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Related Parties: SEBI vs Companies Act!

Published on Thu, Aug 20,2015 | 18:26, Updated at Thu, Aug 20 at 18:30Source : 

By: Sandeep Parekh, Founder and Shashank Patil, Associate, Finsec Law Advisors        
The Companies Act, 1956 (“Companies Act”) and the Listing Agreement both set out different requirements for related party transactions (“RPT”). While the former applies to all companies, the latter applies only to listed companies.

The Definition of Related Party
The Companies Act provides a definition for the term “related party” whereby a list of nine parameters have been prescribed to determine whether a particular entity is a related party. However, under the Listing Agreement, SEBI has prescribed additional parameters, apart from those specified in the Companies Act. Under Clause 49 (VII) (B) of the Listing Agreement, listed companies must also consider the parameters set out under the applicable accounting standards to determine whether a particular entity is a related party.  

The Indian Accounting Standard 24 (“IndAS 24”) deals with related party disclosures. Transactions with such entities will have to meet the higher standards and obligations set out in the Listing Agreement. The table below contains a comparison of the definitions of related party under the Companies Act and IndAS 24:

Section 2(76) of the Companies Act IndAS 24
(i)    a director or his relative;
(ii)    a key managerial personnel or his relative;
(iii)    a firm, in which a director, manager or his relative is a partner;
(iv)    a private company in which a director or manager is a member or director;
(v)    a public company in which a director or manager is a director or holds along with his relatives, more than 2% of its paid-up share capital;
(vi)    any body corporate whose Board of Directors, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager;
(vii)    any person on whose advice, directions or instructions a director or manager is accustomed to act:
(viii)    any company which is
a. holding, subsidiary or an associate company of such company; or
b. subsidiary of a holding company to which it is also a subsidiary;
(ix)    such other person as may be prescribed;
a)    A person or a close member of that person’s family is related to a reporting entity if that person:
i.    has control or joint control over the reporting entity.
ii.    has significant influence over the reporting entity.
b)    An entity is related to a reporting entity if any of the following conditions apply:
i.    The entity and the reporting entity are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others).
ii.    One entity is an associate or joint venture of the other entity (or an associate or joint venture of a member of a group of which the other entity is a member).
iii.    Both entities are joint ventures of the same third party.
iv.    One entity is a joint venture of a third entity and the other entity is an associate of the third entity.
v.    The entity is a post-employment benefit plan for the benefit of employees of either the reporting entity or an entity related to the reporting entity. If the reporting entity is itself such a plan, the sponsoring employers are also related to the reporting entity.
vi.    The entity is controlled or jointly controlled by a person identified in (a).
vii.    A person identified in (a)(i) has significant influence over the entity or is a member of the key management personnel of the entity (or of a parent of the entity).

The threshold prescribed under IndAS is essentially for determining disclosures and auditing. For the purpose of disclosure, the standards are of course very broad, as they ought to be.  Adding this standard to the Clause 49 standard is adding to the length of the definition and making it more burdensome, overlapping and confusing for listed entities. The definition within the Companies Act is easier to understand and adequate for the task at hand. SEBI should consider excluding the accounting standards from its definition of ‘related party’.

Voting rights of Related Parties
Under the Companies Act, the prior approval of the board of directors of a company is required for a RPT relating to any of the seven subject matters listed therein. It must be noted that rules made under the Companies Act state that directors who are interested in the RPT shall not participate in the meeting considering its approval.

Further, the Companies Act requires prior approval of the company’s shareholders, by way of ordinary resolution, if abovementioned transactions are beyond the prescribed monetary thresholds. The Companies Act itself states that no member of the company who is a related party shall vote on such a resolution to approve any RPT, if such member is a related party. The Ministry of Corporate Affairs, vide Clarifications dated July 17, 2014, clarified that this restriction only applies to such related parties which may be related in the context of the RPT for which the resolution is being passed. As a result, other entities that fall within the parameters of related party but are not directly involved or interested in the transaction can vote on the resolution.

Under the Listing Agreement, material RPTs require the prior approval of the company’s shareholders by way of a special resolution. However, unlike under the Companies Act, it is expressly states that all entities falling under the definition of related parties shall abstain from voting irrespective of whether the entity is a party to the particular transaction or not.

This inconsistency leads to some peculiar scenarios. We may consider a few hypothetical fact situation to highlight the issues here. Company X is attempting to enter into a transaction with Company Y, a related party. One of the directors and shareholders of Company X, Mr. A is also a related party of Company X but is unrelated to Company Y. He is opposed to the proposed transaction with Company Y as he believes it is not in the company’s interest. As per the Companies Act, Mr. X may vote during the board meeting and the shareholder resolution as he is unrelated to Company Y and is not interested in this transaction. However, under the Listing Agreement, as he falls under the category of related party, he may not participate in the meeting. As he is not directly or indirectly interested in the transaction, we are of the view that there is no reason to restrict him from exercising his vote.

To take another example. If an independent director of Company X is also an independent director of a Mutual Fund AMC, the Mutual fund would be disbarred from voting even though the director has no interest in the issue at hand. SEBI may consider amending the provision accordingly in order to align it with the position under the Companies Act. Keeping it so broad would only restrict non interested parties (in a particular transaction) from voting and thus harm the interest of the shareholders which SEBI seeks to protect. In some cases, the harm may extend to non-interested parties opposing the vote being barred from voting. This again could not be the intention of SEBI. Restrictions should apply only where a person or its related entities are interested in that transaction.

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