Related Party Transactions: Regulators Entered Disclosure Regime Merely Rather Than Approval: A Welcome Step

Objectivity:-

Some of the reasons behind making the provision for the disclosure and/ or approval for any kind of transactions with related party are as follows:-

1)      To get intimated about the relations to all the person considering its approval,

2)      To enlarge the competition,

3)      To get intimated the various government department and determine, “whether any notional/ undisclosed profit or transaction is not involved”.

Basic thinking of regulator

The regulator proposes to the person entering/ existed in the corporate world to “COME WITH AN OPEN HEART”. It is just like, while anybody moves to the Doctor/ Advocate for some treatment/ consultant, nothing should be undisclosed. The author is thinking the same keeping in the view the basis of the regulatory provisions been made under the Companies Act, 2013.

However, the author is also of the view that while doing the same, regulator has gone behind the era of implementation of Companies Act, 1956 even, where everything was in the knowledge of every person of the family as well as known person. Moreover, at that time, joint family concept were not only acknowledged but followed also. However, under the present modern society, where nuclear family concept has been developed, probable the person disclosing the details will definitely fail to disclose everything as he would be unable to get the information from the other relatives or partners.

The probable way-out for the same can be that either of the following:-

i) Disclosed in the MBP-1 in clearly terms that he does not know the interest of such relative with whom he has no relation or

ii)  the names of relatives with whom his relations are strained

On such kind of prior disclosure, probably he can save himself from penal provisions.

Basic provision of the Companies Act as well as other provisions of the other Act:-

The provisions are not new, however, has been enlarged to some an extent, although with some ambiguity too. Under the Companies Act, 1956 (herein after referred to as “Old Act”), the respective provisions ware existed under section 297 read with section 6 and Schedule 1A with some procedural aspects relating to the same covered under section 297 to 302. There were some relevancy of section 283 regarding vacation of office by directors in relation to contravention of section 299 of the old act. However under the old act, provisions were quite clear in understanding/ applicability/ procedural part.

Under the Companies Act, 2013 (Hereinafter referred to as “New Act”) the respective provisions has been cover under section 188 read with section 2(49), 2(76), 2(77) and Companies (Meetings of Board and its Powers) Rules, 2014. Moreover, there is some relevancy of section 184 read with section 167 of the new Act are there. Apart from the above, there is also some applicability of 134(3) (h) requiring disclosures of the related party transactions in the director report read with Companies (Accounts) Rules, 2014. Further, Section 314 (director, etc., not to hold office or place of profits) of the old act prima facie has been covered under section 188 of the Companies Act, 2013.

By the expansion of the coverage of ‘related parties’ and ‘related party transactions, regulator has attempts to enlarge the scope drastically under the Companies Act, 2013’. For the brevity of the articles, no definitions have been reproduced here. However the author tried here to compare the changes taken place between the Old Act and New Act.

Point of Difference Old Act New Act
Related Section 297 read with other provisions of the Old Act 188 read with other provisions of the New Act
Related Party a)          Director / Relative of Directorb)          Firm in which Director/Relative is a partner

c)          Any other partner is such a Firm or

d)         Private Limited Company in which Director is a Director or member

 

In addition to the related party been covered under the old act, following is also covered in the new act:-

  1. “Key Managerial Personnel” as per Section 2(51)
  2. Firm in which Manager/ Relative is a partner
  3. Private Limited Company in which Manager is a Director or member (even the Director/ Manager hold single share)
  4. Public Limited Company in which Director/Manager is a Director
  5. Public Limited Company in which Director/Manager is a member holding more than 2% of the total Paid Up share capital of the company.
  6. Any Body Corporate whose Board of Directors/ Managing Director/ or Manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager, other than advice given in professional capacity.
  7. Any person on whose advice, directions or instructions, a director or manager is accustomed to act, other than advice given in professional capacity
  8. Any company which is (a) a holding, subsidiary or an associate company of such company; or (b) a subsidiary of a holding company to which it is also a subsidiary;
  9. Such persons as may be prescribed.

As per the draft rules, the following persons are prescribed to be the related parties:

(a) a director or key managerial personnel of the holding, subsidiary or associate company of such company or his relative;

(b) any person appointed in senior management in the company or its holding, subsidiary or associate company i.e. personnel of the company or its holding, subsidiary or associate company who are members of core management team excluding Board of directors comprising all members of management one level below the executive directors, including the functional heads.

