.
In case 5, Transaction (I) is already approved by the shareholders and Transaction (II) crosses the materiality threshold independently. There arises no question of aggregation.
Thus, the decision of aggregating the value of a single indivisible contract in the previous FY for materiality thresholds in the current FY depends upon
- whether such aggregated value crosses the thresholds in the current FY;
- whether the transaction in the previous FY crossed the thresholds back then.
On the other hand, where the transaction is a divisible contract over a term, the estimated value to be utilised in that particular year may be placed for approval before the audit committee, board of directors and shareholders, as the case may be. In case a material transaction was approved by the audit committee on an omnibus basis, it shall continue to be placed before the shareholders. [Section III.B.5 of the Master Circular]. Since the yearly value of the transaction is being approved and utilised, there arises no question of aggregation of previously approved value with proposed transactions in a new FY.
Specific disclosure of tenure of multi-year projects
The law enables securing transparent approvals for indivisible contracts. The ISN requires an estimated break-up financial year-wise in case of a transaction spanning over multiple years to be placed before the audit committee as well as shareholders, as the case may be [Para A5(5)]. (See our FAQs on the Industry Standard Note)
Further, while disclosing RPTs on a half yearly basis as a part of quarterly integrated filing (governance) to the stock exchange, the Master Circular requires disclosure of the aggregate value of the RPT as approved by the Audit Committee as well as the value of transaction during the reporting period.
Conclusion
With SEBI settling RPT approval related non-compliances for settlement fees running into crores[2], compliance officers need to tread more carefully than ever. Deciding whether a multi year contract should be approved as a whole or in parts remains a crucial decision, particularly in the absence of detailed guidance under Companies Act and SEBI LODR. While accounting standards primarily address revenue recognition and may not directly apply to all RPTs, the principles outlined therein can still offer useful guidance in navigating such situations.
[1] Para 39 of the IND AS 115
[2]https://www.sebi.gov.in/enforcement/orders/feb-2026/settlement-order-in-the-matter-of-kalyani-steels-limited_99922.html
Refer to our other resources:
Leave a Reply
Want to join the discussion?Feel free to contribute!