Undoing the knots in related party transactions

Satyavati Berera Pankaj Tewari | Updated on November 23, 2017 Published on November 24, 2013

The new regime encourages disclosure and transparency — India Inc has to gear up.

Related Party Transactions (RPTs) have always been under the regulatory scanner, as abusive RPTs can be manipulated to advance the personal interests of controlling shareholders. The Companies Act 2013 is set to significantly overhaul the rules for doing business with related parties — there is a paradigm shift from a control-based regime to one that is disclosure-based. The changes, however, have received mixed reactions.

Wider scope

The new regime for RPTs seems complex because the definition of ‘related party’ has changed significantly. Related parties now 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 company. Holding company, subsidiary company, associate company, and fellow subsidiary company have also been included. This will significantly impact transactions between group companies.

The scope of transactions has been significantly enhanced and proposes to cover sale, purchase, and leasing of any property of any kind (including immovable property). It must be noted that transactions of immoveable property lie outside the purview of the existing regime.

Greater scrutiny

There is tremendous emphasis on the approval process for related party transactions. The mandatory code of conduct for independent directors stipulates that they should pay sufficient attention and ensure that adequate deliberations are held before approving RPTs, and assure themselves that the same are in the interests of the company.

Non-executive and independent directors are entitled to immunity from prosecution only when they can demonstrate evidence of due diligence. Companies will have to gear up to face greater scrutiny and questioning by independent directors. The management would have to design a format and structure for recording discussions in Board meetings, which will help in asking the right questions and provide evidence of due diligence as well.

The audit committee’s responsibility has been enhanced to include approval of related party transactions. In the current regime, the committee reviews RPTs at periodic intervals, which leaves it with little scope for effective preventive intervention. The Board, in its report to shareholders, will now have to disclose all contracts with related parties along with justification thereof.

‘Interested Member’

A new concept of ‘interested member’ has been introduced. If an interested member is covered under the definition of ‘related party’, he/ she cannot vote. This is to check misuse of shareholding power by controlling shareholders, and prevent stifling of the minority by the majority. Since major transactions have to be approved by shareholders through special resolution, denial of voting rights to interested members would mean approval by majority of the minority.

Doing away with the requirement of obtaining approval from the Government is a huge, positive shift towards a self-regulatory environment. Transactions in the ordinary course of business are exempted from compliance obligations, provided they are conducted on arm’s length basis.

India Inc to gear Up

The penal consequences have been made much stricter, and contraventions in listed companies could result in imprisonment or monetary penalties. The challenge can be addressed through robust internal processes that focus on preventive checks rather than ones that focus on detection.

The management would have to define the limits of the related party universe and lay down guidelines for arm’s length pricing. A comprehensive guidance document for the company and its employees would help in creating awareness and sensitivity.

The new regime encourages disclosure and transparency — India Inc has to gear up.

Satyavati Berera is Executive Director, and Pankaj Tewari is Senior Manager — Risk Advisory Services, PwC India

Published on November 24, 2013
This article is closed for comments.
Please Email the Editor