Related Party Transactions and Minority Rights – Part 1

Related party transactions (RPTs) that treat shareholders inequitably or oppress minority tend to damage capital market integrity. Therefore, RPT’s covering both equity and non-equity transactions, is an important corporate governance and regulatory issue, dogging the mind of the government. Some inter-company transactions with 100 per cent owned subsidiaries might present no great threat of abuse but others where a company has controlling and minority shareholders, RPT’s can cause significant concern. Around the world, group structures and concentrated ownership are normal, the exceptions being the United Kingdom, United States and Australia. Executive compensation is a key concern in certain jurisdictions, particularly the United States and this is accompanied by the threat of financial statement manipulation done in order to retain the job or maximise compensation.

Every jurisdiction has over a period of time developed its own mechanism to minimise the abuse of RPT’s, though there is wide variability in their respective approach. At times, RPT’s can be economically beneficial and necessary. Therefore, with some exceptions such as loans to directors, RPTs are rarely banned, in most jurisdictions. But there is a clear concern globally that such transactions can be abused by insiders such as executives and controlling shareholders and hence need to be regulated or monitored. Searching for the right balance is a difficult but ongoing process which keeps changing as institutions and economies change.

There are a number of empirical studies focusing on the relation between the corporation valuation and cash-flow ownership or control-ownership wedge. A controlling shareholder often has control of a listed company but with very few claims on its cash flows. This creates an incentive to use RPTs to transfer cash to companies in which their rights are greater. The empirical studies conclude that in general cash-flow ownership and control-ownership wedge is associated with lower firm value. Another study shows that the cost of debt financing is significantly higher for such companies.

Extent of RPT’s in India1

In India, there has been a tradition of operating through several companies. The genesis of a multigroup organisation could be traced to the licensing requirements, labour laws, FDI regulations, financial structuring, joint ventures, tax planning, etc. For example, because FDI is prohibited in e-retailing, a local structured entity is set up to operate at a break-even level on behalf of the investors; and the profits are retained in the wholesale entity. Subsidiaries are quite common in the case of real estate companies, as they are the means of owning a land bank. Whilst there are multiple reasons for group structures and transactions between them, some of which are absolutely necessary for various reasons there is no denying that group structures have also been used to create inequitable treatment of minority shareholders by the controlling shareholders.

India is characterised by concentrated ownership and by the widespread use of company groups, often in the form of pyramids in many different activities and companies and with a number of levels. One study of the 1470 companies listed on the NSE indicated that as of March 2010 controlling shareholders (i.e. promoters) held 57 per cent of all shares and institutional shareholders about 20 per cent (Bhardwaj, 2011). One study (Balasubramanian et al., 2009) of 300 companies indicated that 142 included a shareholder with an ownership stake higher than 50 per cent. A further 100 included a shareholder holding 30-50 per cent of the equity. The actual holdings are likely to be more since holdings are often hidden in other corporate bodies in a pyramid structure or in benami names.

Ownership of Indian listed companies

1The statistical information is sourced from the OECD report Related Party Transactions and Minority Shareholder Rights Of the firms sampled by Balasubramanian et al. (2009), 165 of them (a little over a half) are part of an Indian business group which includes one or more other public firms. Another study states that in 2006, 2922 companies were affiliated with 560 Indian owned groups, a predominant majority of these identified with specific families (Sarkar, 2010, p. 299).

Concentrated ownership and group company structures are associated with a particular structure of boards. One study found that 40 per cent of Indian companies had a promoter on the board and in over 30 per cent of cases they also served as an executive director (Chakrabarti et al., 2008, p. 17). Executives of one group company often serve on the boards of other group companies as outside directors. Potentially concerning, Sarkar reports that independent directors are also related to company groups, with about 67 per cent of their directorships in group affiliates, and notably 43 per cent of directorships concentrated within a single group.

Some studies suggest that RPTs have been detriment to the interest of minority shareholders and to valuations of those companies. Using a sample of 600 of the 1000 largest (by revenues) listed companies in 2004, one study found that firm performance is negatively associated with the extent of RPTs for group firms (Chakrabarti et al., 2008).

