CS Deepak Banga

CS Deepak BangaIntroduction- Related Party Transactions (RPTs) refer to transactions between a company and its related entities such as subsidiaries, associates, joint ventures, substantial shareholders, directors, key managerial personnel and their relatives, or entities owned or controlled by them. RPTs are a normal feature of any commerce and business. The decision to enter into transactions with related parties are sometimes genuine but at times gets influenced by consideration other than commercial and do not take place on arm’s length. Therefore, various regulations and laws demand greater scrutiny, analysis, approvals and disclosures to ensure transparency and fairness throughout the entire process of undertaking related party transactions, in order to protect the interest of the Company and/all its stakeholders.

This article examines the relevant provisions of the Companies Act, 2013 (CA, 2013) and the Listing Agreement (LA) relating to RPTs and list out separately the compliances to be done by unlisted and listed companies while dealing with RPTs.

Contents

 UNLISTED COMPANIES
 LISTED COMPANIES
Relevant provisions pertaining to RPTs
·   Section 188,189 and Schedule III of the CA, 2013 read with the Rules framed thereunder;
·   AS-18 issued by ICAI, wherever applicable, (compliance pertains to disclosure requirement only); and
·   Section 40A(2)(b) of Income Tax Act, 1961
·   Section 188, 189 and Schedule III of the CA, 2013 read with the Rules framed thereunder;
·   Clause 32 & 49 of the LA;
·   AS-18 issued by ICAI (compliance pertains to disclosure requirement only); and
·    Section 40A(2)(b) of Income Tax Act, 1961
Process for dealing with Related Party Transactions
 
STEP I
Identification of Related Party
Check whether the party to the proposed transaction is a ‘Related Party’
·   Under Companies Act, 2013
·     ‘Related Party’ with reference to a company has been defined in Section 2(76) of the CA, 2013.
·   Under Companies Act, 2013
   As explained in column 2.
·   Under Listing Agreement
Related Party with reference to a company has been defined in Clause 49(VII)(B) of the LA.
“Related Party”, with reference to a company, means—
(i)  such entity which is a related party under Section 2(76) of the CA, 2013; or
(ii)  such entity which is a related party under AS-18
Conclusion
Listed companies are required to comply with the provisions of both CA, 2013 as well as LA. Therefore, listed companies should examine the party to the proposed contract or arrangement as ‘related party’ both in terms of CA, 2013 and LA separately.
The meaning of ‘Related Party’ in terms of LA is wider   as compared to CA as it covers entities in terms of AS-18 as well, apart from those which are covered in terms of section 2(76) of CA, 2013.
 