Associate Company No definition Defined under Section 2(6)
Significant influence No definition Defined under explanation of Section 2(6). It is to be remember that, for the determination of the association with another, 20% of the total share capital and not total voting capital is to be considered
Control No definition Defined under Section 2(27)
Relative Section 6 read with Schedule 1A Section 2(77) read with Rule 4 of the Companies (Specification of definitions details) Rules 2014 and under the said rule merely Father, Mother, Son, Son’s wife, Daughter, Daughter’s husband, Brother, Sister ((including their step relationship has been included. This coverage is less than the coverage of the Old Act.
Senior Management Not defined. However defined under clause 49 of the Listing Agreement, therefore applicable to the listed companies. Not defined. However defined under clause 49 of the Listing Agreement.
Transactions covered Sale, purchase or supply of any goods, materials or services and underwriting the subscription of any shares / debentures of the company. In addition to the transactions been covered under the old act, following is also covered in the new act :a)      Selling or otherwise disposing of property of any kind.

b)      Leasing of property of any kind

c)      Availing or rendering of any services

d)     Appointment of any agent for purchase or sale of goods, materials, services or property.

e)      Such Related Party’s appointments to any office or place of profit in the company, subsidiary or associate company; and

f)       Underwriting the subscription of securities (including equities and debentures) and derivatives thereof.

Exemptions There were no specific exemptions criteria, However the approval provisions were not applicable if:-a)      Transactions is to be entered into between two limited company , and

b)      If the paid up capital of the company was less than 1 Crore Rupees.

However, even in these cases also, the company was required to comply with the requirement of section 299 to 302.

The provision of section 188 of the new act is not applicable if the transaction entered into by the company is in its ordinary course of business. However these kinds of transactions should be on an arm’s length basis.Further, there is no exemption on the basis of the status of the company like Private or Public Company.
Disclosure under Director report Was not required to disclose Required to be disclosed under section 134 (3) (h) read with section 188(2)
Approval/ Sanction Companies having paid up capital of Rupees One crore or more as they have to take prior approval of Central Government before entering into any related party transaction and the same is sough by making application to the Regional Director (under delegated power of CG) Consent through board through its meeting is always a prerequisite under the New Act. However as per rule 15(3) of Companies (Meetings of Board and its Powers) Rules, 2014, in the following cases, approval from shareholders vide special resolution is also required:(i) Companies having paid up capital of Rs. 10 Crore or more.

(ii) sale, purchase or supply of any goods or materials directly or through appointment of agents exceeding twenty five percent. of the annual turnover as mentioned in clause (a) and clause (e) respectively of sub-section (1) of section 188;

(iii) selling or otherwise disposing of, or buying, property of any kind directly or through appointment of agents exceeding ten percent. of net worth as mentioned in clause (b) and clause (e) respectively of sub-section (1) of section 188;

(iv)  (iii) leasing of property of any kind exceeding ten percent. of the net worth or exceeding ten percent. of turnover as mentioned in clause (c) of sub-section (1) of section 188;

(v)  availing or rendering of any services directly or through appointment of agents exceeding ten percent. of the net worth as mentioned in clause (d) and clause (e) of sub-section (1) of section 188;

(vi) appointment to any office or place of profit in the company, its subsidiary company or associate company at a monthly remuneration exceeding two and half lakh rupees as mentioned in clause (f) of sub-section (1) of section 188; or

(vii) remuneration for underwriting the subscription of any securities or derivatives thereof of the company exceeding one percent of the net worth as mentioned in clause (g) of sub-section (1) of section 188.

Office or place of profit 314 of the old act require special resolution by shareholders and the Central Govt approval for certain cases. Appointment of related party at office or place of profit in the company or in the subsidiary/associate company is also covered as a related party transaction as per section 188 and requires necessary compliance.
Disqualification from Appointment as director Under Old Act, there was no bar in appointment of the person as director, if he violates related party transaction norms. Under the New Act, by virtue of section 164(1)(g), if any person has been convicted of the offence dealing with related party transactions at any time during the last preceding five years, he becomes ineligible to be appointed as director.
Vacation of office by director for violation It was there in terms of section 283(1)(i) for violation of Section 299 of the Old Act. It was there in terms of section 167(1)© and 167(1)(d) for violation of Section 184 of the New Act.
Transactions other than cash There were no such restrictions/ specific provisions while dealt with the related parties. Section 192 of the New Act specifically provides that “No company shall enter into an arrangement by which:-(a) a director of the company or its holding, subsidiary or associate company or a person connected with him acquires or is to acquire assets for consideration other than cash, from the company; or

(b) the company acquires or is to acquire assets for consideration other than cash, from such director or person so connected,

unless prior approval for such arrangement is accorded by a resolution of the company in general meeting and if the director or connected person is a director of its holding company, approval under this sub-section shall also be required to be obtained by passing a resolution in general meeting of the holding company

Contract by One person company No specific provisions were there, as it is a newly incorporated provision in the New Act. Section 193 of the New Act specifies that:-(1) Where One Person Company limited by shares or by guarantee enters into a contract with the sole member of the company who is also the director of the company, the company shall, unless the contract is in writing, ensure that the terms of the contract or offer are contained in a memorandum or are recorded in the minutes of the first meeting of the Board of Directors of the company held next after entering into contract:

Provided that nothing in this sub-section shall apply to contracts entered into by the company in the ordinary course of its business.

