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Evolution of concept of related parties and related party transactions

– Team Vinod Kothari and Company | corplaw@vinodkothari.com

Our Resource Centre on Related Party Transactions can be viewed here

Subsidiaries to refer LODR definition of “related party” – going too far with relationships?

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.

Read more: Subsidiaries to refer LODR definition of “related party” – going too far with relationships?

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.

Enhanced disclosures for RPT approvals under LODR

SEBI accepts WG proposal for detailed review

Ajay Kumar K V | Manager (corplaw@vinodkothari.com)

Introduction

Related Party Transactions (‘RPTs’) involve conflict of interest and may consist of a potential means to transfer funds under the smoke screen of an unrelated party, however, for the benefit of certain related persons. Taking this fact into cognizance, SEBI constituted a Working Group in November 2019 to review the policy structure and gaps pertaining to RPTs in the SEBI (Listing Obligations and Disclosure Requirements) Regulations (‘Listing Regulations’), 2015 vis-à-vis the Indian Accounting Standards and the Companies Act, 2013 (‘Act’).  The Working Group made recommendations on expanding the scope of RPs and RPTs, as well as enhancing disclosures before the audit committee (‘AC’), shareholders, and to the exchanges (‘SEs’).

Consequently, SEBI in its meeting held on 28th September 2021[1] considered and approved the amendments to Listing Regulations in line with the recommendations of WG. The decisions have been implemented vide two separate notifications.

SEBI, vide its notification dated November 9, 2021[2], amended Regulation 23 of the Listing Regulations thereby making significant changes in the definition of Related Parties (‘RPs’), RPTs including the approval mechanism for material RPTs, etc. A detailed analysis of the said amendment can be read here.

However, the provisions with respect to the information to be placed before AC and shareholders for seeking their approval, as well as half-yearly disclosures to stock exchanges were not made part of the aforesaid amendment. These amendments have been introduced vide SEBI circular SEBI/HO/CFD/CMD1/CIR/P/2021/662 dated 22nd November 2021[3] (‘SEBI Circular’).

The Circular broadly provides for the following –

  • Information to be placed before AC;
  • Information to be provided to shareholders for consideration of RPTs; and
  • Format of disclosure of RPTs on a half-yearly basis

The Circular takes effect from 1st April 2022 (while the disclosure is to be triggered in the first half-year of 2022-2023, i.e., for the half-year ended 30th September 2022.)

Various practical implications and considerations arising out of the prescriptions of the Circular are discussed in this write-up.

Applicability

The Circular applies to listed entities which have listed their ‘specified securities’. Pursuant to the SEBI Listing Regulations 5th Amendment, a High Value Debt Listed Entity (‘HVDLEs’) is required to submit the disclosure on RTPs under Reg. 29(3) along with its standalone financial results for each half year.

HVDLEs are those listed entities which have listed its non-convertible debt securities and have an outstanding value of listed non-convertible debt securities of Rs. 500 crore and above as on 31st March 2021.

Thus, from the half-year ended 30th September 2022, HVDLEs are required to submit the disclosure of RPTs in the format prescribed in the SEBI Circular. Our detailed analysis of the amendments w.r.t HVDLEs can be read here.

Information to be provided to Audit Committee

The Act requires ‘relevant information’ to be placed before AC in case of omnibus approvals [refer, rule 6A of Companies (Meetings of Board and its Powers) Rules, 2014 (‘MPB rules’)]; however, relevant information has not been prescribed as such. While one may refer to section 188 read with rule 15 of the MPB rules which prescribes specific information to be placed before the board and shareholders for approval of RPTs. It would be counter-intuitive to say that the information which goes to the board for RPT approval would not go to AC. By obvious interpretation, all such information which rule 15 lists out, ought to be placed before AC as well.

SEBI Circular now specifically provides for minimum information to be placed before AC for consideration/approval of RPTs, including the items as listed below. The quantum of information to be placed before AC under the revised framework is more exhaustive than what is provided in rule 15. Also, while it is the obligation of the listed entity to place these information before AC, as a corollary, it appears equally incumbent on AC to demand such information from the entity.

It may also be important to note (as we discuss below), the notice sent to shareholders for seeking RPT approval shall consist of a “summary of information provided to the audit committee” as well. Hence, all such things which are placed before AC, shall also come before the shareholders, albeit in a summarised form.

