SEBI’s IG on RP identification by unlisted subsidiaries

Team Vinod Kothari & Company | corplaw@vinodkothari.com

October 14, 2024

Related Party Transactions (‘RPT’) regime under the Listing Regulations, consequent to substantial amendments made in November, 2021^[1], is very wide and includes cross RPTs across the group. That is, transactions of a listed entity with related parties of its subsidiaries; as well as, transactions of a subsidiary (listed or unlisted) with related parties of the parent listed entity would come under the purview of “related party transactions”; and therefore, would be subject to enhanced controls at the parent level.

Therefore, the prerequisite for effective implementation of the RPT controls is the correct identification of the Related Party (‘RP’) at both levels – by the parent and by the subsidiary. While in the case of a listed entity, it is clear that the definition of RP under LODR has to be followed; there was a lack of clarity as to whether an unlisted subsidiary should also follow the same definition or it can simply go by the law as applicable to it.

In this regard, SEBI, in a recent Informal Guidance, has opined that unlisted subsidiaries of the listed entities are required to identify the RPs and RPTs as per the provisions of the LODR Regulations.

Possible alternatives for identifying RPs of subsidiaries

The Listing Regulations under Reg. 2(1)(zb), defines an RP to mean the following:

1. as defined under Section 2 (76) of the Companies Act, 2013 (CA, 2013);
2. as per applicable accounting standards;
3. person or entity forming part of the promoter or promoter group of the listed entity;
4. person or any entity holding 10% or more of equity shares, directly or on a beneficial interest basis, at any time during the immediately preceding financial year.

While the listed entities identified RP based on the above definition, there was a lack of clarity on the manner of RP identification for unlisted subsidiaries in India and overseas. The Listing Regulations do not specify the approach to be followed for identifying RPs of unlisted subsidiaries.

Consequently, there could be two possible approaches – one, the subsidiaries maintain a list of their RPs as per Listing Regulations; alternatively, subsidiaries may be allowed to maintain an RP list as per their respective applicable/local laws^[2]. The IG, however, states that the first approach needs to be followed for assessing the RPTs done by the subsidiary with its own RPs.

While the approach of applying an entity-agnostic definition of the Listing Regulations may seem to bring consistency and ease of collation of information across the group; however, there may be several arguments against this approach, as we discuss below.

Issues related to the approach

• Context: Words and expressions in any law have to be read in the context in which they are used. When the term “related party” is used in the context of a listed entity^[3]; one will have to refer to the definition given in Reg. 2(1)(zb) of the Listing Regulations, as the Listing Regulations are applicable to a listed entity (Reg. 3). However, when the term “related party” is used in the context of an unlisted entity, it cannot be said that the Listing Regulations are applicable to or have defined the term for unlisted entities. In case of RPTs, the Listing Regulations have sought to put controls on RPTs undertaken by unlisted entities, albeit only through their listed parents – and not directly. Applying the definition of “related party” to unlisted entities would mean expanding the direct applicability of Listing Regulations to unlisted entities, which cannot be the case. Therefore, when it comes to related party of unlisted entities in India, one will have to look at the residual definition given in Reg. 2(2) of the Listing Regulation, which in turn, refers to the CA 2013. In case of overseas subsidiaries, as CA 2013 is inapplicable, one will have to refer to the laws applicable to such entity.

• Superimposing laws relating to listed entities on unlisted entities: RPTs at the subsidiary’s level crossing the specified threshold under Reg. 23(2) are required to be placed before the Audit Committee of the listed parent. If an unlisted entity is required to prepare its list of RPs in accordance with Listing Regulations, then, virtually speaking, it will have to take all those transactions, which otherwise are not RPTs for it under the Companies Act/local laws, to its Board/Audit Committee (before it is taken to the Audit Committee of the parent). This would mean that the unlisted entity will have to comply with the Listing Regulations, which otherwise are not applicable to the unlisted entity. Although, the SEBI amendments were to have a holistic and group-wide approach towards RPTs; this intent of superimposing listing laws on unlisted entities, if at all, is neither reflected in the present language of the Listing Regulations, nor is there any discussion in the Report of the Working Group on Related Party Transactions.

