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RPTs: Taking Shareholders For Granted?

Published on Fri, Aug 21,2015 | 22:30, Updated at Mon, Aug 24 at 17:15Source : CNBC-TV18 

Related Party Transactions or RPTs are one of the most widely used ways that controlling shareholders exploit the rights of minority shareholders’. We’re not saying that, OECD is. It is to fix exactly this problem that the Companies Act, 2013 provided, for the first time, that material Related Party Transactions must be put to shareholder vote. SEBI’s Clause 49 on corporate governance followed suit. In a nutshell – listed companies in India have to seek shareholder approval for any related party transaction where the amount exceeds 10% of turnover. The law & regulations seek to empower shareholders, but companies are doing their bit to keep shareholders in the dark. Proxy advisory firm IIAS has identified several shareholder proposals on Related Party Transactions, where amounts and time periods are not specified. Worse still, some companies are seeking blanket approval from their shareholders! Are companies taking shareholders for granted? To discuss that, CNBC TV18’s Menaka Doshi is joined by Amit Tandon of IIAS and Sandeep Parekh of Finsec Law Advisors.

Amit Tandon, Founder & MD, IiAS
Sandeep Parekh, Founder, Finsec Law Advisors

Doshi: I will start with quick opening comments on how in the last year or so since the Companies Act has come into effect, the entire regime around Related Party Transactions (RPTs) has changed. What I want to know is have you witnessed companies showing a degree of more transparency when it comes to Related Party Transactions that they report to shareholders?

Tandon: Let me begin by saying that we do recognise that companies are going to be entering Related Party Transactions and we don’t necessarily believe it is bad. At the end of the day it is an operational decision, company managements need to take it, they need to decide who they want it with. There might be a higher degree of comfort in dealing with a known party or someone who is related rather than dealing with someone who is completely new. However, having said so, our own belief is that now that you have the regulations asking you to put these recommendations or these regulations to vote you might as well then give some more clarity to shareholders when you are seeking their approval.

Doshi: That clarity works in different ways right? For instance and I am not referring to Related Party Transaction but Tata Motors had a run in with shareholders when it came to the remuneration of some of their key managerial personnel. The second time around when they put that to vote by providing more detailed information to their shareholders as to why they were exceeding certain permitted limits they managed to get shareholders on their side. It was about communicating effectively to your shareholders. We have seen Related Party Transactions in the case of for instance, United Spirits or even not yet put to vote but in the case of what went down with Maruti Suzuki and its Gujarat plant where institutional shareholders, public shareholders have stood up and said look we are okay with this, this and this but we are not okay with these Related Party Transactions; a more active regime?

Parekh: Let me take you back to Satyam, the famous board meeting.

Doshi: Maytas?

Parekh: Yes and if you remember the law that time allowed the interested director to sit in the board meeting. The Section 300, 301 of the old act basically said they could not vote at the director level but there were pretty much no other prohibitions. Today OECD has come out with this, India had a huge problem of abusive Related Party Transactions and only a couple of countries have this level of approvals of directors, audit committees and shareholders which is I think good because the fact is that a lot of abusive practices were going on. So, we have come a long way.

Doshi: We are going test whether we really have come a long way.

RPT: Providing services, sharing employees & infrastructure, purchase & sale of goods…
Time Period: Indefinite
Amount: Unspecified

RPT: Purchase/sale of raw materials, finished goods etc…
Time Period: Indefinite
Amount: Unspecified

RPT: Formulation, packaging & distribution agreement
Time Period: Indefinite
Amount: Unspecified

RPT: Formation of bidding consortiums, project execution, investments & borrowings…
Time Period: Indefinite
Amount: Rs 10000 cr

Narration: In May 2015, Goodyear sought shareholder approval for Related Party Transactions with a fellow subsidiary. The transactions cover everything from providing services to sharing employees and infrastructure to purchase and sale of goods. Approval has been sought for an indefinite period of time and for unspecified amounts.

