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Related Party Transactions: Diluted & Strengthened!

Published on Mon, Aug 18,2014 | 17:24, Updated at Mon, Aug 18 at 17:24Source : Moneycontrol.com 

By: Menaka Doshi, CNBC-TV18

The inevitable has happened. India Inc. has won. Or has it?
Has the dilution of rules governing related party transactions infact strengthened the scrutiny and approval process?

Burdened by the new disclosure and approval provisions in the Companies Act, 2013 for Related Party Transactions…India Inc. lobbied hard with the Ministry for Corporate Affairs to dilute the pertinent Section 188.

WHY INDIA INC. DISLIKES SECTION 188
For the uninitiated - Section 188 requires all Related Party Transactions (RPTs) entered into by a company to be approved by the Board/Audit Committee, and a large number of RPTs  would need shareholder approval via a special resolution, It also prohibits the interested ‘related party’ from voting on such a special resolution. This is the first time company law has gone so far to regulate RPTs and raise the governance standard. The vigilance is borne out of years of watching promoters undertake abusive RPTs in which companies transacted with promoter and related entities with little or no need for shareholder approval or oversight. Section 188 promises to check these malpractices. 

Except some say the law has gone too far. Too many RPTs will need shareholder approval and as a result shareholders are likely to be inundated with details on hundreds if not thousands of transactions, preventing them from being able to identify and focus on the abusive ones. Here’s why…

In Section 188 (1) the Act lists the type of RPTs that must be approved by the Board…

(a) sale, purchase or supply of any goods or materials;
(b) selling or otherwise disposing of, or buying, property of any kind;
(c) leasing of property of any kind;
(d) availing or rendering of any services;
(e) appointment of any agent for purchase or sale of goods, materials, services or property;
(f) such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company; and
(g) underwriting the subscription of any securities or derivatives thereof, of the company:

The proviso to Sec 188 (1) says that those RPTs, as prescribed by the Rules, shall need shareholder approval via special resolution. The Rules list the following RPTs…

RULE 15 (emphasis supplied by me)
(3) For the purposes of first proviso to sub-section (1) of section 188, except with the prior approval of the company by a special resolution-

(i) a company having a paid-up share capital of ten crore rupees or more shall not enter into a contract or arrangement with any related party; or 

(ii) a company shall not enter into a transaction or transactions, where the transaction or transactions to be entered into— 

(a) as contracts or arrangements with respect to clauses (a) to (e) of sub-section (1) of section 188 with criteria, as mentioned below—

(i) sale, purchase or supply of any goods or materials directly or through appointment of agents exceeding twenty five percent.of the annual turnover as mentioned in clause (a) and clause (e) respectively of sub-section (1) of section 188; 

(ii) selling or otherwise disposing of, or buying, property of any kind directly or through appointment of agents exceeding ten percent of net worth as mentioned in clause (b) and clause (e) respectively of sub-section (1) of section 188; 

(iii) leasing of property of any kind exceeding ten percent of the net worth or exceeding ten percent of turnover as mentioned in clause (c) of sub-section (1) of section 188; 

(iv) availing or rendering of any services directly or through appointment of agents exceeding ten percent of the net worth as mentioned in clause (d) and clause (e) of sub-section (1) of section 188; 

(b) appointment to any office or place of profit in the company, its subsidiary company or associate company at a monthly remuneration exceeding two and half lakh rupees as mentioned in clause (f) of sub-section (1) of section 188; or 

(c) remuneration for underwriting the subscription of any securities or derivatives thereof of the company exceeding one percent of the net worth as mentioned in clause (g) of sub-section (1) of section 188.

The above list does 2 things, it says
1. shareholder approval via a special resolution (75%) is needed for ALL RPTs entered into  by a company with a paid up share capital of Rs 10 crore or more„, [see 3(i)]

That would cover virtually all listed companies and many private companies as well. It means every single RPT entered into by say a Tata Steel or M&M will need shareholder approval. These would run into hundreds of transactions every year, because the definition of related party is wide, netting many transactions. 

