ABSTRACT
The article deals with the related parties’ transactions and talks about section 188 of companies Act 2013 and regulation 23 of the SEBI (Listing obligations and disclosure requirements) regulations, 2015. The article deals with a case where two companies entered into a material related party transaction in view of clause 49 of the Listing Agreement. The question in the present case was that whether the two companies violated section 188 of the companies’ act, 2013 and regulation 23 of the SEBI (LODR) regulation 2015. Section 188 bars the voting power of related parties at the time of entering into a contract or arrangement. In the present case Securities and exchange board of India held that there is violation of section 188 and regulation 23, appeal was filed before appellate tribunal by the two companies.
Key Words- Securities, Companies, section 188 of companies act 2013, related party transactions
INTRODUCTION
The present case deals with two companies namely RT Agro Ltd. And Neelkanth Realtors Pvt. Ltd. The two companies entered into an agreement of purchasing 40,000 square feet of residential space. This proposal was treated as a material related party transaction in view of clause 49 of the Listing Agreement and, accordingly, such proposal was required to be approved by the shareholders of the Company. [1]
SEBI was unjustified in penalizing a Co. by taking a hyper-technical view of the law on related party transactions: SC, Case Details: Securities and Exchange Board of India v. R.T. Agro (P.) Ltd. The Securities and Exchange Board of India (SEBI[2]) plays a crucial role in regulating and overseeing the Indian capital markets. However, in recent years, there have been instances where SEBI’s enforcement actions have been called into question. One such case is the Securities and Exchange Board of India v. R.T. Agro (P.) Ltd., where the Supreme Court of India ruled that SEBI was unjustified in penalizing the company by taking a hyper-technical view of the law on related party transactions. This landmark judgment sheds light on the importance of balanced regulatory oversight and the need to prevent overreach by regulatory authorities.[3]
BACKGROUND OF THE CASE:
Securities and Exchange Board Of India V. R.T. Agro (P.) Ltd.
The case of Securities and Exchange Board of India (SEBI) v. R.T. Agro (P.) Ltd. revolves around allegations of non-compliance with regulations related to related party transactions. R.T. Agro (P.) Ltd. is an agro-processing and trading company operating in India. The Securities and Exchange Board of India, the regulatory authority responsible for overseeing the Indian capital markets, accused R.T. Agro of violating regulations governing related party transactions.
Related party transactions refer to transactions between a company and its related parties, including directors, key managerial personnel, and relatives. These transactions can create conflicts of interest and may not always be conducted at arm’s length. To ensure transparency and protect the interests of minority shareholders, SEBI has established regulations and guidelines governing related party transactions.
SEBI alleged that R.T. Agro failed to obtain prior approval from its board of directors for certain related party transactions and did not disclose the necessary details to its shareholders. As a result, SEBI imposed a monetary penalty on R.T. Agro, citing non-compliance with its regulations and guidelines.
THE ALLEGED VIOLATIONS AND SEBI’S PENALTY
SEBI contended that R.T. Agro had contravened the provisions of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015.[4] These regulations enhance transparency, accountability, and corporate governance in listed companies.
SEBI alleged that R.T. Agro had failed to comply with the requirement of obtaining prior approval from its board of directors for related party transactions, as mandated by the regulations. The company was also accused of not disclosing these transactions adequately to its shareholders. SEBI considered these actions violations of the regulations and imposed a monetary penalty on R.T. Agro.
THE SUPREME COURT’S VERDICT
R.T. Agro challenged SEBI’s penalty before the Supreme Court of India, arguing that SEBI had taken a hyper-technical view of the law on related party transactions. The company contended that it had not acted with any fraudulent intent and had not caused any harm to its shareholders.
In its ruling, the Supreme Court acknowledged the importance of balancing regulatory oversight with the need to foster a conducive business environment. The Court held that SEBI’s insistence on strict adherence to procedural technicalities, without considering the substance of the transactions or any fraudulent intent, was not justified in this case. The Court emphasized that regulations should be interpreted and enforced balanced, considering related party transactions’ underlying purpose and impact.
The Supreme Court’s judgment in Securities and Exchange Board of India v. R.T. Agro (P.) Ltd. highlights the need for regulatory authorities to exercise their powers judiciously, focusing on substance rather than mere procedural compliance. It serves as a precedent for regulatory bodies to consider the intent and purpose of regulations rather than becoming overly fixated on technicalities when evaluating related party transactions.