STEP II: 
What constitutes a Related Party Transaction
 Check whether the proposed transaction constitute a Related Party Transaction
 ·   Under Companies Act, 2013
Transactions specified under clause (a) to (g) of sub section (1) of section 188 of the CA, 2013 only are considered as RPTs.
 ·   Under Companies Act, 2013
As explained in Column 2.
·   Under Listing Agreement
As per Clause 49(VII)(A) of Listing Agreement, a RPT is a transfer of resources, services or obligations between a company and a related party, regardless of whether a price is charged.
   A transaction shall be construed to include single transaction or a group of transactions in a contract.
Conclusion
Listed companies are required to comply with the provisions of both CA, 2013 as well as LA. Therefore, listed companies should examine whether the proposed transaction is a ‘related party transaction’ both in terms of CA, 2013 and LA separately.
The scope of transactions which are considered as RPTs in terms of LA are wider as compared to transactions covered in terms of CA, 2013 as it is not an inclusive list and includes within its ambit all types of transactions including financial transactions, which are not covered under section 188 of CA, 2013.
STEP III: 
Detailed scrutiny of the proposed transaction
Examine the transaction in detail including the parties to the proposed contract or arrangement
Whether the proposed transaction is being done in:
(i)    ordinary course of business
and
(ii)   at arm’s length
Whether the proposed transaction is between :
(i)  two government companies
   or
(ii) holding company and its wholly owned subsidiary whose accounts are consolidated with such holding company and placed before the shareholders at the general meeting for approval.
STEP IV:
Approvals required
 Compliances to be done
(1)  Approval   of Audit Committee (AC)
·         Under Companies Act, 2013
All transactions with related parties [fresh or modification], whether covered under section 188 of the CA, 2013 or not, require approval of AC. The approval of AC can be obtained by way of passing of resolution at a meeting or by circulation.
(1  )Approval of Audit Committee (AC)
·      Under Companies Act, 2013
       As explained in Column 2.
·      Under Listing Agreement
All RPTs require prior approval of AC. The prior approval of AC can be by way of passing of resolution at a meeting or by circulation.
However, AC may grant omnibus approval for RPTs proposed to be entered into by the company subject to the following conditions:
(i) AC shall lay down the criteria for granting omnibus approval in line with the policy on RPTs of the company and such approval shall be applicable in respect of transactions which are repetitive in nature and is in the interest of the company.
The omnibus approval shall specify:
(i) name(s) of related party, nature of transaction, max. amount of transaction that can be entered into
(ii) indicative base price/ current contracted price and the formula for variation in price, if any and (iii) such other conditions as AC may deem fit.
In case the need for RPT cannot be foreseen and aforesaid details are not available, AC may grant omnibus approval for such transactions subject to their value not exceeding Rs.1 crore per transaction.
   Omnibus approvals shall be valid for a period not exceeding one year and shall require fresh approvals after the expiry of one year.
Exception: If answer in Step III is Yes (i.e. transaction is between two government companies or holding company and its wholly owned subsidiary), then irrespective of the value of the transaction, approval of AC is not required in terms of LA.
Conclusion
As listed companies are required to comply with the provisions of both CA, 2013 as well as LA, the approval of AC is required in the following cases:
i.      RPTs in terms of the CA, 2013, irrespective of the value of transaction, whether or not in the ordinary course of business & at an arm’s length and/
ii.     RPTs in terms of LA, irrespective of the value of transaction, not between two government companies or holding company and its wholly owned subsidiary.
(2    Approval of Board at a Board Meeting   (in specified cases)
·   Under Companies Act, 2013
If answer in Step III is Yes (i.e. where the proposed transaction is in ordinary course of business and at an arm’s length), then irrespective of the value of transaction, section 188 of CA, 2013 is not applicable, whereby approval of the Board is not required.
If answer in Step III is No (i.e. where the proposed transaction is not in ordinary course of business and/or at an arm’s length), then irrespective of value of transaction, PRIOR approval of the Board at a meeting is required.
Disclosure in Board meeting Notice:
The agenda of the Board meeting at which the resolution regarding RPT is proposed to be moved should disclose-
(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.
Disclosure by interested directors
Every director of a company who is in any way, whether directly or indirectly, concerned or interested in a contract or arrangement or proposed contract or arrangement entered into or to be entered into
·   with a body corporate in which such director or such director in association with any other director, holds more than 2% shareholding of that body corporate, or
·   with a body corporate in which such director 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
shall disclose the nature of his concern or interest, in Form MBP-1, at the meeting of the Board in which the contract or arrangement is discussed.
Where any director who is not so concerned or interested at the time of entering into such contract or arrangement, he shall, if he becomes concerned or interested after the contract or arrangement is entered into, disclose his concern or interest forthwith when he becomes concerned or interested or at the first meeting of the Board held after he becomes so concerned or interested.
However, a general notice given to the Board by a director in Form MBP-1, to the effect that he is a director or a member of a specified body corporate or is a member of a specified firm is to be regarded as concerned or interested in any contract or arrangement which may, after the date of the notice, be entered into with that body corporate or firm, shall be deemed to be a sufficient disclosure of concern or interest in relation to any contract or arrangement so made.