Information to be provided to shareholders

The SEBI Circular has specifically listed out the details required to be placed before the Audit Committee and the Shareholders which has far-reaching impact on listed entities. It states that a summary of the information provided by the management of the listed entity to the Audit Committee while the RPT was placed before it for approval, shall also be given to the Shareholders while seeking their approval. The probable outcome of the same can be:

  • Where the Audit Committee seeks very limited information for approval of RPTs
  • Where the Audit Committee over-step into an enquiry state where information that may not be relevant to the transaction be placed before it, giving birth to thoughts of concerns in the mind of Shareholders

Another important change is that while placing information to the Shareholders, a statement that the valuation or other external report, if any, relied upon by the listed entity in relation to the proposed transaction will be made available through the registered email address of the Shareholders instead of making the same available for physical inspection at the registered office of the company which has been the existing practice.

The definition of RP as amended vide SEBI LODR Sixth Amendment Regulations, excluded acceptance of fixed deposits by Banks/NBFCs at the terms uniformly applicable/offered to all shareholders/public from the same, however, such transactions still require disclosure in the format specified by SEBI. This seems to be counter-productive as the intent of the law is to ensure that no transaction intended to benefit the RPs get away from the scrutiny of the Audit Committee and the Shareholders. To the paradox, even such transactions that have been executed 100% at par with public shareholders/customers of the company are also required to be disclosed by every listed company.

Snapshot of details requires to be placed before the AC & Shareholders

Some of the items are briefly discussed below:

  1. Type, material terms and particulars of the proposed transaction – By type, one means the kind of transaction – whether it is a purchase or a sale or a loan, etc. “Material terms” is a common expression meaning all such terms which might affect decision-making. Similar expression appears in rule 15(1)(c) as well.
  2. Source of funds for loans/ICDs, etc. in connection with the proposed transaction (clause 4(f)(i)).
  3. Financial indebtedness incurred (clause 4(f)(ii)) – This would indicate the financial burden which the listed entity/subsidiary might be bearing to enter into RPTs. Most entities will have Bank/Financial Institution borrowings (or even other borrowings) as their liabilities; however, it would be important to establish a ‘direct nexus’ between such borrowings and the proposed transaction. As to what constitutes ‘direct nexus’, is a function of various factors depending upon facts of each case. This aspect is also related to disclosure related to ‘source of funds’.
  4. Justification for RPT to be in interest of the listed entity (clause 4(g)) – This requirement is in consonance with the earlier requirement put forth by SEBI relating to the affirmation to be given by CEO/CFO of the listed entity on a half-yearly basis in Annex IV[4] of the Corporate Governance Report to the SEs.
  5. Ratio of proposed transaction to turnover (clause 4(e) read with clause 4(i))-The percentage of the listed entity’s annual consolidated turnover, for the immediately preceding financial year, is represented by the value of the proposed transaction, which is mandatorily (in case a subsidiary is a party, standalone turnover shall be considered) to be placed for approval.  Further, the listed entity may, on a voluntary basis, provide the percentage of the counter-party’s annual consolidated turnover that is represented by the value of the proposed RPT.
  6. Any other relevant information – This is the residual clause. While it enables the entity to put such other information as may be relevant’ notably, it is also open to AC to seek any other information, which in AC’s view is relevant.

Information to be placed for approval of RPTs under the Act

Information to be placed before Board as per Section 188 read with Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014

  • name of the related party and nature of relationship;
  • the nature, duration of the contract and particulars of the contract or arrangement;
  • the material terms of the contract or arrangement including the value, if any;
  • any advance paid or received for the contract or arrangement, if any;
  • the manner of determining the pricing and other commercial terms, both included as part of contract and not considered as part of the contract;
  • whether all factors relevant to the contract have been considered, if not, the details of factors not considered with the rationale for not considering those factors; and
  • any other information relevant or important for the Board to take a decision on the proposed transaction.

Information to be placed before shareholders as per Section 188 read sub-rule 3 of Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014

  • name of the related party;
  • name of the director or key managerial personnel who is related, if any;
  • nature of relationship;
  • nature, material terms, monetary value and particulars of the contract or arrangements;
  • any other information relevant or important for the members to take a decision on the proposed resolution

Though rule 15, as stated above, does not explicitly state the details to be placed before Audit Committee except in case of Omnibus approval of RPTs under rule 6A of MBP Rules , it can be construed that the details to be placed before the Board of directors of the Company for approval of RPTs should be placed before the Audit Committee while seeking prior approval for RPTs by the listed entity.

