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New Clause 49: Top 5 Amendments!

Published on Mon, Sep 22,2014 | 07:39, Updated at Mon, Sep 22 at 07:39Source : CNBC-TV18 |   Watch Video :

The new Clause 49 governance provisions were prompted by the Companies Act, 2013 but go further to impose more stringent conditions for director rotation, related party transactions and the like. Days before it comes into effect the new Clause 49 has been amended by SEBI. Payaswini Upadhyay reports on the top 5 amendments.  

Generally speaking, the amendments to Clause 49 bring it in line with Companies Act, 2013 provisions except in one case. The proviso to Section 188 in the Act implies that no related party can vote on any related party transaction, even if that particular related party is unconnected to that specific transaction. MCA clarified this in July by saying only the concerned related party must abstain from voting. But SEBI's amended Clause 49 has done the opposite - saying all related parties must abstain from voting on all RPTs, even if the related party is unconnected to that transaction.

New Clause 49 Amended!
RPTs: Who Can Vote?

Companies Act, 2013
•    Section 188 Proviso: No related party can vote on RPT related special resolution
•    July Circular: Only related party connected to RPT cannot vote on special resolution

Amended Clause 49
•    All related parties must abstain from voting even if unrelated to the transaction  

Ashwath Rau
Partner, Amarchand Mangaldas
“The SEBI Circular is a step in the right direction in terms of plugging the gap but I also believe they have gone too far because the ideal position should be the SEBI definition coupled with the MCA transaction clarification because as long as you have a wide enough definition of related party- I think the spirit here is to ensure that the entire group of people who are related in the context of a particular transaction should not be permitted to vote on that transaction; not say that even if the party benefitting from the contract has no correlation to another party who vis-à-vis the company qualifies as a related party, then that party too as per current SEBI rules effectively prevented from voting. So to take a very loose example- if you have a Tata and a Birla who hold shares in an entity and each are separately related parties vis-à-vis- that particular entity, certainly Tata and Tata group entities should not vote in a contract between that company and a Tata Group entity but what is the logic in keeping out a Birla. I think a purposive interpretation should permit a Birla to vote.”

In the second important change, SEBI has diluted its definition of related party. Its April Circular went beyond the company law definition to include 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. The amended definition now covers relations as per the Companies Act and Accounting Standards.

New Clause 49 Amended!
Related Party: Definition Diluted

April Circular

- 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


New Clause 49 Amended!
Related Party: Definition Diluted

- Amended Circular

- Companies Act definition
              +
- Accounting Standards Definition

Vishesh Chandiok
National Managing Partner, Grant Thornton India
“Ideally, in my opinion, both the Companies Act 2013 as well as Clause 49 should have stayed out of trying to define related party and the coverage when there is an entire accounting standard on that subject. The MCA is responsible for setting the Accounting Standards applicable to companies anyway; so they have the ability to influence those Standards and I think the multiplicity of definitions leads to dis-harmonization of laws. I think it’s a good step to harmonize laws.”

The third important change regarding RPTs relates to the materiality thresholds. In its April circular, SEBI defined material to include transaction exceeding 5% of annual turnover or 20% of networth; whichever is higher. Only transactions exceeding these thresholds required approval via a special resolution, in which related parties cannot vote. But SEBI has now removed the networth threshold and increased the turnover threshold to 10%.

New Clause 49 Amended!
‘Materiality’ Redefined

April Circular
•    Material: Transactions exceeding 5% of annual turnover or 20% of networth; whichever is higher

Amended Circular
•    Material: Transactions exceeding 10% of annual turnover  

Vishesh Chandiok
National Managing Partner, Grant Thornton India
“It should lead to lesser number of transactions going to shareholders for approval. But the question behind it is – is that such a bad thing? My view on that is No; too much information is also not good because you can miss what I material and what is important to look at. And therefore when you enhance the threshold from 5%-10%, one would think that lesser number of transactions would go to shareholders and I agree with that view. Shareholder approval is a cumbersome, time consuming process and it should only be sought in those extreme circumstances and one would agree with making it simpler.”

