Related Party Transactions

In the modern day regime of the Companies Act, 2013 the legislature has shown its intent to move towards stricter governance norms for the corporations and lay down stringent norms for the way they conduct their business.

Even the industry regulators such as SEBI and IRDA have moved forward in this direction and have laid down different regulations/Guidelines, which mandate stricter governance and ethical norms for the companies to conduct their business, especially when it comes to Related Party Transactions..

One such area where the new statutory and regulatory regime has sought to bring in focus is ‘Related Party Transactions’. The Companies Act, 2013 through Section 188 and the Regulators in the form of Clause 49 of the Equity Listing Agreements and the IRDA Governance Guidelines for Insurance Companies, has come out with certain requirements which try and bring about better governance when the Companies get involved into related party transactions.

In the coming paragraphs of this work, I will try to put my thoughts on certain important aspects of the Related Party Transactions.

The provisions of Section 2(76) define the term ‘Related Party’ and broadly includes director or his relatives, Key Managerial Person (KMP), Firm in which director, KMP or his relative is a partner, private company in which any of these three are director and/or member, public companies in which they are either member or hold (together with relatives) more than 2% paid-up share capital, any body corporate whose directors, MD or manager act in accordance with directions of such directors, KMP or their relatives and the Holding/Subsidiary or associate Companies etc.

The said definition of the related party is much broader in its scope and clarity as compared to the one prescribed under the Accounting Standard 18, in as much as the later focuses on the aspect of ‘significant influence’, whereas the Companies Act, 2013 clearly defines the exact nature of relationships which will fall under the ambit of related party.

Having understood the broad definition of the term ‘related party’, the provisions of section 188 of the Companies Act, 2013 mandate the dos and don’ts while getting into a related party transaction.

The provisions of Section 188 provide that no company shall enter into a contract or agreement with a related party, without the consent of the Board of Directors given by a resolution.

The nature of agreements and contracts as prescribed under the said section are:

• Sale, purchase or supply of any goods/material;
• Selling and/or disposing or buying property (any kind);
• Leasing of property of any kind;
• Availing or rendering any services;
• Appointing of any agent for aforementioned purposes;
• Appointment of related party to office of profit;
• Underwriting the subscription of any securities or derivatives of the Company

The section further mandates approval of the Shareholders in a general meeting through a special resolution, if the paid up share capital of the Company is more than as prescribed (10 Crores) under the Rules framed under the Act or the value of such transaction is exceeding the limits prescribed under the said rules.

  

The section, however, excludes transactions entered in the ordinary course business other than those which are not on an ‘arm’s length’ basis.

Terms arm’s length is defined as a transaction entered into by the related parties as if they were unrelated so that there is no conflict of interest.

From the above brief discussion a sequence of events in the following order would be required to be followed by the Companies while they are proposing to enter into any transaction that may fall within the ambit of ‘related party transaction’.

The IRDA on the other hand mandates disclosure of all related party transaction in L-30 in accordance with the AS-18 under the auspices of Corporate Governance Guidelines and the Regulations on preparation of Financial Statements.

The Act also prescribes certain deterrents in the form of contracts with related parties being voidable at the option of the board, indemnification by interested directors and penalties of up to 25 lakhs in unlisted companies and jail term of up to one year in case of listed companies.    

Section 177 of the Companies Act, 2013 also makes a mention of the ‘Related Party Transactions’, but that is more in the form of rights of the Audit Committee to review certain things which have been put up before it by the Board of the Company.

While reading on the subject, I have come across opinions where Approval of Audit Committee of the board, has been mentioned as the minimum requirement for any RELATED PARTY TRANSACTIONS to be taken up by the Company.

However, I am of the view that the Audit committee, by its very constituents, is an independent body, which is meant to review and opine on wide range of issues, including but not limited to related party transaction, for the sake of better governance. Any thought of approval of any transaction by audit committee would translate into the audit committee becoming an interested party, which is against the very intent of the legislature.

In my view, therefore, before getting into any RELATED PARTY TRANSACTION the Companies need to ensure the following:

·         The transaction is in ordinary course of business and is at Arm’s length;

·    To demonstrate the above it needs to have ready information e.g. comparative pricing, type of services rendered, cost benefit analysis to justify the transaction, to name a few;

·         Alternatively seek prior approval of the board and shareholders (if any required).

In a nutshell the new Act lays down huge importance on the fact that, in the modern day era of diversification, while utilization of resources and capabilities within the same group companies may help saving on costs and optimization of resources, any misuse of related party transaction may lead to loss to the stakeholders.

In coming days I would also try and put some effort on analyzing Clause 49 requirements for the Related Party Transactions, which are important for the listed companies.

Views, Opinions, discussions are welcome....