Non-Participation of Interested Director
Any director who is interested in any contract or arrangement with a related party, shall not be present at the meeting during discussions on the subject matter of the resolution.
Specific duty of Independent Directors pertaining to RPTs
The independent directors are required to pay sufficient attention and ensure that adequate deliberations are held before approving RPTs and assure themselves that the same are in the interest of the company
(2)   Approval of Board at a Board Meeting                                                 (in specified cases)
·   Under Companies Act, 2013
     As explained in column 2.
·   Under Listing Agreement
All ‘material’ RPTs are subject to the approval of the shareholders & thus require approval of the Board at its meeting or by circulation.
A transaction with a related party is considered ‘material’ if the transaction/ transactions to be entered into individually or taken together with previous transactions during a FY exceeds 10% of annual consolidated turnover of the company as per the last audited financial statements of the company.
Conclusion
As listed companies are required to comply with the provisions of both CA, 2013 as well as LA, the approval of the Board is required in the following cases:
i.    RPTs in terms of CA, 2013 which are not in the ordinary course of business and/or at arm’s length, irrespective of value of transaction and/
ii.   ‘material’ RPTs in terms of LA which are not between two government companies or holding company and its wholly owned subsidiary.
(3)  Approval by Shareholders (in specified cases)
·      Under Companies Act, 2013
If answer in Step III is Yes (i.e. where the proposed transaction is in ordinary course of business and at an arm’s length), then irrespective of the value of transaction, section 188 of CA, 2013 is not applicable, whereby approval of the shareholders is not required.
If answer in Step III is No (i.e. where the proposed transaction is not in ordinary course of business and/or at an arm’s length), examine the value of transaction to see whether it exceeds the threshold limit# given in Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014.
–       If the value of transaction does not exceed the threshold limit, no prior approval of shareholders is required to be passed in terms of Section 188.
–       If value of transaction exceeds the threshold limit, then PRIOR approval of the shareholders by way of Special Resolution at a General Meeting or through Postal Ballot is required.
(3) Approval by Shareholders                    (in specified cases)
·   Under Companies Act, 2013
As explained in Column 2.
·   Under Listing Agreement
Approval of the shareholders through Special Resolution at a General Meeting or through Postal Ballot is required in case of Material Related Party Transactions.
Exception: If answer in Step III is Yes, (i.e. transaction is between two government companies or holding company and its wholly owned subsidiary), then irrespective of the value of transaction, approval of shareholders is not required in terms of LA.
    Shareholders who are not entitled to vote in terms of LA
All entities falling under the definition of related parties in terms of LA shall abstain from voting on such resolution irrespective of whether the entity is a party to the particular transaction or not.
Conclusion:
As listed companies are required to comply with the provisions of both CA, 2013 as well as LA, the approval of the shareholders is required in the following cases:
i.  RPTs in terms of CA, 2013 which are not in the ordinary course of business and/or at arm’s length AND the where value of transaction exceeds the threshold limit given in Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014 and/
ii. ‘material’ RPTs in terms of the LA which are not between two government companies or holding company and its wholly owned subsidiary.
Sub clause of Sec. 188(1)
Nature of transaction
Threshold Limit#
(a) & (e)
Sale, purchase or supply of any goods or materials, directly or through appointment of agent
Exceeding 10% of Turnover of the company or Rs.100 Crore whichever is lower.
(b) & (e)
Selling or otherwise disposing of, or buying, property of any kind, directly or through appointment of agent
Exceeding 10% of Net worth of the company or Rs.100 Crore whichever is lower.
(c)
Leasing of property of any kind
Exceeding 10% of Net worth of the Company or 10% of Turnover of the company or Rs.100 Crore whichever is lower.
(d) & (e)
Availing or rendering of any services, directly or through appointment of agent
Exceeding 10% of Turnover of the company or Rs.50 Crore whichever is lower.
The above threshold limit shall apply for transaction or transactions entered into either individually or taken together with the previous transactions during a financial year.
(f)
Appointment to any office or place of profit in the company, its subsidiary company or associate company
Monthly remuneration exceeding Rs.2.5 lacs
(g)
Underwriting the subscription of any securities or derivatives thereof, of the company
Exceeding 1% of Net Worth of the company
 Net worth/ Turnover shall be computed on the basis of the audited financial statement of the preceding financial year.
Disclosures in General meeting notice
The explanatory statement to be annexed to the notice of a general meeting shall contain the following particulars namely:-
(a) name of the related party ;
(b) name of the director or key managerial personnel who is related, if any;
(c) nature of relationship;
(d) nature, material terms, monetary value and particulars of the contract or arrangement;
(e) any other information relevant or important for the members to take a decision on the proposed resolution.
–   For transaction between holding and its wholly owned subsidiary, special resolution passed by holding company is sufficient.
Shareholders who are not entitled to vote
Related Party in the context of the contract or arrangement for which the special resolution is being passed (i.e. only contractual parties) shall not vote on such resolution.
 