• Interpretational issues: The approach of applying the definition used in Listing Regulations on unlisted entities might lead to certain interpretational issues. For instance, while assessing a related party under “applicable accounting standards”, the question would be whether the subsidiary would follow the accounting standards applicable to the listed entity or that applicable to the subsidiary itself. If it is contended that the unlisted subsidiary will refer to accounting standards as applicable to the listed entity, it would again be considered as a superimposition of inapplicable laws. Besides, there would be multiple interpretational issues given that AS/IndAS are vastly different. On the other hand, if it is opined that the subsidiary can follow accounting standards as applicable to it, then by juxtaposition, the same analogy (that terms are to be read in the context of which they are used) would apply to the definition of RP as well. There might be similar interpretational issues involved in this approach and the concern becomes more pertinent in the case of overseas subsidiaries (see below).

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

• Overseas subsidiaries: Applying the definitions of Indian law to overseas entities may raise concerns as to extra-territorial jurisdiction of the regulator.

1. It would be interesting to note that in the context of regulation 46 of LODR Regulations, which requires a listed entity to disseminate audited financials of its subsidiaries on its website, SEBI in its Informal Guidance to HCL Technologies Limited, referred to the exemption granted by MCA in this regard under section 136(1) of the CA, 2013 and opined that where a foreign subsidiary is not required to get its financial statements audited under any law of the country of its incorporation, and which does not get such financial statement audited, the listed entity may place such unaudited financial statements on its website in accordance with the provisions of the said section. Hence, the Ministry as well as the regulator had, in the past, acknowledged that the compliance domain of overseas entities is limited to the laws of the country in which they are incorporated and, therefore, domestic laws were not imposed on them.
2. Regarding judicial precedents. although, there have been no direct precedents on the issue; Courts have, at different points of time and in different contexts, have given different views. For instance, in Vodafone International Holdings B.V v. Union of India & Anr, Supreme Court (SC) observed that “It is generally accepted that the group parent company is involved in giving principal guidance to group companies by providing general policy guidelines to group subsidiaries. However, the fact that a parent company exercises shareholder’s influence on its subsidiaries does not  generally imply that the subsidiaries are to be deemed residents of the State in which the parent company resides.”  However, at the same, SC in GVK Inds. Ltd. & Anr. v. the Income Tax Officer, recognised the powers of the Parliament to make laws with respect to extra-territorial aspects or causes that have an impact on or nexus with India. In Securities and Exchange Board of India v. Pan Asia Advisors Ltd. & Anr., SC applied the “effects test”, and upheld the power of SEBI to deal with lead managers based overseas for GDRs issued in India, as “it will have a far reaching consequence on the Indian investors on securities as well as the stock market” – although it may be noted that the judgment specifically noted various sections of SEBI Act, 1992, inter alia, sections 11B, 11C, 12 and 12A.
3. Further, applying domestic definitions to overseas subsidiaries may create complexity for the overseas subsidiaries. For example, the terminologies used in foreign jurisdictions are not the same as those used in India; terms such as “relative” (a part of the definition of related party) may have completely different meanings in different jurisdictions. Further, the definition of “subsidiary” or “associate’ may also be different. As a result, there is a strong possibility of inaccuracy, incompleteness, or irreconcilability in the list of related parties provided by such foreign subsidiaries.

• Operational issues: Imposing the definition of Listing Regulation on unlisted entities might increase the compliance burden on the unlisted entities, requiring them to assess RPs under multiple laws.

Alternatively, if the subsidiaries identify the RPs based on the definition applicable to it, the same would be more convenient for the subsidiaries as it would anyways maintain the list of RPs to comply with its applicable law.

Concluding remarks

The framework of RPTs requires accurate RP identification to ensure compliance and effective group governance. SEBI’s informal guidance on identifying RPs for unlisted subsidiaries, although provides a view on the approach to identification of related parties by subsidiaries for the purpose of enabling compliances by the listed parent; however, in our humble view, the approach may pose its own set of difficulties as discussed above. On the other hand, a group-wide approach to RPTs which simultaneously respects entity-specific boundaries might be more feasible in terms of ease of interpretation as well as ease of implementation of the law. It is to be noted that the views expressed in the IG are those of the department and do not constitute SEBI’s final decision, as explicitly stated in the IG. Therefore the views expressed in IG should not be seen as the regulators final take on the issue.

In any case, a clear explanation in the Regulations itself might be desired to ensure uniformity in the implementation of RPT controls by listed entities and their unlisted subsidiaries

^[1] SEBI (Listing Obligations and Disclosure Requirements) (Sixth Amendment) Regulations, 2021, w.e.f. 1.4.2022

^[2] We have discussed both approaches in our write-up, Identification Of Related Parties Of Subsidiaries.

^[3] Needless to say that, if the unlisted subsidiary is tracking the RPTs between itself and RPs of its parent listed entity, it will have to the RP list of the parent listed entity prepared in accordance with Listing Regulations.