‘Related Party’ under the Companies Act, 2013 (‘CA 2013’) is extremely broad and tries to include relationships on account of common directors, important managerial figures, etc., serves as model definition of ‘Related Party’ to the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘SEBI LODR’).
The previous definition of Related Party under SEBI LODR included entities belonging to promoter or promoter group of listed entity and holding 20% or more of listed entity’s shareholding. This section of definition has been updated with effect from April 1, 2022 and any individual or entity that is a promoter or promoter group of listed entity, regardless of shareholding, will now be considered as ‘Related Party’ with some deeming fiction to cover entities holding equity shares: of 10% or more (effective from April 1, 2023) in listed entity, either directly or indirectly, at any time during the immediately preceding fiscal year, as defined in Section 89 of the CA 2013. Overall, definition of ‘Related Party’ has been significantly broadened to ensure adequate disclosure to the relevant stakeholders.
Related Party Transactions (‘RPTs’) under CA 2013
The following transactions are covered by Section 188 of CA 2013 read with Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014 (‘CA Rules 2014’), which states that a company cannot enter into a contract or arrangement with a related party without prior approval of the Board or Shareholders, as the case may be:
Approvals for RPTs under CA 2013
Whenever a Company enters into any RPT under Section 188 of CA 2013, prior approval of the Company’s Board of Directors is required. With the caveat that a director must abstain from the meeting while it is being discussed if they have any stake in a deal or agreement with a related party.
However, if a contract or arrangement that a director is interested in falls under the purview of Section 184(2) of CA 2013 and is not a contract or arrangement that is included in Section 188(1) of CA 2013, the director may participate in the Resolution in the following circumstances:
i. In case of a Private Company or Specific IFSC Company after disclosure of interest.
ii. In case Section 8 Company where transaction amount does not exceed INR 1 Lac.
Whenever a company enters into RPT that exceeds the above-mentioned limits, it must obtain shareholder approval via a special resolution. However, the company’s Member who is a related party may not vote in General Meeting on such resolution for RPT approval unless:
ii. A company where 90% or more members are relatives of promoters or are related parties.
Where a company has an Audit Committee, transactions with related parties must be approved in accordance with Section 177(4)(iv) of CA 2013 and Rule 6A of CA Rules 2014. Furthermore, the Audit Committee may grant omnibus approval in the company’s interest for RPTs proposed by the company, subject to the following conditions:
(a) the transactions’ repetitive nature (past or present); and
(b) the rationale for the demand for omnibus approval.
(a) name of the related parties;
(b) nature and duration of the transaction;
(c) the maximum amount of transaction that can be entered into;
(d) the mechanism for price variation, if any, as well as the indicative base price, currently contracted price, and
(e) any other information as the audit committee may deem fit.
Exemptions under CA 2013
(i) In the event that a transaction is entered into by the company in the regular course of business and on an arm’s length basis, neither the board nor the shareholders will need to approve it.
(ii) Even if they exceed the limit, transactions between a holding company and its wholly-owned subsidiary whose accounts are consolidated do not need shareholder approval; instead, the holding company’s resolution will be adequate for the transaction’s purposes.
(iii) Even if it exceeds the restrictions, no shareholder approval is necessary in the case of a Government company where:
RPTs under SEBI LODR
“Related Party” has been defined to now encompass more than only transactions involving listed entities and subsidiaries and their related parties. This suggests that even in cases where it is not a party to RPTs of a subsidiary, listed entity would still need to comply with the approval and disclosure obligations.
The term also includes certain categories of unrelated transactions as RPTs starting on April 1, 2023, i.e., transactions whose goal is to benefit related party of listed entity or any of its subsidiaries. Any transfer of assets, obligations, or services between listed entity and related party, regardless of whether a price is charged or not, is defined as RPT under Regulation 2(1)(zc) of the amended SEBI LODR.
The inclusion of transactions that directly or indirectly benefit listed entity gives the concept of RPTs under amended SEBI LODR greater significance than the definition under CA 2013. This idea may be developed to counter use of intricate structures to transfer funds from listed entities to parties that appear to be unrelated but are actually intended to benefit listed entity or its related parties. As a result, since amended SEBI LODR do not include such an exception, transactions carried out in the ordinary course of business and at arm’s length that are subject to the limits of CA 2013 will now be scrutinised.
Exemptions under SEBI LODR:
(i) Preferential issuance of certain securities in accordance with the SEBI (Issuance of Capital and Disclosure Requirements) Regulations, 2018;
(ii) Offers of dividends, subdividing or consolidating securities, issuing rights or bonus, or buy back of shares made uniformly to all shareholders;
(iii) Acceptance of fixed deposits at consistently applicable terms by banks and NBFCs.
Materiality of RPTs
Previously, a transaction was deemed significant during a fiscal year if it surpassed 10% of listed entity’s annual consolidated turnover as reported in its most recent audited financial statement. However, under the revised definition, RPTs would only be regarded as substantial if total value of all transactions made within a financial year, whether made separately or in combination, exceeded INR 1,000 Crores or 10% of the listed entity’s annual consolidated turnover, whichever was lower. This financial threshold aims to encompass high-value corporate deals that could not otherwise exceed the 10% level.
Role of Audit Committee:
The amended SEBI LODR necessitates prior approval of the Audit Committee of listed entity for:
i. All RPTs – effective from April 1, 2022;
ii. Subsequent material modifications to RPTs: The Audit Committee of listed entity needs to define ‘Material Modification’ and disclose them as a part of policy – effective from April 1, 2022;
iii. RPT to which subsidiary of listed entity is a party, but listed entity is not a party:
a. If the aggregate value of RPT is more than 10% of annual consolidated turnover in accordance with last audited financial statement of listed entity – effective from April 1, 2022; and
b. If the aggregate value of RPT is more than 10% of annual standalone turnover in accordance with last audited financial statement of listed entity – effective from April 1, 2023.
RPTs excluded from audit committee / shareholders’ approval:
Although, in first General Meeting following date of notification, on November 9, 2021, all material RPTs already in existence should be put up for approval by shareholders. RPTs approved by the Audit Committee before to April 1, 2022 that continue after that date and become material according to revised materiality threshold will also be presented to the shareholders at General Meeting on the basis of said justification.
Challenges before Listed Entities:
In near future, listed entities might experience a number of practical difficulties related to stringent scrutiny, with a variety of approvals from shareholders and the Audit Committee, posing a variety of complications for many listed entities due to the linkage to company’s size in terms of turnover, which may also result in a significant increase in burden of compliance for listed entities with increased costs.
The Audit Committee now has more duties since it must define “Material Modification” (a word that is not defined in amended regulation) and examine RPTs even when the party is not listed entity but a subsidiary.
Even while SEBI has deemed all transactions with third parties that have intention of benefiting a related party or that have that impact to be RPTs, there isn’t a clear definition of what this test of intention of benefit would entail. Nevertheless, it will be challenging to determine the goal and impact of any such transaction that might benefit related party of listed entity or any of its subsidiaries.
See note 1 above.
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