It is clear that the structure and ownership of Indian listed companies creates incentives that, is conducive to RPT’s. This could result in short changing the minority and compromising their rights. Therefore, it has to be balanced by corporate governance arrangements, company law, financial regulations and regulatory environment.

An Expert Committee (popularly known as JJ Irani Committee) to advise the Government of India on the new Company Law was set up by the Ministry of Company Affairs vide Order dated 2nd December, 2004. This eventually culminated in the Companies Bill, which at the time of writing this article has been passed by the Lok Sabha and is awaiting passing at the Rajya Sabha and the final assent of the President of India. The Companies Bill contains significant provisions to regulate RPT’s, many of which are discussed in this article. Clause 49 of the listing agreement contains SEBI’s corporate governance norms which includes matters relating to RPT’s though they are not as comprehensive as the Companies Bill.

Who is a related party?

One of the biggest challenges in regulating RPT’s is defining a related party. A related party obviously is someone with whom there is a special relationship. Transactions are entered into with the related party which may not be at arm’s length, and causes gain to the controlling shareholders and loss to the minority shareholders. Whilst a spouse is a related party, a close friend is not a related party under the Companies Act. Marriage is a legal relationship and hence easy to prove, friendship is not a legally solemnized relationship and hence difficult to prove. Obviously such differences create challenges in defining a related party. In India, there is a tradition of extended families unlike in the West. Therefore typically in the western countries a spouse and dependent children are relatives, but in India the regulators have taken a more form based approach to define relatives and have specified innumerable relationship. In the western countries, many would not know who their daughters son’s wife is; but under Indian legislation the law would treat them as relatives.

A comparison of the related party definitions under Companies Bill, Companies Act and Accounting Standards is provided in Annexure 1. The related parties have been far more extensively defined under the Companies Bill. The Companies Bill includes as related parties key managerial persons, holding-subsidiary relationship, etc which were not hitherto covered under the Companies Act. However, all three, i.e., the Companies Act, Companies Bill and AS-18 Related Party Disclosures have deficiencies in the way related parties are defined.

Example 1 & 2 explain the deficiencies in the AS-18 definition of related parties, whereas Example 3 explains the deficiencies in the Companies Bill definition.

Which RPT’s are covered?The Companies Bill like the Companies Act contains restrictions over both equity and non equity RPT’s. The non equity transactions covered under the Companies Bill are far more comprehensive than the Companies Act and practically covers almost all transactions (see Annexure 1). The BOD has to consent to the RPT’s under both the Companies Act and the Bill. The Companies Bill specifically casts a duty on independent directors to ensure that adequate deliberations are held before approving RPT’s and assure themselves that the same are in the interest of the company.

Materiality thresholds are clearly necessary in establishing an efficient management regime for RPTs. Care needs to be taken to ensure that a material transaction does not escape regulation by breaking it into a transaction of several small amounts. Under the Bill the requirements to obtain a special resolution apply to a company whose paid up capital or the RPT value is beyond a threshold amount. Those thresholds will be prescribed by the rules, which are not yet exposed/published. U/s. 297 of the Companies Act, a company with a paid up share capital of not less than Rs 1 crore, was required to take previous approval of the Central Government.

The requirement of section 297 of the Companies Act does not apply to purchase/sales which were made by cash at prevailing market prices. Similarly, clause 188 of the Companies Bill does not require a company to take a special resolution of non related parties on a RPT, if that transaction was entered into in the ordinary course of business and was at arm’s length. It is not clear when a transaction would be not in the ordinary course of business. Given that the Bill was heavily influenced by what happened in the case of Satyam, an example of a transaction not in the ordinary course of business may probably be the proposed transaction of acquisition of Maytas by Satyam, i.e. acquisition of a real estate company by a software company.