On a careful analysis of the above, it can be seen that the capital market regulator has made the regulatory framework of RPTs more water-tight as compared to the existing norms under the Act. The listed entities shall now place exhaustive details before the Audit Committee and the Shareholders as compared to the norms for unlisted companies in the country.

New format of disclosure of RPTs under Reg. 23(9) of Listing Regulations

The SEBI Working Group had in its report, provided a format for disclosure of RPTs on a half-yearly basis as specified under Reg. 23(9). So far, the listed entities have been preparing the disclosure as per the IND-AS 24 since the regulator had not specified a format for the disclosure of RPTs.

The SEBI has now prescribed a format for disclosure of RPTs as recommended by the Working Group. The notes to the disclosure format put forward significant questions on how listed companies will ensure compliance w.r.t RPTs.

The note 1 states, opening and closing balances, including commitments, to be disclosed for existing related party transactions even if there is no new related party transaction during the reporting period. This would mean that those transactions which are continuing in nature, even though there were no transactions during the reporting period shall be disclosed, including any commitments. The term ‘commitments’ would mean those arrangements where both the parties agree to perform their obligations under the contract.

In note 3, exemption has been granted to listed banks for disclosures with respect to related party transactions involving loans, inter-corporate deposits, advances or investments. However, the same has not been extended to listed NBFCs. This could lead to additional compliance burden for NBFCs even though they are engaged in the financial activities.

The note 9 states “Transactions such as acceptance of fixed deposits by banks/NBFCs, undertaken with related parties, at the terms uniformly applicable /offered to all shareholders/ public shall also be reported.”

SEBI had excluded acceptance of fixed deposits by Banks/NBFCs at terms uniformly applicable/offered to all shareholders/public from the definition of RPTs but had explicitly stated that such transactions shall be disclosed.

Having said that, one should interpret the said note in such a way that the requirement of disclosure is only for acceptance of deposits by Banks/NBFCs which have been excluded from the definition of RPTs and not any other transaction which have been availed by any related party at par with the general public.

Conclusion

The recent amendments to the Listing Regulations evidences the growing concern over the regulatory framework for RPTs. The definition of RPT has been widened to include a bunch of transactions that have never been in the radar when it comes to RPTs.

SEBI Circular also put forward new challenges for listed entities for ensuring absolute compliance of the revised regulatory framework for RPTs and few of the new requirements may bring concerns for NBFCs to ensure compliance. Furthermore, the disclosure requirements for RPTs under the Listing Regulations have been made more stringent and elaborative to enable enhanced public disclosure of RPTs.

 

[1] https://www.sebi.gov.in/media/press-releases/sep-2021/sebi-board-meeting_52976.html

[2] https://www.sebi.gov.in/legal/regulations/nov-2021/securities-and-exchange-board-of-india-listing-obligations-and-disclosure-requirements-sixth-amendment-regulations-2021_53851.html

[3] https://www.sebi.gov.in/legal/regulations/nov-2021/securities-and-exchange-board-of-india-listing-obligations-and-disclosure-requirements-sixth-amendment-regulations-2021_53851.html

[4] https://www.sebi.gov.in/legal/circulars/may-2021/format-of-compliance-report-on-corporate-governance-by-listed-entities_50338.html

 

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/

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/

 

SEBI widens the sweep of related party provisions drastically

Presentation on Amended SEBI Framework on Related Party Transactions: https://vinodkothari.com/2021/11/presentation-on-amended-sebi-framework-on-related-party-transactions/

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/

Snapshot of SEBI (LODR) (6th Amendment) Regulations, 2021

Presentation on Amended SEBI Framework on Related Party Transactions – https://vinodkothari.com/2021/11/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/

Read our other articles on the subject at https://vinodkothari.com/article-corner-on-related-party-transactions/

Other Corporate Law articles: http://vinodkothari.com/corporate-laws/

SEBI notifies stricter norms for RPTs

Presentation on Amended SEBI Framework on Related Party Transactions: https://vinodkothari.com/2021/11/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/

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/

RBI eases norms on loans and advances to directors and its related entities

Payal Agarwal, Executive, Vinod Kothari & Company ( payal@vinodkothari.com )

RBI has recently, vide its notification dated 23rd July, 2021 (hereinafter called the “Amendment Notification”), revised the regulatory restrictions on loans and advances given by banks to directors of other banks and the related entities. The Amendment Notification has brought changes under the Master Circular – Loans and Advances – Statutory and Other Restrictions (hereinafter called “Master Circular”). The Amendment Notification provides for increased limits in the loans and advances permissible to be given by banks to certain parties, thereby allowing the banks to take more prudent decisions in lending.