Supreme Court’s Ruling In Securities And Exchange Board Of India V. R.T. Agro (P.) Ltd
The Supreme Court’s ruling in Securities and Exchange Board of India v. R.T. Agro (P.) Ltd. addressed the allegations made by SEBI against R.T. Agro regarding non-compliance with regulations on related party transactions. In its verdict, the Court found that SEBI’s penalization of the company was unjustified, as the regulatory authority had taken a hyper-technical view of the law.
The Supreme Court emphasized the need for a balanced approach in interpreting and enforcing regulations, particularly when the consequences of non-compliance can be severe. The Court recognized the important role of regulatory authorities like SEBI in protecting investor interests and maintaining market integrity. However, it also cautioned against exercising regulatory powers arbitrarily or overreaching, which could potentially stifle legitimate business activities and discourage entrepreneurship.
The Court observed that SEBI’s insistence on strict adherence to procedural technicalities, without considering the substance of the related party transactions or the absence of fraudulent intent, was unwarranted in this case. It highlighted that regulations governing related party transactions aim to prevent unfair dealings and protect minority shareholders. While transparency and accountability are crucial, a myopic focus on procedural requirements without considering the actual impact on shareholders or the underlying purpose of the regulations may lead to unintended consequences.
In its judgment, the Supreme Court emphasized that evaluating related party transactions should prioritize substance over form. The regulations aim to prevent abuse and ensure fairness, but regulatory authorities should not overly burden legitimate business transactions with rigid procedural requirements. The Court recognized the importance of balancing regulatory oversight and fostering a conducive business environment for economic growth and entrepreneurship.[5]
The ruling in Securities and Exchange Board of India v. R.T. Agro (P.) Ltd. has broader implications for regulatory authorities in India. It serves as a reminder to regulators to exercise their powers judiciously, taking into account the intent and purpose of the regulations rather than getting entangled in technicalities. It emphasizes the need to focus on the impact and substance of related party transactions while still upholding the principles of corporate governance and shareholder protection principles.
Overall, the Supreme Court’s verdict, in this case, reiterates the importance of a balanced regulatory environment and prevents regulatory overreach that could hinder legitimate business activities. It sets a precedent for regulatory authorities to evaluate related party transactions fairly and holistically, promoting transparency and accountability while fostering a conducive business environment for economic growth.[6]
SECTION 188: RELATED PARTY TRANSACTION:
Except with the consent of BOD given by the resolution and subject to such conditions as prescribed, no Company shall enter into contract or arrangements with related party with respect to: Sale, purchase or supply of any goods and materials, Selling or otherwise disposing of, or buying, property of any kind, Leasing property of any kind, Availing or rendering any services, Appointment of any agent for purchase or sale of goods, materials, services or property, Such related party’s appointment to any office or place of profit in the Company, its subsidiary Company or associates Company and, Undertaking the subscription of any securities or derivatives of Company. No member can vote on the resolution in which he is a related party. Nothing in this sub section shall apply if transaction entered by the Company is in ordinary course of business other than transactions which are not at arm’s length.[7]
DEALING WITH RELATED PARTY TRANSACTIONS:
The Company can enter into any contracts/ arrangements/ transactions with related party only after seeking prior approval of the following:
1. Audit Committee: Companies which are required to set up audit committee shall get the prior approval of for every related party transaction, whether at arm’s length basis or not. Audit committee may also grant omnibus approval for RPT proposed to be entered by the Company subject to the following conditions: Audit committee shall, after obtaining approval of board of directors, lay down the criteria while granting omnibus approval and such approval shall be applicable in respect of transactions which are repetitive in nature. Audit committee satisfy itself the need for such omnibus approval for transactions of repetitive nature and such approval is in interest of the Company. Audit Committee shall consider the following factors while specifying the criteria for making omnibus approval: Repetitiveness of transactions (In past or future) Justification for the need of omnibus approval. Such omnibus approval shall specify: Names of related parties, nature of transaction, period of transactions, maximum amount of transactions that can be entered into, in aggregate in a year, Maximum value per transactions which is allowed. Indicative base price/ current contracted price and formula if any. Other conditions as audit committee may deem fit. Audit committee shall review at least on quarterly basis, all related party transactions where omnibus approval was given. Such omnibus approval shall be valid for a period not exceeding 1 year and shall require fresh approval after expiry of financial year. Omnibus approval shall not be made for transactions in respect of selling or disposing of undertaking of the company.[8]
Omnibus approval
The audit committee in case of repetitive transactions gives consolidated or standing approval which is termed as omnibus approval.