Given that a special resolution of disinterested parties is required only when a transaction is not at arm’s length; there would be considerable pressure on how the term arms length is interpreted. It is defined under the Bill as “arm’s length transaction is a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest.” The Indian Income-tax Act also contains a somewhat similar definition. However, there are too many questions around what is an arm’s length price. Who will judge what is an arm’s length price? Can the arm’s length price determined under Indian Income-tax Act be applied for Company Law purposes as well? What if the income-tax assessing officer disallows the arm’s length price determined by the company (for which it had not taken a special resolution of disinterested parties) – would that mean that the company has not complied with the requirements of the Bill? What if a continuing royalty arrangement was approved by the Central Government u/s. 297 of the Companies Act – would that need a special resolution of the AGM on the Bill being enacted? The Ministry of Corporate Affairs will need to provide guidance on these issues.

The Companies Bill also imposes significant restriction on equity related RPT’s. These are briefly described below and are set out in greater detail in Annexure 1:

•    Loans/guarantees to directors and connected persons are prohibited both under the Companies Act and the Bill. However, u/s. 295 of the Companies Act, loans/guarantees can be extended to directors and connected persons by obtaining Central Government approval. Under clause 185 of the Companies Bill, loans/guarantees can be extended to directors/connected persons only in limited circumstances such as when it is pursuant to a scheme applicable to employees or in the case of companies whose business is to extend loans.

•    Loans and investments under both the Companies Act and the Companies Bill are subjected to overall limits of 60% of paid up share capital, free reserves and securities premium or 100% of free reserves and securities premium. Under the Companies Act any loan made by a holding company to its wholly owned subsidiary is exempt. The Companies Bill does not provide that exemption.

•    The Companies Bill contains restrictions on non-cash transactions involving directors. The Companies Act does not contain similar restrictions.

•    The Companies Act and the Companies Bill contain several provisions protecting minority rights, though there are slight differences in the two legislations. The important provisions are on changing shareholder’s rights, appointment of directors by small shareholders, the requirement to have a nomination and remuneration committee and stakeholders committee, restriction on managerial remuneration and prevention of oppression and mismanagement.

•    The Companies Bill imposes more elaborate responsibilities and duties on audit committees and independent directors.

•    The Companies Bill provides the acquirer with powers to acquire shares of dissenting minority shareholders in a scheme of merger/amalgamation at a price determined by a registered valuer. The Companies Act also contains similar requirements, except that there is no specific provision for price to be determined by a registered valuer.Numerous provisions of SEBI are also designed to protect the interest of minority shareholders. One such example is the open offer requirement in the takeover code to provide a reasonable exit option to minority shareholders.

Related Party Disclosures

AS 18 requires significant disclosures to be made in the financial statements with respect to RPT’s. AS 18, among other matters, requires disclosure of “any other elements of the RPT’s necessary for an understanding of the financial statements.” An example of such a disclosure is an indication that the transfer of a major asset had taken place at an amount materially different from that obtainable on normal commercial terms. However, this disclosure is rarely made.

The Companies Bill requires disclosure in the BOD’s report of contracts/arrangements with related parties. The report will also disclose justification for entering into such transactions. These disclosure requirements are not contained in the existing Companies Act. It may be noted that the disclosure requirements under AS-18 and the Companies Bill would be overlapping, but there are some significant differences. Firstly, there are differences in the definition of related parties between AS-18 and the Companies Bill. Secondly, AS-18 does not require to disclose justification for entering into RPT’s; the Companies Bill requires such a disclosure. AS-18 disclosures are made in the financial statements, whereas the Companies Bill disclosures are required in the BOD’s report. Finally, AS-18 allows aggregation of disclosures, the Companies Bill does not allow aggregation of disclosures.

The Companies Bill requires disclosure to the members in the financial statements of the full particulars of loans given, investments made or guarantee given or security provided and the purpose for which the loan or guarantee or security is proposed to be utilised by the recipient of the loan or guarantee or security. No such requirement exists under the Companies Act. The Companies Bill also requires every listed company to disclose in the BOD’s report, the ratio of the remuneration of each director to the median employee’s remuneration and such other details as may be prescribed. These disclosure requirements did not exist under the Companies Act. Post the Satyam episode, SEBI reacted with, inter alia, new rules in February 2009 requiring greater disclosure of the promoter shareholdings and any pledging of shares to third parties. Those disclosures were found to be very useful by investors and analysts. SEBI also requires promoters to make disclosures of changes in their shareholdings to the stock exchanges.

