All you wanted to know about related party transactions

In the Mahabharata-like war that has erupted at IndiGo Airlines, one promoter — Rakesh Gangwal — has accused another — Rahul Bhatia — of irregular related party transactions (RPTs) among other misdoings. Bhatia has refuted this strongly, saying that the transactions are on arm’s length basis. Disputes over RPTs have been a recurring theme in India Inc. from time to time.

Related party transactions are just that — transactions that a company does with parties related to it. So, if Company A buys goods or services from its director X, it counts as an RPT. Similarly, if Company A takes on rent premises owned by Y, a relative of director X, it is also an RPT.

There is a long list of persons and entities that are considered related parties by the law. These include the company’s directors, key managerial persons, and their relatives. Also, firms or private companies in which such directors, managers, or their relatives are partners or directors are covered under the definition. So also are holding companies, subsidiaries and associate companies — among others that can exercise influence on the company. Simply put, any person or entity that can give rise to vested interest risk for the company is considered a related party.

In RPTs, there is a risk that the related party may be favoured with terms that could harm the interests of the company’s shareholders.

For instance, if Company A rents office premises from Y, a relative of its director X, and pays higher than market rent in a sweetheart deal, it helps Y and indirectly X, but harms shareholders of Company A. That said, RPTs need not always be bad for a company’s shareholders. In many cases, RPTs make commercial and operational sense for the company. So, the Companies Act has not banned RPTs but instead laid down safeguards to be followed.

As a result, RPTs, in general, need the approval of the company’s Board of Directors and the Audit Committee. And if RPTs are of specified types or their value exceeds specified limits (say 10 per cent of net worth or annual turnover, or ₹100 crore), the majority of the shareholders (excluding interested parties) have to give their approval through special resolutions. But such ratification and approvals are not necessary when the RPT is done on arms-length basis — that is, the transaction is done on purely commercial terms as it would be with unrelated parties.

Non-compliance with the law and rules could render RPTs void and entail penalties for the violator.

It is one thing to offer cushy deals to your relatives or related parties in personal transactions. It’s your money entirely, you may want to buy goodwill, and you are free to do what you want — no questions asked. But it is altogether another thing when it comes to related party transactions of companies. Here, apart from the promoters and directors, there could be thousands or even millions of shareholders, each of whom has put in money in the company and whose interests need to be protected. So, sweetheart clauses in company RPTs that favour a few to the detriment of many are a no-no. Arm’s length transactions keep the peace.

Simply because, as a shareholder, it is your money that is at stake. If a company in which you have put money is conning you through unfavourable RPTs, you will be better off heading for the exit door. Bad corporate governance eventually comes to bite shareholders even if they’re not the villains.

Right or wrong — it’s a relative call.

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