With the board’s approval, the audit committee frames the criteria for the omnibus approval that shall include-
- The maximum gross transaction value in a year.
- The maximum value for a transaction.
- The manner of the transaction and the extent of disclosure to be made for the transaction.
- The transaction should be reviewed at periodic intervals.
- The transaction does not fall under omnibus approval.
- While starting the criteria, the following should be mentioned-
- Repetitiousness of the transaction that has been made in the past or will be made in the future.
- The reasons for the requirement of omnibus approval shall be taken into consideration.
- The omnibus approvals are valid for one fiscal year only.
- The omnibus approvals cannot be given for selling or disposing of undertakings.
2. Board of Directors: All related party transactions which are proposed to be entered by Company which are: not in ordinary course of business. Or not at arm’s length. Shall require prior approval of BOD by means of resolution. Where directors are interested in related party transactions, he/she shall abstain from discussion and voting on resolution. 3. Shareholders: Prior approval of shareholders is required for: All material related transactions as per listing[9] agreement. All RRT entered by the co. which are not in ordinary business or not in arm’s length, whose value exceed the threshold limit as prescribed under provisions of Companies Act, 2013 read with rule 15 of Companies (meeting of board and its powers) Rules 2014 (Ordinary Resolution)
Shareholders: Shareholder approval is required in the case of a related party transaction that does not take place in the normal course of business or is not at arm’s length price and the amount of the transaction is in excess of the materiality threshold. The approval is given only after passing a resolution.
The approval of the shareholders is also needed in the case of listed companies if a related party transaction exceeds the materiality threshold under listing regulations.
Exemptions from approval
Related party transactions do not require the approval of the board of directors and prior approval of the shareholders if the transaction is done in the ordinary course of business.
Related party transactions do not need the approval of the board of directors or prior approval of the shareholders if they are carried out on the basis of arm’s length.
Related party transactions do not require prior approval of the shareholders and audit committee if the transaction is done by listed companies or any kind of transaction takes place between its wholly owned subsidiary company, whose accounts are consolidated and retained so that they can be approved in the general meeting.
Related-party transactions are not applicable to private companies or IFSC-registered public companies.
Related party transactions are not carried out if more than ninety percent of the members are relatives of the related parties or promoters.
Translations are not allowed in cases where the related parties are government companies or the ministry in charge has given its approval to the government companies.[10]
‘Related party transaction’ under SEBI (Listing Obligations and Disclosure Requirement) Regulations, 2015
According to Regulation 2(1)(zc) of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirement) Regulations, 2015, [11]‘related party transaction’ means any kind of transfer of resources, services, or obligations that takes place between the entities that are listed and a related party, irrespective of whether a price is charged or transaction with a related party. This shall be deemed to include a single transaction or a group of transactions for which a contract is made. It can be presumed that this Section shall not be applied where the
IMPORTANCE OF SUBSTANCE OVER FORM
The principle of “substance over form” is a fundamental concept in various areas of law and business. It emphasizes the significance of considering a transaction or situation’s underlying essence or economic reality rather than solely focusing on its formal or technical aspects. This principle holds immense importance in legal, financial, and regulatory contexts for several reasons:
Accurate Representation of Transactions: Emphasizing substance over a form ensures that transactions are represented in a manner that accurately reflects their true nature. It prevents parties from manipulating or structuring transactions distorting their economic reality, thereby promoting transparency and integrity in business dealings.
Fairness and Equity: The principle ensures fairness and equity among parties involved by prioritizing substance. It prevents individuals or entities from exploiting legal or technical loopholes to gain unfair advantages or evade their obligations. Instead, it promotes a level playing field by assessing the actual impact and fairness of the transaction.
Preventing Regulatory Arbitrage: In regulatory contexts, the substance over form principle prevents entities from engaging in regulatory arbitrage, exploiting inconsistencies or gaps in regulations to achieve a desired outcome while bypassing intended regulatory oversight. Regulators must look beyond superficial compliance and assess transactions’ true substance to ensure market integrity and investor protection.