The Duty of the Controlling Shareholders

In some jurisdictions a controlling shareholder has a fiduciary duty to other shareholders and the company. An abusive RPT would be against the interests of non-controlling shareholders and thus represent a breach of duty. A key feature in many jurisdictions is the duty of controlling shareholders to other shareholders not to infringe the minority rights. Such a duty opens another legal way of disciplining RPTs. There is an oppression remedy in India with 447 cases lodged in 2011/12. However, the process appears to be quite long with 1170 cases pending as at 31st March 2012.The Role of Board of Director’s and Audit Committees

Many jurisdictions require BOD’s, particularly an independent committee to play a significant role in minimizing the abuse of RPT’s. An important aspect of the Corporate Governance framework in India concerning RPT’s is Clause 49 issued by SEBI. With respect to RPTs, it contains the following requirements:

•    Audit committees shall review annual financial statements (before submission to the board for approval) with particular reference to several factors, one of which is disclosure of RPTs.

•    Audit committees shall also review, on a more general basis, any statements of “significant RPTs (as defined by the audit committee) submitted by management”.

•    Listed companies must periodically give their audit committees a summary statement of “transactions with related parties in the ordinary course of business” as well as details of “material individual (related) transactions that are ‘not in the normal course of business’ or not done on an arm’s length basis (‘together with management’s justification for the same’)”.

•    For subsidiaries, a significant transactions report must be given to the holding company’s board along with the board minutes of the subsidiary.

•    A quarterly compliance report on corporate governance is required to be submitted to stock exchanges. One element of this disclosure is the basis of RPT’s. Companies must also include a section on corporate governance in their annual reports and it is suggested that they include “disclosures on materially significant RPT’s that may have potential conflicts with the interests of the company at large”.

In this regard, the Companies Bill is more stricter and requires pre-approval by audit committee of RPT’s. The Companies Bill requires the Audit Committee to approve or modify transactions with related parties and scrutinize inter-corporate loans and investments. Further, the Companies Bill gives Audit Committee the authority to investigate into any matter falling under its domain and the power to obtain professional advice from external sources and have full access to information contained in the records of the company.

There are some safeguards for independent directors in the form of numbers. Thus, in India, 50 per cent will be independent directors if the chairman is an executive director or a representative of the controlling shareholder; otherwise it is a third. There is also at least one independent director from any holding company on the board of a material non-listed subsidiary. Another protection of independence is via the nomination and election of board members.

Director liability is often put forward as a means of ensuring that directors and especially independents fulfil their duties. The case of Satyam in India indicates that liability is, nevertheless still important. The scandal has been a shock for independent directors, with many resignations in the following year as they reassessed their liability and damage to reputations. Indeed, liability is sometimes the least important sanction. In Belgium, France and Israel, it is reported that independent directors are very concerned about their reputations.

The Companies Bill contains numerous penalties on directors, and is more onerous than the Companies Act. For example, with respect to RPT’s, it will be open to the company to proceed against a director or any other employee who had entered into such contract or arrangement in contravention of the requirements for recovery of any loss sustained by it as a result of such contract or arrangement. This disgorgement provision was not contained in the Companies Act. Violating the requirements of clause 188 of the Companies Bill could also land the director in jail for a period of one year. Similarly violating the requirements of clause 186 with regards to loan and investment could land the director in prison for two years. However with respect to independent director’s liability, the Bill is far from clear.

Clause 149(12) of the Companies Bill clarifies that independent directors and other non executive directors shall be liable only in respect of such acts of omission or commission by a company that had occurred with his or her knowledge, attributable through Board processes, and with the consent or connivance or where he or she had not acted diligently. From this it appears that the clause seeks to provide immunity to independent director’s from civil or criminal action in certain cases. However clause 166(2) of the Bill seems to be a contradiction. It states that the whole Board is required to act in good faith in order to promote the objects of the company for the benefit of its members as a whole and in the best interest of the company, its employees and shareholders, the community, and for the protection of the environment. This clause narrows the distinction between independent directors and executive directors and also extends the responsibility of the directors to protecting the environment and taking care of the community.