Statutory restrictions

Section 20 of the Banking Regulation Act, 1949 (hereinafter called the “BR Act”) puts complete prohibition on banks from entering into any commitment for granting of loan to or on behalf of any of its directors and specified other parties in which the director is interested. The Master Circular is in furtherance of the same and specifies restrictions and prohibitions as below –

 

*since the same does not fall within the meaning of loans and advances for this Master Circular

Loans and advances without prior approval of Board

The Master Circular further specifies some persons/ entities that can be given loans and advances upto a specified limit without the approval of Board, subject to disclosures in the Board’s Report of the bank.  The Amendment Notification has enhanced the limits for some classes of persons specified.

Serial No. Category of person Existing limits specified under Master Circular Enhanced limits under Amendment Notification
1 Directors of other banks Upto Rs. 25 lacs Upto Rs.  5 crores for personal loans

(Please note that the enhancement is only in respect of personal loans and not otherwise)

2 Firm in which directors of other banks interested as partner/ guarantor Upto Rs. 25 lacs No change
3 Companies in which directors of other banks hold substantial interest/ is a director/ guarantor Upto Rs. 25 lacs No change
4 Relative(other than spouse) and minor/ dependent children of Chairman/ MD or other directors Upto Rs. 25 lacs Upto Rs. 5 crores
5 Relative(other than spouse) and minor/ dependent children of Chairman/ MD or other directors of other banks Upto Rs. 25 lacs Upto Rs. 5 crores
6 Firm in which such relatives (as specified in 4 or 5 above) are partners/ guarantors Upto Rs. 25 lacs Upto Rs. 5 crores
7 Companies in which relatives (as specified in 4 or 5 above) are interested as director or guarantor or holds substantial interest if he/she is a major shareholder Upto Rs. 25 lacs Upto Rs. 5 crores

Need for such changes

The Master Circular was released on 1st July, 2015, which is more than 5 years from now. Considering the inflation over time, the limits have become kind of vague and ambiguous and required to be revisited. Moreover, the population all over the world is facing hard times due to the Covid-19 outbreak. At this point of time, such relaxation can be looked upon as the need of the hour.

Impact of the phrase ‘Substantial interest’ vs ‘Major shareholder’

The Master Circular uses the term “substantial interest” to generally regulate in the context of lending to companies in which a director is substantially interested.

The relevant places where the term has been used are as below –

Completely prohibited Allowed with conditions
Section 20(1) of the BR Act – for companies in which directors are substantially interested Para 2.2.1.2. of Master Circular – for companies in which directors of other banks are substantially interested – upto  a limit of Rs. 25 lacs without prior approval of Board

 

Para 2.1.2.2. of Master Circular – for companies in which directors are substantially interested Para 2.2.1.4. of Master Circular – for the companies in which the relatives of directors of any bank are substantially interestedupto Rs. 25 lacs without prior approval of Board After amendment, the para stands modified as – for the companies in which the relatives of directors of any bank are major shareholdersupto Rs. 5 crores without prior approval of Board

While the Amendment Notification itself provides for the meaning of “major shareholder”, the meaning of “substantial interest” for the purposes of the Master Circular has to be taken from Section 5(ne) of the BR Act which reads as follows –

  • in relation to a company, means the holding of a beneficial interest by an individual or his spouse or minor child, whether singly or taken together, in the shares thereof, the amount paid up on which exceeds five lakhs of rupees or ten percent of the paid-up capital of the company, whichever is less;
  • in relation to a firm, means the beneficial interest held therein by an individual or his spouse or minor child, whether singly or taken together, which represents more than ten per cent of the total capital subscribed by all the partners of the said firm;

The above definition provides for a maximum limit of shareholding as Rs. 5 lacs, exceeding which a company falls into the list of a company in which director is substantially interested. The net effect is that a lot of companies fall into the radar of this provision and therefore, ineligible to take loans or advances from banks.

