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SEBI's New Clause 49!

Published on Mon, Apr 28,2014 | 16:18, Updated at Mon, Apr 28 at 17:13Source : CNBC-TV18 |   Watch Video :

Our top story this week- India’s new Clause 49! It is that Clause in the Listing Agreement that first ushered in corporate governance norms in India. That was in 2000. This year we have a new Clause 49 that not only aligns SEBI’s corporate governance norms with those laid out in the Companies Act, 2013 – but in some cases even goes beyond. Payaswini Upadhyay reports on the top 3 changes that will impact listed companies in India

Excessive promoter remuneration, higher royalties to foreign parent companies, loans to wholly owned subsidiaries at low interest rates, intra-group transfers- time and again, minority shareholders have been short changed by such related party transactions by companies and their managements. 

The Companies Act, 2013 has sought to address this by mandating that all related party transactions need audit committee approval. SEBI’s new Clause 49 adds prior approval.

NEW CLAUSE 49!
Related Party Transactions

Companies Act, 2013
- Audit Committee approval for all RPTs

SEBI
- Prior approval by Audit Committee for all RPTs

Amal Ganguli
Independent Director
“In the case of SEBI guidelines, now, even if the transaction is in the ordinary course of
 business and at arms length – that still has to be pre-approved by the Audit Committee; of course if it is material. But the pre-approval is going to cause enormous difficulties because in a lot of cases, subsidiaries are spread all over the world. I am myself on the Board of a company which has 57 or so subsidiaries spread all over the world. Pre-approving related party transactions between the parent and those subsidiaries – whether they are at arms length or not- I can’t imagine how it will be done.”

The Companies Act requires all RPTs not in ordinary course of business and not at arms length to be approved via special resolution. SEBI says all material RPTS need approval via special resolution.

Companies Act defines related party transactions mostly in connection to directors, relatives and KMP. SEBI extends the definition to include those in control or joint control or having significant influence.

NEW CLAUSE 49!
Related Party Transactions

Companies Act, 2013
-    Special resolution approval for all RPTs not in ordinary course of business & not at arms length
-    Applicable to companies with paid up capital of more than Rs 10cr + prescribes transactional thresholds
-    Defined in connection to directors, relatives, KMP

SEBI
-    All material RPT's need special resolution approval
-    Material: Transaction exceeding 5% of annual turnover or 25% of networth
-    Extended to those in control/ joint control/having significant influence

Umakanth Varottil
Professor, National University of Singapore
“The concept of control, we know, has been subject to quite a lot of issues. If you were to take a scenario where an entity has a small shareholding in another company and if they have Board rights, negative veto rights so on and so forth, those contractual right may also give rise to an element of control. What this does is, it gives room for a lot of interpretation, discretion to be exercised by SEBI which may then be taken to Appellate authorities etc. So I see this giving rise to a lot of interpretational issues and disputes than the Companies Act does which is both clear and streamlined

SEBI’s related party definition extends to entities related to a company if they are members of the same group; if one entity is an associate or joint venture of the other; and if both entities are joint ventures of the same third party.

NEW CLAUSE 49!
Related Party  

Companies Act definition
              +
Person who has control/joint/control/significant influence
Members of the same group
Associate or joint venture
Joint ventures of the same third party

Shardul Shroff
Managing Partner, Amarchand Mangaldas
"In a two party joint venture- if it’s a contract between a company and say one of the shareholders, you can identify but what if it is a party contract between two joint ventures- who is the counter party, whose vote has to be taken on one side and whose vote has to be taken on the other side. You can never be in a situation where no vote is to be taken  So when there is a majority-minority kind of situation- a promoter and a minority- the concept of who is the party related is very clear but if the only two shareholders are counter parties, then who will vote? Take a hypothetical example- one partner is GE, other partner is SBI and let’s assume there are two JVs in such a situation- in one, GE has the majority and in the other, SBI has a majority- now if there is a contract between two JVs, and in one, one of them is a related party and in the other, majority is the counter party- what vote will take place?”