Further Section 193(2) provides that the company shall inform the Registrar about every contract entered into by the company and recorded in the minutes of the meeting of its Board of Directors under sub-section (1) within a period of fifteen days of the date of approval by the Board of Directors.

Disclosure in the Agenda of Board Meeting There was no specific requirement as to the Agenda As per rule 15 of Companies (Meetings of Board and its Powers) Rules, 2014, the Agenda of Board Meeting should disclose the following points specifically:(a) the name of the related party and nature of relationship;

(b) the nature, duration of the contract and particulars of the contract or arrangement;

(c) the material terms of the contract or arrangement including the value, if any;

(d) any advance paid or received for the contract or arrangement, if any;

(e) the manner of determining the pricing and other commercial terms, both included as part of contract and not considered as part of the contract;

(f) 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

(g) any other information relevant or important for the Board to take a decision on the proposed transaction.

 TRANSACTIONS ON ARM’S LENGTH BASIS

The most welcome initiative steps by the regulator is exemption granted to transactions with related party which are made in the ordinary course of business made on arm’s length basis. Moreover, the provision is available to all companies, whether listed or unlisted.

Third proviso to Section 188(1) is reproduced below:

Provided also nothing in this sub-section shall apply to any transactions entered into by the company in its ordinary course of business other than transactions which are not on an arms’ length basis.”

Explanation (b) to this sub-section state as under:-

the expression “arm’s length transaction” means a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest.

It is quite clear that the onus to prove that the particular transaction is on arm’s length basis is on the Company. The ordinary course of business means the Company regularly carries on business or regularly trades in such field. Arm’s length basis means the transactions should be independent and is being done on same terms and conditions as if done with some unrelated party.

Since the provisions of Section 188(1) of the Act are not applicable to transactions made on arms’ length basis, as such, the author is of the view that the Companies are also not required to approve the transaction even in the Board meeting and/ or pass the special resolution in the general meeting. However, the Companies are required to make entries in the register maintained under format MBP-4.

TRANSACTIONS BETWEEN HOLDING AND WHOLLY OWNED SUBSIDIARY COMPANY

In terms of rule 15(2) of the Companies (Meetings of Board and its Powers) Rules, 2014, where the Holding Company passes the special resolution in respect of related party transaction with its wholly owned subsidiary company, then it shall be sufficient compliance.

Sub-rule (2) is reproduced below:

(2) In case of wholly owned subsidiary, the special resolution passed by the holding company shall be sufficient for the purpose of entering into the transactions between wholly owned subsidiary and holding company.

In the opinion of the author, the effect of the this provisions is that, in a case where the holding company is entering into related party transactions with its wholly owned subsidiary company, there is no need to conduct general meeting of its wholly owned subsidiary company and merely Special resolution passed by the members of holding company shall suffice its approval. However, approval through board meeting is always a prerequisite.

Further, Apart from the above said procedural exemptions of Special resolutions by the wholly owned subsidiary company as well as the non applicability of the provisions on certain transactions mentioned hereinafter in this article, in respect of transactions with subsidiary and associate company, both the companies have to pass the resolution in Board Meeting/ shareholders of the company (depending upon case to case). Here the author is of the view that either the regulator have forgo to provide some remedy for the interested director/ member to vote or probably is interested to promote the appointment of independent director/ member.

Inapplicability of Section 188

The provisions of section 188 will not apply to:

1. Arms Length Contracts in normal course of business.

2. Transactions between the Company and any other partner of the Firm in which Director/Manager/Relative is a partner.

3. Services availed in a professional capacity from body corporate/person.

4. Contract with a private or public company in which relative of a director / manager is a director /member.

Process of Disclosure and its Compliances:-

Section 184(1) of the New Act requires every director to disclose his interest in the first participated board meeting after his appointment and at the first meeting of the board thereafter in every financial year. Further, whenever there is any change in the disclosure already made, the same should also be intimated in the first board meeting held after such change. The said disclosure is in relation to the other companies, body corporate, firms, or other association of individuals including shareholding in form MBP-1.