Framing of Policy
Not required as there is no such provision in the CA, 2013
Required to frame Policy on materiality of RPTs and Policy on dealing with RPTs
Review of RPTs
·      Under Companies Act, 2013
There is no such provision in the CA, 2013.
·      Under Companies Act, 2013
   As explained in Column 2.
·      Under Listing Agreement
The Audit Committee shall mandatorily review :
–   statement of significant RPTs (as defined by the Audit Committee), submitted by the management
–   atleast, on a quarterly basis, the details of the RPTs entered into by the company pursuant to each of the omnibus approval given
Disclosure of RPTs
·   Under Companies Act, 2013
o Particulars of every contract or arrangement with related parties entered into under section 188(1) shall be referred to in the Board’s Report along with the justification for entering into such contract or arrangement, in Form AOC-2.
o In the Balance Sheet, under Long Term Borrowings and Short Term Borrowings, Loans and Advances from Related Parties are to be shown as separate line items. Similarly, under Long Term Loans and Advances and Short Term Loans and Advances, Loans and Advances to Related Parties are to be given as separate line items.
·   Under AS-18
As per AS-18, the following facts should be disclosed in the financial statements:
(i)Related party relationships;
o  When the existence of relationship is due to the concept of the control- even when there are no transactions between the related parties, still the following disclosure is needed:
 i.  Name of the related party and
 ii.  Nature of the related party relationship
o  When the existence of relationship is due to significant influence, then no disclosure of name of related party and nature of related party relationship is required, if there are no transactions during the year between the related parties.
and
(ii) Details of transactions between a reporting enterprise and its related parties viz. name, description of the relationship, nature of transactions, volume of transactions and other details necessary for understanding of the financial statement.
Disclosure is must for the related parties even if the transactions are arm’s length transactions or transactions are not influenced by the relationship.
·   Under Companies Act, 2013
   As explained in Column 2.
·   Under Listing Agreement
Details of all material transactions with related parties is required to be disclosed quarterly alongwith the compliance report on corporate governance.
The company shall disclose the policy on dealing with RPTs on its website and a weblink thereto shall be provided in the Annual Report.
·   Under AS-18
As explained in Column 2.
Register(s) to be maintained
·   Under Companies Act, 2013
Every company is required to maintain one or more registers in Form MBP 4 and enter therein particulars of :
– company or companies or bodies corporate, firms or other association of individuals, in which any director has any concern or interest [section 184(1)]; However, the particulars of the company or companies or bodies corporate in which a director himself together with any other director holds 2% or less of the paid-up share capital would not be required to be entered;
– contracts or arrangements with a body corporate or firm or other entity as mentioned in Section 184(2) in which any director is, directly or indirectly, concerned or interested;
–  contracts or arrangements with a related party entered into with respect to transactions to which section 188 applies.
The entry should be made at once, in chronological order and should be authenticated by the Company Secretary of the company or by any other person authorized by the Board for the purpose.
Such register should be placed after entering the particulars, before the next meeting of the Board for signature by all the directors at the meeting
·   Under Companies Act, 2013
   As explained in Column 2.
·   Under Listing Agreement
There is no such requirement.
Contract or Arrangement which are voidable
 
