A close watch on related party deals

Harpreet Singh Pankaj Tewari | Updated on February 17, 2013 Published on February 17, 2013

In line with developed jurisdictions, a new concept of ‘interested shareholders’, who cannot vote on approval of related party transactions, has been introduced.

Related party transactions have always been under the regulatory lens. Abusive transactions could be misused to further the interest of controlling shareholders. Apart from denting investor confidence, they adversely impact fund-raising through the capital market. The new Companies Bill proposes a regime that is based on disclosure, transparency and self-regulation — a paradigm shift from the control-based regime.

Broader scope and coverage

Related parties have been elaborately defined to include a director or key managerial person or his relative; firms or companies in which a director, manager or his relative is a partner or director; public companies in which a director or manager of the company is a director, or holds, together with his relatives, more than 2 per cent of the share capital in such a company; holding, subsidiary or fellow subsidiary company.

The term ‘key managerial personnel’ is a new addition to the list of related parties covering senior personnel such as Chief Executive Officer, Chief Financial Officer, Managing Director, and Company Secretary.

The scope of transactions has been significantly enhanced, and proposes to cover sale, purchase, and leasing of property of any kind, including immovable property. Appointment of any agent for purchase and sale of goods, material, services or property is also covered.

Enhancing transparency

The board of directors will now have to disclose all contracts with related parties, along with the justification for it, in their report to shareholders. The role of the audit committee has been enhanced to include approval of related party transactions. Currently, the audit committee reviews such transactions on a periodic basis after the transactions have taken place. Mandating pre-approval by the audit committee will remove the limitations associated with a post-transaction review.

Liberal measures

There is reason to cheer as well — prior approval from the Government for specified transactions has been done away with. In the existing regime, the Government’s prior approval is required for transactions above a threshold limit of paid-up capital.

Some novel concepts

A new concept of arm’s length transaction, drawing inspiration from transfer pricing regulations, has been introduced. This replaces the existing term of ‘cash at prevailing market price’. Transactions done on an arm’s length basis, in the ordinary course of a company’s business, are covered in the category of exceptions and lie outside the ambit of compliance obligations.

While the companies no longer need Government nod, prior approval of shareholders, by way of special resolution for specified transactions, would be needed. As many of the abusive transactions are undertaken between company groups controlled by the controlling shareholders, there is a need to address this malaise. Hence, in line with some of the developed jurisdictions, a new concept of ‘interested shareholder’ has been introduced. Interested shareholders will not be allowed to vote on resolutions pertaining to approval of related party transactions.

Deterrence and punishment

The penal consequences have become harsher — contraventions in listed companies could result in imprisonment or monetary penalties. This has severe adverse ramifications on an individual’s eligibility for appointment to senior managerial positions.

Prevention — better than detection

Companies would have to design appropriate policies and set up a mechanism to track, record, and disseminate the list of related parties. Robust internal processes with strong checks and balances would also be needed. This will go a long way in boosting investor confidence and improving corporate governance.

Harpreet Singh is Executive Director and Pankaj Tewari is Senior Manager, Risk Advisory Services, PwC India

Published on February 17, 2013
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