“In-laws” in law of Related Party Transactions: Too far, Too much?

– Sikha Bansal, Senior Partner | corplaw@vinodkothari.com

Related party includes certain relationships solely on account of marriage

• Definition of “related party” in section 2(76) of the Companies Act, includes “relatives” of directors and KMPs, and goes to include private companies where a director’s or KMP’s relative is a director or member, or firms where the director’s relative is a partner; or even a public company, where the director is a director, and along with his “relatives” holds 2% or more of the share capital.
• A son-in-law/ daughter-in-law are also “relatives” in section 2(77) of the Companies Act.
• The provision does not take into account whether there is any financial/economic dependence or influence involved in such relationships and the “in-laws” are considered relatives solely because of the marital relationship.

Practical considerations involved in applying RPT controls to “in-laws”

• When a wedding in a director’s family happens, a new related party comes into being – son in law or daughter in law. Not only the new RP, but even the companies where the new RP holds directorships or shares becomes a part of the list of “related parties”, linked with a particular director.
• Obviously, the only way for the company to come to know of this relationship is by way of intimation from the director in question. The director also, particularly in case of economically independent relations such as son-in-law, cannot keep a constant tab on the companies/entities where a son-in-law has directorships or investments.
• Consequently:
  • A son-in-law may not have intimated or intimated on a real time basis the directorship/private company investments.
  • The director in question would not have come to know of such directorships/investments or would not have come to know of the same on a real time basis.
• In fact, in most of the cases, a financial independent person who takes care of his/her own economic interests would not want to disclose or divulge personal and financial details to anyone.
• Therefore, it is not feasible to envisage a real time updation of familial relationships, or the economic interests of such relationships of a director in question
  • Hence, information time lags are quite natural.
• The concerns as discussed above become more prominent where the concerned director is that of a subsidiary. In that case, the information has to flow through several layers, creating more barriers.

Accounting standards rely on the element of “influence”

• AS-18 definition of “relative” is as follows:

“10.9 Relative – in relation to an individual, means the spouse, son, daughter, brother, sister, father and mother who may be expected to influence, or be influenced by, that individual in his/her dealings with the reporting enterprise.”

• IndAS 24 does not use the terminology “relative”, but uses the expression “close members of the family” and the same is defined as follows:

“Close members of the family of a person are those family members who may be expected to influence, or be influenced by, that person in their dealings with the entity including: (a) that person’s children, spouse or domestic partner, brother, sister, father and mother; (b) children of that person’s spouse or domestic partner; and (c) dependants of that person or that person’s spouse or domestic partner.”

• Definition of “relative” under AS-18 is clear – a person (including even father, mother, etc.) would be considered a “relative” when there is an element of influence (or expectation thereof) between the individual (that is, the director) and that person. Such an element is often deemed to exist when there is a financial dependence involved, or when families are staying together.
• Similarly, the definition of “close members” in Ind AS 24 also hinges on “expected to influence” or “influenced by”. The inclusive part only includes children, spouse, siblings, or the person’s “dependents” – and not all relatives (not even spouses of the children).

Scope of ‘relative” under insider trading laws

• Insider trading laws ought to be and are seen as strict as RPT laws – as both these laws deal with abuse of position and conflict of interest.
• Notably, Prohibition of Insider Trading Regulations define “immediate relative”to mean a spouse of a person, and includes parent, sibling, and child of such person or of the spouse, any of whom is either dependent financially on such person, or consults such person in taking decisions relating to trading in securities.
• Therefore, even in case of insider trading laws, only the spouse is always seen as an immediate relative, irrespective of the element of financial dependence or decision-making element. All other relationships are taken into account only when the elements of financial dependence or decision-making are present.

Whether the company or the director can be held at fault?

• RPT controls for companies are driven by conflicts of interests coming to play on transactions.
• As explained above, if there are information gaps, and neither the director nor the company could know the economic interests of the “in-laws”; and the company ends up transacting with such person;  it cannot be contended that the transaction was inspired by the relationship (because, the company, at the first place, did not know it was transacting with a related party). In fact, in such cases, the chances of conflict of interest or abuse of position would be minimised.
• At the same time, it is important to ensure that a director does not misuse the “information gap” to his advantage, and can continue to push transactions with an interested party while not fulfilling the obligation of providing timely information to the company.

Possible solution

• Hence, a possible solution is:
  • List of relatives, including entities where such relatives hold economic interest (as per the requirements of the Companies Act/Accounting Standards), should be updated by companies frequently – say, every quarter, instead of annually.
  • The director of the company/subsidiary company must intimate the information immediately as it is received, to the holding company/subsidiary company (as the case may be); and in turn, the subsidiary company (in applicable cases) should pass on the information immediately to the holding company (as transactions with related parties of subsidiaries are RPTs for the holding company as well).
• Transactions which could have been entered into by the company with the said “relative” (or concerned entity) without the knowledge of the company that such person was, in fact, an RP, should be placed before the audit committee for information purposes when the list of RPs is updated as per agreed frequency.
  • In our view, in such cases, the transactions should be considered as RPTs only from the time the relationship comes to the knowledge of the company.
  • Given the above, there should be no question of any “ratification” of such transactions. Although, it might be important for the audit committee to be aware of such transactions for decision-making purposes.
  • In case of delays on the part of directors/ subsidiary companies, the audit committee should appropriately give its adverse observations to the director/ subsidiary.
• And, for all proposed transactions in future, the company should take prior approval from the audit committee.
• The transactions would be disclosed to the stock exchange u/r 23(9) accordingly.

Possible approach towards law and policy making

• Law cannot remain divorced from ground realities. Several reports suggest that India has moved on from the concept of joint families, and nuclear families now constitute more than 50% of the Indian households (which is basically – the individual, the spouse and the kids). That does not even include brothers and sisters.
• In such cases, to assume that sans any financial dependence or any influence in decision-making, a mere establishment of a marital relationship might lead to a position of “conflict of interest” would be quite impractical or even irrational.
• Therefore, there might be a need to align the law with practical considerations and difficulties involved so as to facilitate due compliance without stressing on outdated or impractical formalities.

Refer to our other resources:

1. RPTs: Do extreme comparables distort arm’s length?
2. RPTs: Testing Multiyear Contracts for Materiality
3. Related Party Transactions- Resource Centre