·   Under Companies Act, 1956
Voidable Contract or Arrangement
–  A contract or arrangement entered into by the company without disclosure of concern or interest by director under section 184(2) or with participation by a director who is concerned or interested in any way, directly or indirectly, in the contract or arrangement, shall be voidable at the option of the company.
–  Where any contract or arrangement is entered into by a director or any other employee-
o without obtaining the consent of the Board or
o without approval by a special resolution in the general meeting and
   if it is not ratified by the Board or, as the case may be, by the shareholders at a meeting within three months from the date on which such contract or arrangement was entered into, such contract or arrangement shall be voidable at the option of the Board.
Indemnify loss by Director
If such contract or arrangement is with a related party to any director, or is authorized by any other director, the directors concerned shall indemnify the company against any loss incurred by it.
It shall be open to the company to proceed against a director or other employee who had authorized for entering into such contract or arrangement in contravention of the provisions of section 188 for recovery of any loss or damage sustained by it as a result of such contract or arrangement.
·   Under Companies Act, 1956
As explained in Column 2.
·   Under Listing Agreement
There is no such provision.
Penal Provisions
·   Under Companies Act, 2013
– Penalty for violation of section 184
If a director of the company contravenes the provisions of Section 184(1) or 184(2), such director shall be punishable with imprisonment for a term which may extend to one year or with fine which shall not be less than Rs.50,000/- but which may extend to Rs.1 lac or with both.
–  Penalty for violation of section 188:
Any director or any other employee of a   company, who had entered into or authorized the contract or arrangement in violation of the provisions of section 188 of CA, 2013 shall be punishable with fine of not less than Rs.25,000/- but which may extend to Rs.5 lacs
–  Disqualifications for appointment of director
A person shall not be eligible for appointment as a director of a company, if he has been convicted of the offence dealing with RPTs under section 188 at any time during the last preceding five years
·      Under Companies Act, 2013
–   Penalty for violation of section 184
   As explained in column 2.
–   Penalty for violation of section 188
Any director or any other employee of a company, who had entered into or authorized the contract or arrangement in violation of the provisions of section 188 of CA, 2013 shall be punishable with imprisonment for a term up to 1 year or with fine not less than Rs.25,000/- but which may extend to Rs.5 lacs or with both.
–   Disqualifications for appointment of director
   As explained in Column 2.
·Under Listing Agreement
(i)  Non submission of Corporate Governance compliance Report under Clause 49 within 15 days of the end of each quarter – Rs.1000/- per day till the date of compliance and in case of subsequent and consequent non-compliance, Rs.2,000/- per day till the date of compliance
(ii) Non compliance of the conditions of the LA shall be punishable with imprisonment for a term which may extend to 10 years or with fine, which may extend to Rs.25 crore or with both [Section 23(2) of Securities Contracts (Regulation) Act, 1956]

PROCESS FOR DEALING WITH RELATED PARTY TRANSACTIONS

RPT(Author – CS Deepak Banga is a Company Secretary working with Jaypee Group and can be contacted at csdeepakbanga@gmail.com)

More Under Company Law

Posted Under

Category : Company Law (3705)
Type : Articles (16226)
Tags : Companies Act (2170) Companies Act 2013 (1943)

2 responses to “Understanding Related Party Transactions”

  1. KP says:

    If Mr. X is director in Company A.
    now if Company A is promoter company of Company B.
    Will Mr. X be treated as related party of Company B ?
    Also if MR. X is partner in a firm Firm C which enters in a transaction with Company B. Will the transaction be treated as related party transaction ?

    PS: Company A and B have several other directors and Mr. X holds no position in company B.

  2. Chandra says:

    Related party transanctions has relevance to valuation of goods manufactured and sold by one related party to other under Section 4 of Central Excise Act, 1944. Analysis of the nature given in the article above, if done from the percepctive of valuation under Central Excise Act will be of immence help to many. We will welcome such an article also.

Leave a Reply

Your email address will not be published. Required fields are marked *