Lumax Auto Technologies doesn’t even bother to describe the various Related Party Transactions it proposes to undertake with Lumax Industries except to say they involve the purchase and sale of raw materials, finished goods, etc. there is no mention of the time period or amount.

Astrazeneca Pharma India has asked shareholders to approve a formulation packaging and distribution agreement with its British parent for again, an indefinite period of time and an unspecified amount.

At IL&FS Transportation, shareholders have been asked to approve Related Party Transactions of up to Rs 10,000 crore per annum with present or future related parties of which about 40 have been listed. In all cases, the ones that I have outlined, IIAS has advised shareholders to vote against these Related Party Transactions.

Doshi: You are calling them blanket approvals and you are absolutely opposed to them?

Tandon: Absolutely. Our way of looking at it is fairly straight forward. Are you giving shareholders some information on which they can vote or are you pretty much saying that let me do what I want to do. So, all these cases fall under the category of let me do what I want to do, I have requirement so I am kind of putting it to vote and after that I will continue to do what I do. So, that is kind of the acid test which we have applied in all these cases and asked shareholders to kind of step back and not support the transactions.

Parekh: My first comment is I think they are egregious communication pieces. Related Party Transactions in most of these transactions which we are looking at, they are kind of critical and important part of doing business.

Doshi: Are such blanket approvals permitted because from what the Companies Act says, you can take approval only for a year if I have got that correctly?

Tandon: That is right. It says omnibus resolutions are valid for a year.

Parekh: Let me explain that. I read all these things pretty carefully including the Companies Act and my sense is they are all within the law. I will explain why. The reason is that the omnibus limitation of one year applies only to the audit committee which is why there is no restriction on shareholders giving five years or ten years blanket approval.

Doshi: Or even open ended according to you because some of these are open ended. There is no kill date to them.

Parekh: That is what the legal provision is and that is how these people are reading it. Let me supplement it. Section 188 of Companies Act gives a blanket exemption for ordinary course of business arm’s length transaction.

Doshi: And Clause 49 overrides that.

Parekh: I have seen these six transactions which I saw today, each one of them says that Section 188 does not apply to us because these are at arm’s length. They are complying with Clause 49 which is two parts. The first part is audit committee which says you cannot give blanket approval except audit committee cannot give for more than one year. It is silent about whether shareholders can give for more than one year which is what they are exploiting. The second thing which is happening here is what I said earlier, it is just really awful communication.

Tandon: If you look at it, a couple of these companies are multinationals and if anyone who has worked at a multinational will tell you the senior management spends all their time filling in excel sheets on a month-to-month (M-o-M) and a quarter-to-quarter (Q-o-Q) basis so there is no reason why at least a basic minimum information can’t be provided. You could say that last year we have entered such transactions aggregating about 900 million, this year, other things being the same it could be a little higher or a little bit lower but even that little bit of communication is not being made to shareholders.

Doshi: There are three things I want to say in defense of these companies especially because the companies are not here. Firstly, the provisions that Goodyear put to vote or the resolution that they have put to vote have received the requisite approval and more so the ones that have been voted on have sailed through to that extent, so let me put that out.

Tandon: Let me just come back on Goodyear. There was quite a of engagement between a set of shareholders and the company and then what the company then said was they will have a meeting saying that if there are any changes from the existing arrangement because the shareholders were happy with the exiting arrangements, we will come to shareholders to vote which has given shareholders some comfort.

Doshi: Equally many of these companies including Goodyear have said the contract is available for you to go and look at, at our registered office. Now, I will admit not too many shareholders are going to go to the company’s registered office to look at the contract, the details of which are missing maybe in the communication to shareholders because it is way too bulky I could imagine but if you were one of those shareholders who wanted to question them you could go to the registered office and seek a copy of the contract and look through it and then raise any issues if you may have.

Tandon: You could do that but at the end of the day it is so much easier now with technology for companies being able to at least – I understand you could turn around and say it has got commercial implications for me but you could share a little bit more than what you have done.

