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Making sense of SEBI’s 8th April clarification

Vinod Kothari & Vinita Nair | corplaw@vinodkothari.com

It has been 5 months since notification of SEBI (Listing Obligations and Disclosure Requirements) (Sixth Amendment) Regulations, 2021 making major recast of the regulatory processes on related party transactions;  the 8000 odd corporates consisting of the bulk of India’s financial as well as real sector continue to decode, interpret, and implement the revised framework. On the advocacy front, companies continue to make representations to, seek clarifications from SEBI ((including through stock exchanges). There is no doubt that SEBI,  as a regulator, is open to interface with companies and is often receptive to useful suggestions.

Within a span of 10 days, the 8th April clarification is the second clarification on the approval for material related party transactions (‘material RPTs’). SEBI circular dated March 30, 2022 provided a one-time relaxation by allowing companies to seek prior approval for material RPTs at the first general meeting convened after April 1, 2022. This time the clarification vide SEBI circular dated April 8, 2022 pertains to the validity term of the prior approval of shareholders for material RPTs. The circular has been rolled out, clearly,  in response to the representations made seeking clarity. The issue in hand is the insistence of the new RPT framework requiring prior approval of shareholders if the materiality threshold is crossed, which, now, has an absolute monetary frontier of Rs 1000 crores as well. So, when do companies seek shareholders’ approval, if they clearly estimate the value of the transactions with a related party crossing the frontier? The 30th March circular granted a time upto the first general meeting in FY 22-23, but what about the next financial year? Not to see their transaction volumes suddenly hitting the Rs 1000 crores limit, do companies necessarily have to get shareholders’ approval before the beginning of the financial year? For most companies, the usual routine process of shareholders’ approval is through the annual general meeting, which happens around the July-September period. But what about continuing transactions from April, till the AGM date?

It seems that the SEBI’s circular of 8th April was trying to answer this question. However, as companies try to decipher and knit-pick each word of the regulator, they may possibly be left with so many different questions after reading the 8th April circular.

We had, in our earlier write up titled ‘New Materiality Thresholds for RPTs: Nagging questions on shareholders’ approval’, done a detailed analysis of transactions and contracts and discussed various aspects of shareholders’ approval for material RPTs. In this article,  we intend to help companies to avoid any “confusification”, and see the 8th April circular as SEBI’s attempt to help companies to implement the process of shareholders’ approval, without affecting business and commercial considerations.

A.  The hierarchy of RPT approval:

1. The audit committee (‘AC’) is the first and unarguably the most relevant point of control on RPTs. This remains the case even under the new RPT framework.

2. AC approves RPTs in three ways:
   • An omnibus approval for small value transactions, if the value per transaction is within Rs 1 crore (or lesser value if so fixed by the AC).
   • Omnibus approval for recurring transactions, which are commonly bunched up together by type of transaction, and by a related party (such that all transactions of the same type, and with the same entity are bundled together), and taken for omnibus approval. In almost consistent corporate practice, this approval is done before the beginning of the financial year, for the ensuing financial year.
   • A specific approval for isolated or specific transactions, which continue to arise from time to time, and are generallying non-recurring in nature, or were otherwise not taken for approval as a part of the omnibus approval.

3. Unless the transactions are failing either of the two tests – ordinary course of business,  and arms’ length, the transactions are not taken to the board of directors. Further, if the transactions are not crossing the materiality thresholds (all transactions during a financial year, with a related party, exceeding the lower of 10% of last financial year’s consolidated turnover, or Rs 1000 crores), they are not taken to shareholders. Of course, if the board so feels appropriate, particularly in cases where transactions are not in ordinary course or are failing the arms’ length test, the board may refer the transactions to shareholders’ approval, even where not mandated by the law.

4. Thus, the board will come into picture on failure of ordinary course of business and/or arms’ length test, or when the transactions are expected to cross the materiality threshold.

5. Shareholders’ approval is to be taken only where transactions are material, or material transactions are undergoing material modification.

6. As per settled corporate practices, shareholders’ approval may be given (a) by a postal ballot; or (b) at a meeting of shareholders. The meeting may be the annual ritual, that is, the AGM, or an extra-ordinary one, EOGM.

B.  Manner of seeking shareholders’ approval:

1. What do shareholders approve? A single transaction, a single contract, multiple transactions, or multiple contracts, or an unspecified bunch of transactions and contracts with one party, or unspecified transactions and contracts with unspecified parties?

2. Since the framework for shareholders’ approval, till April this year, permitted post facto approval, most companies would have actually gone for a post-facto approval, for all that has been done, and for all that is expected to be done, and commonly as a part of the AGM resolutions. However, from this financial year, the process changes to a prior approval – hence, the practices in this regard are yet to standardize. This is possibly where SEBI was trying to be of assistance.

