The Securities and Exchange Board of India has amended, vide Notification dated 9th November, 2021, certain provisions concerning related party transactions as contained in the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (the LODR Regulations). These amendments will come into force from 1st April, 2022, except for certain specific provisions which shall come into effect from 1st April 2023. These amendments are a follow-up to the decisions taken at SEBI’s Board Meeting held on 28th September, 2021. Those decisions, in turn, are partial / modified implementation of the recommendations made by the Working Group constituted by SEBI on related party transactions vide its report dated 22nd January, 2020 (released by SEBI on 27th January, 2020). Let us take a look at these amendments.
BACKGROUND
Related party transactions, generally stated, are specified transactions between a company and certain parties related to it in a manner defined under the relevant law. Related party transactions are a sensitive issue where there is scope of benefit to the company but which also carry serious potential of abuse. Hence, not just company law and securities laws, but even tax and other laws provide for safeguards against abuse in such transactions.
In the case of companies, the concerns are special. The scheme of management of a company is that shareholders appoint a Board of Directors to run the company. While the Board oversees the running of the company and meets regularly to review the progress, lays down strategy, etc., the actual day-to-day running is carried out by full-time employees. Hence, there are layers between the actual owners – the shareholders – and those who run the company. If transactions are carried out between the company and directors / senior management (or entities connected to them), there is obviously a conflict of interest. Steps and controls would have to be laid down in law to ensure that this conflict of interest does not prejudice the company / its shareholders. The matter is further complicated by the fact that, usually, in Indian companies, there is a dominant group of shareholders, referred to as the promoters, who have ownership and management control over the company. Transactions with such promoters (or entities connected to them) would also have a similar conflict of interest which needs to be resolved.
At the same time, considering the manner in which businesses are generally run, related party transactions are unavoidable. Arguably, related party transactions could actually result in more efficiency and other benefits. Hence, related party transactions do not deserve a total ban. Both the Companies Act, 2013 (the Act) and the LODR Regulations have elaborate provisions to regulate related party transactions. As often pointed out earlier in this column, it is unfortunate that both the Act and the LODR Regulations regulate related party transactions in differently worded provisions. Thus, questions such as who are related parties, what is a related party transaction, how should they be regulated, etc., are answered differently by the Act and by the LODR Regulations.
What makes it worse is that SEBI keeps amending and reforming the LODR Regulations at a rapid pace – and thus the gap widens further. While there have been attempts earlier to narrow these differences, these are far from adequate. SEBI has now made some further amendments which we will discuss here. Note that the LODR Regulations apply to companies whose shares (and, in certain cases, debt securities) are listed on stock exchanges.
AMENDMENT TO THE DEFINITION OF RELATED PARTIES
The present definition, inter alia, deems only those members of the promoter group who hold 20% or more of the shares of the company as related parties. This part has been amended and now all members of the group shall be deemed to be related parties. The definition of promoter group itself is quite widely framed. Each of the members of the group, whether holding shares or not, will now be deemed to be a related party (as discussed earlier, with effect from 1st April, 2022).
The definition is amended even further whereby any person holding 20% or more of the equity share capital at any time during the immediately preceding financial year shall be deemed to be a related party. And with effect from 1st April, 2023 this limit will be lowered to 10% for a person to be deemed to be a related party. It appears that SEBI considers a higher, even if non-majority, shareholding a source of influence sufficient enough to consider a person as a related party and thus transactions with such persons requiring to be regulated!
The shareholding of 20% / 10% should be by a person and the concept of ‘group’ or ‘persons acting in concert’ is not made applicable. That said, it is also provided that the 20% equity shareholding (or 10% with effect from 1st April, 2023) may be held by such person directly or on a beneficial interest basis as provided in section 89 of the Act. Section 89, as amended a few years back, now has a more elaborate definition of what constitutes beneficial interest. A concern may arise here. It is stated that the holding may be direct or on a beneficial interest basis. While this results in clarity that transactions with such an entity shall be related party transactions, the question is whether the transactions should be with such beneficial owner or the company. Let’s take an example. In listed company L, a company A holds 25% shares. The beneficial owner in company A, as per section 89, is one Mr. P. Thus, Mr. P would be deemed to be a related party. The question is whether transactions with only Mr. P would be deemed to be a related party transaction and not transactions with the company A?