Doshi: One final piece of defense and that specifically has to do with IL&FS Transportation and other infrastructure companies like it. They have made the effort in their explanatory statement to explain how in the infrastructure business you need to create so many special purpose vehicles (SPVs), here is how the SPV does business or transactions with the parent, here is what the parent provides for the SPV, here is what infrastructure agreements and bid contracts, etc require, therefore we undertake all these RPTs but we are capping it at Rs 10,000 crore when we are asking you for your approval. The current list of RPTs we have which are 40, we have listed all of them but we can’t tell you which future ones will have to be created depending on the bids we enter into in the course of the year and hence those will have to be added on to this. That seems like a fair explanation, doesn’t it?

Tandon: Yes, they have laid out a rationale but at the end of the day it is both present and future, we don’t know what they will create, what they will do. So, therefore all I am saying is it is a little bit of the same mould as let me do what I want to do.

Parekh: The broad picture has to be that if they are not abusive, we should let the boards take course.

Doshi: You don’t agree with the voting action that IIAS has recommended in many of these?

Parekh: Not necessarily but I do agree that all of them are kind of wanting in terms of communication.

RPTs: Upto Rs 97.5 cr
Revenue: Rs 215 cr
Profit: Rs 18 cr

RPTs: Rs  2.7 cr
Revenue: Rs 614 cr
Profit: Rs 4 cr

RPTs: Upto Rs 1100 cr (2 years)
Revenue: Rs 385 cr
Profit: Rs 49 cr

Narration: Earlier this year SQS India BFSI sought and received shareholder approval for availing and rendering of services with its foreign parent of up to Rs 97.5 crore each, that is just about half the total income of the company which is Rs 215 crore – that is what it earned last year and the time period in this contract, unspecified.

Action Construction Equipment (ACE) sought and received approval for a Related Party Transactions including the transfer of about Rs 1.75 crore to its CSR fund, its profit for FY14, just for the record was Rs 4 crore.

Igarashi Motors India whose revenue for FY15 was Rs 385 crore proposed Related Party Transactions of up to Rs 1,100 crore for two years that is up to March 2016 even though all public shareholders and 73 percent of institutional shareholders voted against the RPT proposal at Igarashi, the promoter votes ensured its passage. Again on all three counts IIAS has expressed concern regarding the quantum of the Related Party Transactions and hence recommended voting against them.

Doshi: Your only problem here is that the amounts in many cases seem like half of total income or exceeding total income as pointed out in the Igarashi matter.

Tandon: It is radically high so you might not as well come to shareholders to ask for it. It has to have some linkage with the existing size of operations.

Parekh: Igarashi I am not commenting on because they are my clients. However, the broad principle is that it is coming to shareholders only because it is material. Many times 50-70 percent of turnover but if it was below 10 percent it would not even come to shareholders. So, that is the legal requirement really.

Doshi: In the case of SQS, in the case ACE this got approved by shareholders. In the case of Igarashi all public shareholders voted against the Related Party Transactions. 73 percent of institutional shareholders voted against the Related Party Transactions but because they make up for a very small percentage of the shareholding and the promoter interestingly voted in this transaction obviously in favour of the RPTs, the proposal is passed or the resolution passed. So that is a slightly bit of an outlier.

Tandon: We are not sure what the scrutiniser has done in this case, what the regulators and what the exchanges are doing but at the end of the day the question we have asked the company is how did the promoter get to vote on something which is clearly proposed as a Related Party Transaction; they cannot.

Doshi: IIAS has asked the question are companies taking shareholders for granted in doing what they have as I have illustrated with many Related Party Transaction resolutions. Would you say they are taking shareholders for granted?

Parekh: I would say somewhat. Number one, communication which I have been talking again and again about and second is they have acted a bit cute with the fact that the if the Companies Act does not invoke because it is supposed to be at arm’s length. All six of the ones which I saw were all at arm’s length and therefore all of them said Section 188 does not apply to us, Companies Act does not apply to us and all of them are fulfilling the Clause 49 requirement which curiously has very strict standards for the audit committee but has no requirement for what has to be disclosed to the shareholders in the notice which is where the cuteness is coming from.

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