In terms of Section 117 read with Section 179(3) and the rules framed there-under, the Companies is required to file the said MBP-1 form with the office of Registrar of Companies in form MGT-14 within 30 days from the date of Board Meeting wherein the above said disclosure have been placed.

Further, apart from the above disclosure and in terms of Section 184(2) every director who is interested directly or indirectly has to give disclosure in respect of contract or arrangement with body corporate in which such director or such director in association with any other director, holds more than two per cent shareholding of that body corporate, or is a promoter, manager, Chief Executive Officer of that body corporate, or with a firm or other entity in which such director is a partner, owner or member, as the case may be.

Now therefore, every director is required to give disclosure of his interest in two ways i.e. one under Section 184(1) in MBT -1 form and another under section 184(2) to company with list of relatives, names of firms, shareholding more than 2% and also shareholding more than 2% in association with any other director.

Clubbing of shareholding of other directors has newly been introduced under the New Act. Under the Old Act the holding was merely inclusive of shareholding together with relatives which has now been extended together with other directors.

While dealing with the Companies, the shareholding of 2% (two percent) or more is of utmost importance. In case the directors hold less than two per cent holding, as per the explanation given, it is not considered as interest and the company can enter into transaction. The author is of the view that one should consider the calculation of two per cent holding together with relatives and other directors also.

Ambiguity still sustained:-

1)      The term ‘person’ is not defined in the Companies Act 2013. The regulator perhaps forgoes to define the same and now it is not clear whether inference should be drawn from the definition provided under the Income Tax Act or otherwise.

2)      Who can be considered/ call as a connected party has not been defined under the new Act.

3)      Where any director/ shareholder is interested in any contract or arrangement with a related party, such director/ shareholder shall not be present and vote at the meeting during discussions on the subject matter of the resolution relating to such contract or arrangement. Further, their presence also shall not be counted as quorum. The main difficulty for companies is that in India most of Companies are closely held which family operated/ subsidiary/ wholly owned companies. Such companies cannot pass the related party transactions in Board/ Shareholder Meeting. In such cases, it is advisable to consider appointment of independent directors/ or create new shareholders by means of transfer or allotment.

4)      “Goods” has not been defined under the Companies Act, 2013 and the same is to be considered keeping in view of “Sale of Goods Act”.

5)      “Service” has not been defined under the Companies Act, 2013 and therefore the same is to be considered keeping in view of the “Service Tax Act”. It is to be kept in mind that with the enforcement of Finance Act 2012, Section 65 relating to the “definitions” of the various terms relating to the service tax has been omitted. However, two important sections which have been introduced defining the new service tax code are Section 65B which provides for a whole new set of definitions in context of taxable services under the head “Interpretations” and Section 66D which states the “Negative list of service

Penal Provisions:-

Section 188(5) of the New Act provides that any director or employee of a company, who entered into or authorized the Contract or arrangement in violation of the above provisions in case of listed company shall be punishable with imprisonment for a term which may extend to one year or with fine of minimum Rs. 25,000/- and maximum Rs. 500,000/- or both.

In case of any other company, the non-compliance will result in a fine of minimum Rs. 25,000/- and maximum Rs. 500,000/-.

Further, if a company contravenes the provisions of section 134 regarding disclosure in Board’s Report, the company shall be punishable with fine which shall not be less than Rs. 50,000/- but which may extend to Rs. 2,500,000/- and every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to three years or with fine which shall not be less than Rs. 50,000/- but which may extend to Rs. 500,000/-, or with both.

Clearly, the non-compliance is a compoundable offence.

Conclusion:- The author is of the view that the scope of compliance has been increased by amending the definition of related parties and related party transactions. The responsibilities of compliance have also been increased on the Board and the shareholders of the company. The additional disqualification of director and duty of disclosure in the Board’s Report requires extra vigilance on the part of the company. Removal of the requirement of getting approval of Central Government and introduction of entering transaction on arm’s length basis is boosting factors for the corporate world. The regulator has also made various regulations for the timely intimation to them as well as to the investors.

Disclaimer:

The entire contents of this document have been prepared on the basis of relevant provisions and as per the information existing at the time of the preparation. Though utmost efforts has made to provide authentic information, it is suggested to cross-check the relevant sections, rules under the Companies Act, 2013. The observations of the author are personal view and the author does not take responsibility of the same and this cannot be quoted before any authority.

(Author – CS Pankaj Kumar Singhal, FCS, LL.B. is a Company Secretary in Practice, Delhi and can be contacted at singhalkap@gmail.com)

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