Economic Efficiency: Substance over form is crucial for promoting economic efficiency. It allows businesses to structure their transactions and operations to align with their economic objectives without unnecessary burdens or restrictions imposed by technicalities. By considering the substance and economic impact, regulators and courts can balance necessary oversight and encouraging entrepreneurship and growth.
Flexibility and Innovation: The principle recognizes the need for flexibility and innovation in business transactions. By focusing on substance, regulators and courts can avoid stifling legitimate business activities by excessively burdening them with rigid formalities. This encourages entrepreneurs and businesses to explore new avenues, take calculated risks, and drive economic progress.
Effective Risk Assessment: Assessing the substance of transactions allows for a more accurate evaluation of risks and potential consequences. By considering the economic reality, regulators and stakeholders can identify potential risks and make informed decisions accordingly. It enables a more comprehensive understanding of the risks associated with a transaction and the appropriate measures required for risk mitigation.
In summary, the principle of substance over form is of paramount importance in various legal, financial, and regulatory contexts. By prioritizing the true economic essence of transactions, it promotes transparency, fairness, equity, economic efficiency, and effective risk management. It balances regulatory oversight and the need to foster a conducive business environment, ensuring that laws and regulations serve their intended purpose while allowing for legitimate business activities and growth.
IMPLICATIONS FOR REGULATORY AUTHORITIES
The principle of substance over form carries significant implications for regulatory authorities. Here are some key implications for regulatory authorities when considering the substance of transactions:
Balanced Regulatory Approach: Regulatory authorities should adopt a balanced approach when interpreting and enforcing regulations. They should focus on transactions’ substance and economic reality rather than getting entangled in technicalities. This approach ensures that regulations are applied fairly and effectively without imposing unnecessary burdens or hindering legitimate business activities.
Risk-Based Regulation: Evaluating the substance of transactions allows regulatory authorities to identify and address risks more effectively. By understanding the true nature of transactions, authorities can allocate their resources and regulatory efforts based on the level of risk posed by different activities. This enables a targeted and risk-based approach to regulation, optimizing the use of regulatory resources and promoting efficient oversight.
Adaptive Regulations: Considering the substance of transactions encourages regulatory authorities to adopt adaptive and flexible regulations. Rather than relying on rigid rules that may become outdated or easily circumvented, authorities can design regulations focusing on the underlying objectives and principles, allowing for innovation and adaptability in response to changing business practices and market dynamics.
Preventing Regulatory Arbitrage: Regulatory authorities must be vigilant to prevent regulatory arbitrage. By emphasizing substance over form, regulators can discourage attempts by entities to manipulate transactions or structures to evade regulatory oversight. This ensures that regulations are effectively enforced and that entities cannot exploit loopholes or inconsistencies to their advantage.
Stakeholder Engagement and Transparency: Regulatory authorities should engage with stakeholders and seek their input on matters related to the substance of transactions. By involving industry participants, investors, and other stakeholders, regulators can gain valuable insights into market practices and potential risks. This engagement fosters transparency, accountability, and a collaborative approach to regulation.
Compliance Education and Guidance: Regulatory authorities should provide clear guidance and education to help businesses understand and comply with the substance of regulations. By providing practical examples and clarifications on how the substance of transactions should be assessed, authorities can help businesses navigate the regulatory landscape and ensure compliance without unnecessary confusion or ambiguity.
Overall, the principle of substance over form challenges regulatory authorities to adopt a more holistic and pragmatic approach to regulation. By focusing on the substance of transactions, authorities can enhance the effectiveness of their oversight, promote fairness and transparency, and create an enabling environment for legitimate business activities to thrive.
Judicial pronouncements
In the case of Public Prosecutor v. T. P. Khaitan (1957)[12], the meaning of the word ‘interest’ under Section 188 was interpreted as personal interest. The meaning is not restricted to financial interest only but may also include those interests arising out of a fiduciary or personal relationship. The interest of the related party may be direct or indirect.