However, the Amendment Notification provides an explanation to the meaning of “major shareholder” as –

“The term “major shareholder” shall mean a person holding 10% or more of the paid-up share capital or five crore rupees in paid-up shares, whichever is less.”

This eases the strict limits because of which several companies may fall outside the periphery of the aforesaid restriction. Having observed the meaning of both the terms it is clear that while ‘substantial interest’ lays down strict limits and therefore, covers several companies under the prohibition list, the term ‘major shareholder’ eases the limit and makes several companies eligible to receive loans and advances from the bank subject to requisite approvals thereby setting a more realistic criteria.

The BR Act was enacted about half a century ago when the amount of Rs. 5 lacs would have been substantial, but not at the present length of time. Keeping this in mind, while RBI has substituted the requirement of “substantial interest” to “major shareholder” in one of the clauses, the other clauses and the principal Act are still required to comply with the “substantial interest” criteria, thereby, keeping a lot of companies into the ambit of restricted/ prohibited class of companies in the matter of loans and advances from banks.

Other petty amendments

Deeming interest of relative –

The Amendment Notification has the effect of inserting a new proviso to the extant Master Circular which specifies as below –

“Provided that a relative of a director shall also be deemed to be interested in a company, being the subsidiary or holding company, if he/she is a major shareholder or is in control of the respective holding or subsidiary company.”

This has the effect of including both holding and subsidiary company as well within the meaning of company by providing that a major shareholder of holding company is deemed to be interested in subsidiary company and vice versa.

Explanations to new terms –

The Amendment Notification allows the banks to lend upto Rs. 5 crores to directors of other banks provided the same is taken as personal loans. The meaning of “personal loans” has to be taken from the RBI circular on harmonisation of banking statistics which provides the meaning of personal loans as below –

Personal loans refers to loans given to individuals and consist of (a) consumer credit, (b) education loan, (c) loans given for creation/ enhancement of immovable assets (e.g., housing, etc.), and (d) loans given for investment in financial assets (shares, debentures, etc.).

Other terms used in the Amendment Notification such as “major shareholder” and “control” has also been defined. The meaning of “major shareholder” has already been discussed in the earlier part of this article. The meaning of “control” has been aligned with that under the Companies Act, 2013.

Concluding remarks

Overall, the Amendment Circular is a welcoming move by the financial market regulator. However, as pointed out in this article, several monetary limits under the BR Act have become completely incohesive and therefore, needs revision in the light of the current situation.

 

Case Study I – Related Party Transactions – [Case 1]

In our series of case studies on corporate laws, we present to you our first case study on Related Party Transactions. Readers and viewers are invited to share their views and solutions in the comment section below –

Case Study 1- Related Party Transactions

SC uses ‘smoke-test’

Classifies persons as ‘related parties’ on the basis of ‘intermingled transactions’ 

-Sikha Bansal & Megha Mittal

(resolution@vinodkothari.com)

While in general, in order to classify a transaction as a related party transaction, one needs to first determine whether the parties involved are ‘related parties’; however, in a recent case Phoenix Arc Private Limited v. Spade Financial Services Limited & Ors.[1] (‘Ruling’), the Hon’ble Supreme Court (‘SC’) has deduced ‘relationship’ between the parties on the basis of the underlying transactions.

The SC has read the definitions of ‘financial creditor’ and ‘related party’ (in relation to the corporate debtor) under sections 5(7) and section 5(24), respectively, of Insolvency and Bankruptcy Code, 2016 (‘Code’), in light of the ‘collusive arrangements’, ‘and ‘extensive history demonstrating interrelationship’ among the parties. Broadly put, it was held that the board/directors of these companies were ‘acting’ under the pervasive influence of common set of individuals, having ‘deeply entangled’ interrelationships. Besides, the SC refused to entertain the entities as financial creditors, as the debt was merely an eye-wash, arising out of sham and collusive transactions.

Therefore, the Ruling, in a way, uses ‘smoke’ to trace if there is a ‘fire’. The presence of collusion, entangled interrelationships, etc. have been seen as indicators suggesting that the parties were in fact ‘related’ and are thus ineligible to occupy seats in the committee of creditors.

This article touches upon the significant aspects of the Ruling, including how this ‘smoke-test’ used by the SC can act as a precedent in interpreting the provisions of the Code, specifically those relating to related parties.

Read more