AMENDMENTS TO DEFINITION OF RELATED PARTY TRANSACTIONS
The present definition considers any transaction involving transfer of resources, services or obligations between a company and a related party as a related party transaction. It is now provided, to simplify things a little, that transactions between the holding company and related parties of its subsidiaries will be related party transactions for the holding company. Similarly, transactions between a subsidiary and the related party of the holding company would also be deemed to be related party transactions.
However, with effect from 1st April, 2023 a further twist is given to this to widen the scope even further. If the effect of any transaction is such that it is for the benefit of any related party as now defined (i.e., related parties of the holding company / subsidiaries), even then it will be deemed to be a related party transaction. While the intention seems to be clear, that is, to cover structuring whereby related parties get the benefits indirectly, the amendment does not give any further guidance as to how does one ascertain that a particular transaction is for the benefit of such newly-deemed related parties? This may create challenges for the Audit Committee and the Board.
The definition is further amended whereby certain transactions are now explicitly excluded. An issue of specified securities on a preferential basis that is in compliance with the SEBI ICDR Regulations will not be a related party transaction. Payment of dividends, bonus or rights issues, buybacks, etc., will not be related
party transactions if they are uniform across all shareholders in proportion to their shareholding. Acceptance of fixed deposits by banks or non-banking financial companies will not be related party transactions if the terms offered are the same as offered to all shareholders / public, provided that disclosure of such transactions is made to the exchanges every six months in the prescribed format.
AMENDMENTS TO PROVISIONS RELATING TO MATERIAL RELATED PARTY TRANSACTIONS
The scheme of the LODR Regulations is that related party transactions above the specified threshold are deemed to be material transactions requiring approval of shareholders. While such thresholds are laid down, the Board of Directors is also required to lay down a policy on materiality of related party transactions and how they should be dealt with, including clear thresholds. At present, a transaction with a related party would be considered as material if it, taken together with previous transactions in the financial year, exceeds 10% of the annual consolidated turnover as per the audited financial statements of the preceding financial year. It is now provided that if the transaction (taken along with earlier transactions in that financial year) exceeds Rs. 1,000 crores, then, too, the transaction will be deemed to be a material transaction. Thus, if the amount crosses 10% of such annual consolidated turnover or Rs. 1,000 crores, whichever is lower, it would be treated as material. This amendment will affect relatively large companies.
The present Regulations provide that related party transactions shall require prior approval of the Audit Committee. An amendment now requires that even ‘subsequent material modifications’ to related party transactions shall require such approval. The Regulations, however, do not define what constitute ‘material modifications’. Instead, the Regulations require the Audit Committee to define this term and make it a part of the policy on materiality of related party transactions.
It is now also provided that a related party transaction to which the subsidiary, and not the holding listed company, is a party and which transaction exceeds 10% of the consolidated turnover as per the preceding financial year’s audited financial statements, then the prior approval of the Audit Committee of the listed company would be required. With effect from 1st April, 2023, this clause will have effect if the value of such transaction exceeds 10% of the standalone turnover of the subsidiary.
The purpose of making a separate category of material related party transactions is to make them subject to approval by shareholders. It is now provided that even material modifications to related party transactions shall require approval of shareholders. Moreover, all approvals of shareholders of related party transactions will now have to be prior approvals.
CONCLUSION
This latest series of amendments to related party transactions seems aimed more towards expanding the scope to ensure that transactions are not structured in a manner that in substance they benefit related parties but in form they do not get caught in the net. The broad structure and scheme, however, remains the same. That is to say, non-material transactions may be approved at the level of the company and material transactions would require approval of the shareholders. Thus, there continues to be no outright ban on related party transactions. Also, no approval of any authority such as the Government or SEBI is required. The approvals remain internal and there are also elaborate disclosure requirements. Thus, stakeholders have a say in and have knowledge of such transactions. (Also refer detailed analysis on Page 26)