In the case of Needle Industries Ltd. v. Needle Industries Newey (India) Holding Ltd. (1982), [13]the question raised was whether all the transactions with related parties needed scrutiny and compliance with Section 188 of this Act. The third provision to sub-section (1) of Section 188 gives an answer to this question, as it is an exemption clause. It exempts any transaction that is entered into by the entity in the ordinary course of business other than those transactions that are not on the basis of arm’s length.
In the case of IndusInd Bank v. Additional Commissioner of Income Tax (2012)[14], the meaning of ‘arm’s length transaction’ was defined as an amount for which assets can be exchanged between a willing and knowledgeable buyer and a willing and knowledgeable seller in an arm’s length transaction.
CONCLUSION
The concept of ‘related party transaction’ was introduced in Section 188 of the Companies Act, 2013, which helps us understand the relationship of the related party for business and commercial transactions. All the companies, in their day-to-day affairs, have to enter into transactions for carrying out their businesses. Any transaction that takes place between parties who are either relatives or parties that are closely linked with one another is normally termed a “related party transaction.” When such transactions take place, they may sometimes create disputes or other illegal situations that can have an impact on its financial position. Therefore, to protect the interests of the stakeholders and maintain accountability and transparency in business matters, the legislature amended the old Companies Act and inserted this Section in the new Act.
The Supreme Court’s judgment in Securities and Exchange Board of India v. R.T. Agro (P.) Ltd. highlights the importance of maintaining a balanced regulatory environment. While SEBI’s mandate is essential for safeguarding investor interests, the Court’s ruling emphasizes the need to prevent regulatory overreach and avoid excessively technical interpretations of the law.
The case serves as a precedent for regulatory authorities to evaluate related party transactions fairly and holistically, considering the underlying substance rather than becoming entangled in procedural requirements. By doing so, regulators can promote transparency, accountability, and a conducive business environment, fostering economic growth while protecting investor interests.
REFERENCES
- https://indiankanoon.org/doc/549307/
- https://blog.ipleaders.in/section-188-of-companies-act-2013/
- SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015
- https://www.caclubindia.com/articles/related-party-transactions-42046.asp
- https://www.livelaw.in/tags/securities-and-exchange-board-of-india-vs-rt-agro-private-limited-2022-livelaw-sc-424
- https://corpbiz.io/learning/sebi-ruling-in-sc-case-securities-and-exchange-board-of-india-v-r-t-agro-p-ltd/
[1] https://indiankanoon.org/doc/162449976/
[2] Board of India v. R.T. Agro (P.) Ltd. The Securities and Exchange Board of India (SEBI) (SC) 424
https://www.livelaw.in/tags/securities-and-exchange-board-of-india-vs-rt-agro-private-limited-2022-livelaw-sc-424
[3] https://corpbiz.io/learning/sebi-ruling-in-sc-case-securities-and-exchange-board-of-india-v-r-t-agro-p-ltd/
[4] SEBI Listing obligations & Disclosure Requirements Regulations, 2015
[5] https://corpbiz.io/learning/sebi-ruling-in-sc-case-securities-and-exchange-board-of-india-v-r-t-agro-p-ltd/
[6] https://corpbiz.io/learning/sebi-ruling-in-sc-case-securities-and-exchange-board-of-india-v-r-t-agro-p-ltd/
[7] https://corpbiz.io/learning/sebi-ruling-in-sc-case-securities-and-exchange-board-of-india-v-r-t-agro-p-ltd/
[8] https://www.caclubindia.com/articles/related-party-transactions-42046.asp
[9] https://taxguru.in/company-law/section-188-related-parties-bar-voting-operates-e-time-entering-contract-arrangement-sc.html
[10] https://blog.ipleaders.in/section-188-of-companies-act-2013/
[11] SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015
[12] Public Prosecutor vs T.P. Khaitan And Ors. on 22 August, 1956 AIR 1957 Mad 4, 1957 CriLJ 69
https://indiankanoon.org/doc/549307/
[13] Needle Industries (India) Ltd., & … vs Needle Industries Newey (India) … on 7 May,1981 AIR 1298, 1981 SCR (3) 698 https://indiankanoon.org/doc/292160/
[14] Indusind Bank Limited, Mumbai vs Pr. Commissioner Of Income Tax -2, … on 28 August, 2019 https://indiankanoon.org/doc/98852758/
By Tanya Goyal and Khushi Bansal 4TH year students of University of Upes Dehradun
Author Bio
