Mohan Lavi

Related-party deals

Mohan R Lavi | Updated on September 18, 2019 Published on September 18, 2019

More disclosures needed for transparency

It is not surprising that most of the accounting transgressions that have occurred over the last two decades can be traced to transactions with related parties. Enron did not consolidate a special purpose entity called Chewco, Satyam did what they did to cover up transactions with subsidiary Maytas, and the IL&FS saga is one of teeming and lading of monetary transactions with related parties. More recently, CG Power and Industrial Solutions informed the Bombay Stock Exchange that the total liabilities of the company and the group may have been understated by ₹1053.54 crore and ₹1,608.17 crore, respectively, as at March 31, 2018.

To ascertain and establish completeness of the liabilities an initial exercise was conducted by making enquiries with lenders, current and past, for any additional claims from them in respect of either the company or its subsidiaries. Subject to appropriate legal examination, these amounts have been either recorded as liabilities or disclosed as contingent liability in the Management Compiled Financial Information.

Arm’s length transaction

Related-party transactions can neither be avoided nor banned since the very nature of business is that entities deal with one another irrespective of whether they are “related” or not. The only requirement from the regulators for related-party transactions is that it should be at arm’s length. But in reality it is impossible to have a formula to calculate the arm’s length price. Section 188 of the Companies Act attempts to impose some rules to conduct transactions with related parties — usually there should be the consent of the board of directors; a special resolution is needed for certain types of transactions; and no member of the company shall vote on resolutions in which they are interested. The section also states that the conditions would not apply if the transactions are at arm’s length.

Accounting standards and regulatory requirements mandate detailed disclosures of transactions with related parties. Despite all this, some entities conduct transactions with related parties without worrying too much about transgressing the laws. This stems from the confidence that since the related party is controlled by one company, they can always manage to wriggle out of any situation.

We can expect SEBI to react to the CG Power episode by prescribing more compliances. The regulator can ask the audit committee to confirm whether all transactions with related parties were done at arm’s length; ask companies to disclose past transactions with related parties which were not at arm’s length; and can ask the auditors to make a specific comment in their report that all transactions with related parties have been conducted at arm’s length.

Internal auditors could be tasked with auditing related-party transactions in real time. SEBI could also look at the annual disclosures of related party transactions and penalise companies that have not disclosed everything that has to be disclosed — both qualitative and quantitative.

Looking back at all the issues involving related-party transactions, there has never been any issue with the initial transaction and its disclosure. It is in the second leg of the transaction — a loan that needs to be repaid, interest that needs to be paid, preventing a guarantee from being revoked, or consolidating a subsidiary that has recently been incurring huge losses — where the rules are being flouted at will. This is because there is no money to pay the loan/interest or to honour the guarantee.

Companies should be asked to keep shareholders posted about such information.

The writer is a chartered accountant

Published on September 18, 2019
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