M&M CFO V Parthasarathy told me in a discussion on RPTs onCompanies, Act (a special series telecast on CNBC TV18) that his company’s RPTs would run into ‘20 pages of transactions’

In that same discussion Tata Group General Counsel Bharat Vasani spoke of one Tata Company that ‘transacts with 1700 related parties’

Imagine the volume of information shareholders would have to peruse and approve. It could lead to absurd voting decisions. And remember the ‘related party’ interested in such a transaction cannot vote.

2. Secondly, the Rules put in transaction thresholds - for instance Rule 3 (ii) (a) (i) says if a company enters a RPT involving the sale of goods exceeding 25% of annual turnover, the transaction needs shareholder approval via special resolution.

These transaction thresholds apply if the company has a paid up share capital of less than Rs 10 cr.

On the face of it, the transaction thresholds are rather high - very few goods purchases would exceed 25% of annual turnover. But since they apply to smaller companies, mostly private ones going by size, there isn’t much to object to. After all, the main purpose should be to improve governance in listed companies and most listed companies would likely be covered by 3 (i). 

Troubled by the voluminous disclosures, Board and shareholder approvals for RPTs, many companies and industry chambers complained to the MCA that Section 188 was proving too burdensome to comply with. After months of lobbying, India Inc has found success!

FREEDOM FROM SECTION 188?
On Saturday, August 16th, MCA gave companies freedom from Section 188, by substantially diluting the Rules accompanying the provision.

The new Rules DO NOT INCLUDE the threshold of Rs 10 cr in paid up share capital! That sub clause [3 (i)] has been DELETED. All that’s left now are transaction thresholds. Which have been reduced, ostensibly to make up for the loss of the first threshold.

So, irrespective of the company’s paid up share capital, if the RPT crosses the size thresholds laid down by the new Rules, then the transaction requires shareholder approval via a special resolution.

Here’s a summary of the transactions that now require shareholder approval, via a special resolution, on which the interested ‘related party’ cannot vote…

- Sale, purchase or supply of any goods or materials, directly or through agent: Exceeding 10% of turnover OR Rs 100 cr, whichever is lower

- Selling or otherwise disposing off or buying property of any kind, directly or through an agent: Exceeding 10% of networth OR Rs 100 cr, whichever is lower

- Leasing of property of any kind: Exceeding 10% of networth OR 10% of turnover or Rs 100 cr, whichever is lower

- Availing or rendering of any services, directly or through appointment of agent: Exceeding 10% of turnover OR Rs 50 cr, whichever is lower

The new Rules maintain previously set thresholds for the appointment to an office of profit and underwriting services…

Interestingly, the MCA has put in a NEW SAFEGUARD - the new Rules say that the threshold limits specified apply to a transaction or a series of transactions in a financial year. It’s a clumsily word explanation but seems to imply that a company cannot break up a transaction into smaller ones in order to avoid the specified thresholds and hence a shareholder vote.

DILUTION OR STRENGTHENING?
There’s no denying that the Rules accompanying Section 188 have been diluted.  Earlier a company with a paid up share capital of Rs 10 cr or more would need shareholder approval, via a special resolution, for all RPTs. For other companies the Rules imposed transaction thresholds (very high).

Now there is no threshold linked to paid up share capital. There are only transaction thresholds, which have been lowered (to atleast Rs 100 cr).

Rs 100 cr seems to be a reasonable transaction threshold, allowing companies to skip shareholder approval for small, routine transactions and giving shareholders the chance to focus on the bigger, more abusive transactions. So one could say the dilution is in fact a strengthening of sorts of the provision. Of course rogue companies will still try and structure transactions so as to avoid these thresholds…and they may succeed, but shareholders will not be kind to them. Not anymore.

It is also important to note here that SEBI’s new Clause 49 (applies to all listed companies) measures RPTs differently. It sets a materiality threshold for RPTs needing special resolution approval…

SEBI: Clause 49
All ‘material’ transactions need shareholder approval via special resolution
Material: Transaction exceeding 5% of annual turnover or 25% of networth

No exemption for transactions in the ordinary course of business or at arm’s length
Between Companies Act, 2013 and SEBI Clause 49 a large number of related party transactions will now come to shareholders for approval. The ball is in your court. To read, analyse, object and defeat. The law can only empower…shareholders need to do the hard work of wielding it.

 
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