SEBI’s related party transaction rules may hurt ‘ease of doing business’

The Securities Exchange Board of India (SEBI) recently announced additional disclosure requirements to be placed by listed entities before the audit committee for approval by shareholders for consideration of related party transactions (RPTs). The new norms will be applicable from April 1, 2022. The SEBI’s new norms are cumbersome as well as opaque with inherent discrepancies and defeat government’s mission of ‘Ease of Doing Business’. It’s important that the government steps in to strike a balance between micromanagement and bringing about transparency in disclosure requirements as most of these amendments go against the philosophy. 

In the latest amendment’s SEBI’s regulations have laid down a threshold of Rs 1,000 crore and mandating that all RPTs exceeding this said limit of Rs 1,000 crore or 10% of annual consolidated turnover to take require prior approval of the shareholders. While the Companies Act, 2013 and Rules does not prescribe any limit on related party transactions for seeking shareholders’ approval. Related party transactions (RPTs) are currently governed by the Listing Regulations as well as the Companies Act, 2013.

As per the provisions of the Companies Act, 2013, RPTs which are in the ordinary course of business and at arm’s length need to be approved only by the Audit Committee of the Board. Further, in terms of Section 188 of the Companies Act, 2013 read with Rule 15 of the Companies (Meetings of Board and its Powers) Rule, 2014, the board can approve RPTs, which are not at arm’s length or not in ordinary course of business up to the prescribed threshold of 10% of turnover etc. Only those transactions which go beyond the threshold require approval of the shareholders. Listing Regulations on the other hand (before the 6th Amendment Regulations) mandate that all RPTs exceeding 10% of the annual consolidated turnover (‘material transactions’) need to be approved by the shareholders.

This is a much larger scope than the 20% originally suggested in the Report by the Working Group on Related Party Transactions. There will inevitably be a possibility of micromanagement and supervision since these transactions would include those which would also indirectly benefit the RPT along with those with a direct nexus. It would lead to need for in depth reviews by the listed entity to evaluate RP transactions. Thus, the very purpose of the SEBI rules would be defeated by scrutiny of such transactions and increased compliances on a secretarial and financial level. Even as authorities are looking at increasing disclosure and transparency with sectoral data reporting deficits, this would be difficult to implement. 

Increased Compliance 

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Of the fifty companies listed in Nifty-50. Forty-seven companies had annual consolidated turnover ranging from Rs 5,40,000 crores–Rs 11,000 crore in FY2020-21. For most of these companies, the threshold of Rs 1,000 crore does not constitute even one per cent of turnover. The process of seeking shareholders’ approval leads to delay in execution of contracts and quite often the counterparties are not willing to wait for these approvals which may take significant amount of time. Most companies in the country face issues of operating cash flow bottlenecks along with seasonal dips and these rules could lead to operating difficulties.

Further, many corporates create subsidiaries and joint ventures for strategic business reasons and subjecting contracts of more than Rs 1,000 crore to shareholders’ approval will only delay the execution of such contracts. Furthermore, the level of scrutiny will lead to need for interaction between secretarial, finance teams of corporates prior to entering such transactions which would deter free market practices and defeat the very concept of ease of doing business principle.

In fact, most of the transactions are market led and hence competitiveness of Indian products in the global market drives these operations. Since these orders are meant to meet the requirements across the globe, they are often likely to exceed Rs 1000 crores in size, either as a single transaction or as a series of transactions. Such export orders need to be executed expeditiously since the market dynamics could change quickly over a short period of time. 

Defeats Make in India Spirit 

 Given the elaborate procedures and time involved, the process of seeking shareholders’ approval is likely to be a serious impediment in contracting and execution of such orders. The minimum time for taking such approval from the shareholders, even though postal ballot, would range between 45 to 60 days. Consequently, the country may lose valuable business and export opportunities. This will also adversely impact the foreign exchange earnings and Government’s ‘Make in India’ initiatives. In this context, it may also be noted that all transactions involving export of goods and services to related parties are already subjected to a detailed regulatory scrutiny in the form of international Transfer Pricing audit under the Income-tax Act, 1961. 

It may be noted that none of the major international frameworks on RPTs have prescribed such absolute thresholds, as laid down by the 6th Amendment Regulations. In most of the cases, international frameworks do not require shareholders’ approval for related party transactions in the normal course of business. Quite often, private equity and other institutional investors also invest in companies with no intention to run operations or have any control. 

Given the challenges arising out of recently notified amendments to related party transactions, as aforementioned, it is requested that SEBI should take a pragmatic and balanced approach in this connection. The requirement of approval by shareholders for RPTs which are in ordinary course of business and at arm’s length should be done away with and should be aligned to the Companies Act, 2013. The threshold limit of Rs 1000 crores for seeking shareholders’ approval for material RPTs should be done away with. In other words, current provisions w.r.t. threshold limit of 10% of the annual consolidated turnover of the listed entity should be retained. 

To conclude, Indian companies will have a hard task before them of complying with the regulations in their present form. It is necessary to be more practical and flexible and have a stage-wise rollout of regulations. It would be preferable to have a more realistic reporting of classification of RPT transactions.

Mangesh Bhende is a senior partner at Synemarke Legal and Miket Bahuva is a company secretary. The views expressed are personal 

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