Listed companies would feel the pinch in executing related party transactions not just on account of a wider definition but also because of an element of retrospectivity that Clause 49 brings in. It says that all existing material related party transactions that are likely to continue beyond March 31st 2015 will need shareholder approval by a special resolution.

Shardul Shroff
Managing Partner, Amarchand Mangaldas
“If a contract has been entered into and it’s executed partially, it would be an extremely strange principle of law that subsequent to the contract being performed, you are asking for a minority vote and if the minority doesn’t approve it with a requisite majority, you can cause cancelation or even damages being raised by the counter party. So that could become a very serious problem in terms of contract law.”  

SEBI’s Clause 49 has also introduced new requirements for material un-listed subsidiaries – material being defined as that in which the parent’s investment exceeds 20% of its net worth or that which contributes 20% to the parent’s consolidated income.

The new provisions include- at least 1 Independent Director of holding company should be present on the subsidiary’s Board. And the audit committee of listed holding company to review financial statements & investments of the subsidiary

NEW CLAUSE 49!
Material Subsidiary

-    Defined as one in which parent's investment exceeds 20% of its net worth/contributes 20% to parent's consolidated income
-    One ID of holding company to be on subsidiary's Board
-    Parent company's Audit Committee to oversee financial statements & investments

Amal Ganguli
Independent Director
"Overseeing the business will mean the parent company getting involved to a much greater extent and actually passing judgment on the business decisions that are taken in those subsidiaries and that fits in with the law that says each company has its own Board and its own shareholders and its run as a separate entity If, for example, a subsidiary says to the parent we want to go in a particular line of business or a contract and we think it’s a good business risk, there are good prospects of profit but we need to borrow a large amount of money- is it possible for parent Board to evaluate and say that you can’t go ahead with it. Now that can give rise to all kinds of conflict immediately."

The Companies Act says the sale of 20% or more of an undertaking of a specified size, must be approved via a special resolution. SEBI extends that to material subsidiaries as well – saying a sale of shares that results in loss of control of the subsidiary or a sale of 20% and more of the assets of the subsidiary needs special resolution approval.

NEW CLAUSE 49!
Material Subsidiary

Companies Act, 2013
- Sale of 20% or more of undertaking's asset needs special resolution approval

SEBI
- Special resolution approval requirement applicable to material subsidiary as well
- Applicable if it results in loss of control/sale of 20% and more of subsidiary's assets

In 2012, executives were paid 85 times compared to their average employee; reveals a study by proxy advisory firm- IIAS. In promoter-run Sensex companies, the median ratio was 190 times. The Companies Act, 2013 requires companies to disclose remuneration of directors and key managerial personnel. It also requires listed companies to disclose the ratio of the remuneration of each director to the median employees’  remuneration. Clause 49 takes this disclosure requirement one step further. Listed companies must disclose all elements of remuneration package of individual directors namely, salary, benefits, bonues, stock option details, pension, service contracts, notice period, severance fees etc.

Umakanth Varottil
Professor, National University of Singapore
“In other countries where this has been implemented, it has also resulted in several unintended consequences. There have been studies in the United States that suggest that more disclosures around Executive compensation, it drives the market for compensation further up which was not what governance specialists had thought of when this was suggested. In other markets, there have been issues as to whether this is competitive information that may be sensitive from a human resources hiring perspective. So putting this information out in the market may lead to several unintended consequences.”

These were the Top 3 impact areas where SEBI has raised the bar for the listed company universe. There is one more important change that most people come to terms with but it still requires a special mention and that has to do with the tenure of independent directors – the Companies Act gives independent directors 2 terms of 5 years each. SEBI’s Clause 49 says an Independent Director who has already served on a company’s board for 5 years can serve only one more term of 5 years. It also places restriction on the number of Boards they can sit on and requires them to offer reasons for their resignation. There are stricter conditions for audit committee’s too- Companies Act requires majority of the members to be independent; Clause 49 increases it to 2/3. To implement this new avatar of Clause 49, corportate India, you have time till October 1st.

In Mumbai, Payaswini Upadhyay

 
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