Ashwath Rau
Partner, Amarchand Mangaldas
“On the face of it, 5% looks lot lower than 10%- so it looks like lot more flexibility to companies by limiting the number of transactions that need to go to the shareholders. But when you look at it in the context of the April Circular which had 5% of turnover or 20% of networth whichever was higher, 20% of networth to my mind in most companies – not necessarily all- is likely to be a significantly larger sum than 10% of turnover. So in that sense this is a reduction in the threshold rather than increase.”

The fourth important amendment relates to Independent Directors and Boards. In a departure from the Companies Act, 2013 - SEBI’s April Circular said an Independent Director who has already served on a company’s board for 5 years can serve only one more term of 5 years. SEBI has NOW eased this requirement and brought it in line with the Companies Act that gives independent directors 2 terms of 5 years each starting April 2014.
 
The definition of Independent has also been amended. SEBI’s April Circular gave a wide meaning to it to say that a person who has or had a pecuniary relationship with the company, its subsidiary, associate, promoters, directors etc will not be considered as independent. SEBI has now amended this to say that there should not be any material pecuniary relationship. But what is material has not been defined.

New Clause 49 Amended!
Independent Directors: Tenure

April Circular: One more term of 5 years if 5 year term already served
Companies Act, 2013: 5years + 5 years + 3years cooling off
Amended Circular: Tenure aligned as per Companies Act, 2013

New Clause 49 Amended!
Independent Directors: Definition

April Circular
•    No pecuniary relationship with company, its subsidiary, associate, promoter, directors etc

Amended Circular
•    No material pecuniary relationship with company, its subsidiary, associate, promoter, directors etc

Ashwath Rau
Partner, Amarchand Mangaldas
“If one were to look at it purely conceptually, is there a benefit on account of there being a materiality threshold under the Listing Agreement when its not there under the Companies Act- there is. The Companies Act has a requirement of 1/3rd of Board to be independent whereas the Listing Agreement says if you have an Executive Chairman – that one-third jumps to half the Board. To satisfy the incremental requirement between 1/3rd and half, a person who may have a pecuniary relationship outside of his remuneration could qualify as an independent director under the Listing Agreement. The interpretation issue is going to be what is material.”

Eki Kshirsagar
Independent Director, Tata Chemicals, Rallis India, Merck…
“Material is defined under various Accounting Standards. The new Companies Act – I think in Section 149(d)- gives you levels of 2% or Rs 50 lakhs or more – that gives you guidance. If you say it needs to be defined, then you have to go and ask them. But to my mind, let it be open ended. And sometimes even an immaterial relationship can prove difficult.”

The fifth amendment brings good news for schemes. SEBI’s April Circular laid down a special resolution requirement for divestments in material subsidiaries and sale, disposal and lease of assets that amount to more than 20% of the assets of the material subsidiary. The amended Clause 49 has done away with the special resolution requirement if the scheme has been approved by the court.

Interestingly, there is another SEBI Circular on schemes of arrangements from May last year that assumes importance here. It said that all schemes with related parties must be approved by the majority of minority shareholders.

This begs the question- if a scheme is undertaken with a related party, will the amended Clause 49 apply or SEBI’s May Circular?

New Clause 49 Amended!
Carve Out For Schemes

April Circular: Special Resolution Required For
•    Divestment in material subsidiary
•    Sale/lease/disposal of assets amounting to more than 20% of material subsidiary’s assets

Amended Circular: No Special Resolution Required For
•    Court approved divestment in material subsidiary
•    Court approved sale/lease/disposal of assets amounting to more than 20% of material subsidiary’s assets

May 2013: SEBI’s Circular On Schemes
•    Majority of minority to approve schemes of arrangements with related parties

Ashwath Rau
Partner, Amarchand Mangaldas
“To my mind, it should be the majority of the minority simply because this is a generic related party transaction circular whereas the old SEBI Circular in 2013 is specific to related party mergers and court based schemes. So I would think specific prevails over generic.”

The last key amendment brings good news for Audit Committees. SEBI’s April Circular mandated prior Audit Committee approval for all RPTs. The regulator has now enabled Audit Committees to grant an omnibus approval for RPTs that the company intends to enter into- there are of course time and value thresholds to these approvals. Overall, the amended Clause 49 is a dilution of the April Circular at some places and alignment with the Companies Act at others. Whether it has been able to strike a balance between the requirements of companies and minority shareholders’ interests- we’ll know better once the Clause goes live on October 1st.

In Mumbai, Payaswini Upadhyay

 
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