3. SEBI circular of 30th March eliminates any possibility of blanket, non-speaking and non-specific approvals for transactions, and particularly so if the particulars of related parties themselves are not disclosed. Hence, as regards the granularity of the details is concerned, it should be clear that companies need to provide as much granular details as may make the process of shareholders’ approval meaningful. Unless there is a blind trust between the shareholders and the management (which, of course, is not good corporate governance), the shareholders as the approving body will like to know as much as needed for a meaningful and informed seal of sanction.

4. However, there may be various modes of shareholders’ approval:
   • Series of similar transactions (for example, purchase of goods, sale of goods, services, financial transactions, etc) with a related party, with an estimated value during a financial year. This is, perhaps, what SEBI has referred to in 8th April circular as omnibus shareholders’ approval, as there is no concept of ‘omnibus shareholder’s approval’ in Reg. 23.
   • A particular contract, whether limited to a financial year, or spanning over more than one financial year, where the particulars of the contract, along with the definitive term over which it will run, have been disclosed to the shareholders for their approval.
   • A particular (or some particular) contracts or transactions taken to shareholders for approval, and the rest of the transactions left for the power of the AC to approve by way of omnibus approval.

5. So, do shareholders’ approval have to be limited to a particular financial year, or may span across financial years? There is no doubt that materiality thresholds are to be tested for a financial year; therefore, generally speaking, the shareholders’ approval is sought for transactions during a financial year. The exception to this is the approval of a specific multi-year contract, where the contract itself is approved by the shareholders.

6. The process of annual omnibus approval by the AC is already standardized, with almost 8 years of sections 177 and 188 of the Companies Act. However, it is quite clear that it is a lot easier to call the AC meeting and get an approval for transactions before the onset of the financial year; will that be the case with shareholders’ approval too? Lest companies, in every case, have to necessarily insist for an approval before the start of the financial year, SEBI was trying to be helpful in its 8th April circular.

7. So, in our view, this is what SEBI was trying to say (and the pieces that remain unsaid, which we deduce, for the sake of a comprehensive understanding)
   • Companies may take shareholders’ approval by postal ballot, EOGM or AGM. The fact that the 8th April circular does not refer to postal ballot does not intend denial of postal ballot as the mode of shareholders’ franchise.
   • If companies take material RPTs for shareholders’ approval in AGM of 2022, does it necessarily have to pertain to transactions done in FY 22-23, or can it cover recurring transactions during the part of FY 23-23, upto the AGM 23 date? This is where SEBI is trying to help by saying in the affirmative.
     • However, companies need to understand that if the shareholders’ resolution intends to cover the period upto the next date of AGM, it should be worded accordingly.
     • There will also be a question of the underlying AC approval, because the omnibus approval of the AC would only be for FY 22-23 – we deal with this question separately below.
   • However, many companies have already taken shareholders’ approval, either by way of postal ballots or by EOGM (more likely the former). In this case, Para 5 of the 8th April Circular says that the approval will be valid only for 1 year. Does it, therefore, imply that the companies which prepared ahead of the SEBI’s clarificatory circular, and took shareholders’ approval, will now be regretting their actions, because they are mandating a similar exceptional approval year after year?
     • In our view, it will be perfectly in order to take any such approval for the needed modification in the coming AGM, and have the AGM extend the validity of the shareholders’ approval upto the date of the next AGM.

8. Now, the lurking issue is – if the AC would have granted approval only for transactions during the ensuing financial year, is SEBI intending to shift the entire basis of RPT approvals, from financial year to the AGM-to-AGM period? That cannot be the case, as the entire basis of RPT controls is based on transaction’s volume during a financial year, compared to the turnover of the last financial year. ACs commonly see the trend of volumes achieved during a financial year, and accordingly scale up or scale down their omnibus approval limits. So, if the AC, for example, has given an omnibus approval for transactions during FY 22-23, can the AGM give an approval for transactions beyond FY 22-23, upto the AGM 23?
   • In our view, the shareholders’ approval, and that by the AC, operate in two different fields. The AC is the basic point of control and approval. Shareholders simply set out peripheries of related party transactions, and approve deviations, if any, from ordinary course of business and arms’ length principles. The fact that shareholders have approved, say, transactions upto a limit of Rs 5000 crores, does not absolve the AC from its own threshold-level scrutiny as well are review.
   • Therefore, there is no conflict between the AGM approving transactions from AGM to AGM, and the AC continuing to review, authorize and scrutinize transactions on FY basis. One cannot contend that the approval by the AGM of transactions beyond FY 23 amounts to approval for something which is not even proposed by the AC, because the AC will still continue to approve transactions for each financial year.
   • By way of abundant clarity, the language of the shareholders’ resolution may state that the approval by the shareholders, of transactions within specified limits, from the AGM to AGM (and possibly, in case of AGM 22, from 1st April 2022 to AGM 23), is without prejudice to the need for the AC to approve, authorize and review transactions on a financial year basis.
   • AC approval will be continued to be obtained on a financial year basis.

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