The importance of independent board members around the world in approving RPTs does raise questions whether independent directors are really independent. Whether an independent director is likely to stand against policy determined on a group basis by the very shareholders who have often elected them? Particularly in India independent directors see themselves as advisors to controlling shareholders rather than as watchdogs who will ensure equitable treatment of all shareholders. If controlling shareholders cease to be pleased with the efforts of an independent director, such a director can be certain that his or her term will not be renewed. Most investors would not regard independent directors as effective in India, particularly in the case of family owned companies.

The ability of small shareholders to appoint a director of their choice under the Indian Companies Act (and the Companies Bill) has been ineffective in dealing with the issue of providing adequate representation to small shareholders. This is because small shareholders have not been able to galvanise themselves to appoint the director. In any case, a single director appointed by small shareholders on a large board is generally rendered useless.The role of Minority shareholders

Taking shareholders approval is a universal practice with regard to equity RPTs but less common for non-equity transactions. However, clearly in the context of concentrated ownership voting per se is not enough. Thus Italy and Israel and to some extent, on an ex post basis, France, call for approval only by disinterested shareholders, i.e. the majority of the minority. Israel has also had to recognise another necessary policy trade-off. Where there is a small free float there is always a possibility of hold-up by some minority shareholders who can abuse their position.

Given that independent directors may not be successful or only partially successful in minimizing the abuse of RPT’s, two other options were considered by the JJ Irani Committee. The JJ Irani Committee deliberated on whether transactions/contracts in which the company or directors or their relatives are interested should be regulated through a “Government Approval-based regime” as is the case under the prevailing Act or through a “Shareholder Approval and Disclosure-based regime”. The Committee looked into international practices in this regard and felt that the latter approach would be appropriate in the future Indian context. SEBI felt that whilst the shareholder approval was a good way of allowing each company to decide for themselves, a majority shareholder could easily pass a resolution in favour of the resolution. At the recommendation of SEBI, the Companies Bill was drafted to require a special resolution of the company in which the related party would not be allowed to vote. Whilst this addressed the issue of oppression of the minority by the majority, concerns were raised of potential “hold ups” which we discuss in the following paragraphs.

Oppression of Majority by Minority

In late 2004, KarstadrQuelle, Germany’s largest department-store operator, risked bankruptcy without an increase in capital. The crisis got out of hand after a small group of just six shareholders constituting only 0.24% of the entire share capital took legal action to challenge the shareholders’ resolution to increase share capital urgently required to rescue the company. KarstadrQuelle was forced into lengthy negotiations it could ill – afford before finally reaching a settlement with the minority shareholders. Under the German law just one minority shareholder could hold a company to ransom and even ruin a company. A single shareholder with only one share could block shareholders’ resolutions and put major decisions at risk by delaying plans by months or even years through filing lawsuits.

Over the years, Germany witnessed considerable growth in professional blackmailers who touted themselves as Robin Hoods of the investment world. They rarely had any interest in the company other than holding one share, so that they could participate in an AGM tourism, challenge shareholders’ resolutions and arm twisting the companies into a hush settlement. This had become a lucrative profession for them, nuisance to the companies and rarely benefitted the minority shareholders. In the 15 years prior to 2004, the number of shareholders’ suits had increased tenfold in Germany. Around half of the suits were initiated from the same club of professional minority investor, who brought about a hundred actions each year. The German government reacted to the phe-nomenon of extortive shareholders suits and came out with a new legislation UMAG in 2005 expected to partly remedy the problem of shareholder suits.

India should learn from this experience of Germany. In the Companies Bill a special resolution is required of non interested shareholders to approve RPT’s. Given that the attendance of minority shareholders at AGM is very low, it is possible that a small group of rabble rousers can expose companies to the same blackmailing experienced by the German companies. However, given that RPT’s need a special resolution only when they are not in the ordinary course of business and not at arm’s length, the requirement of a special resolution by minority shareholders should not be seen as a harsh step. Besides, companies can make use of postal ballot, if they believe that a transaction which is not at arm’s length is actually good for the company and all its shareholders!The Role of the Government/Regulator

The dispensation of the Central Government approval for RPT’s and replacing it with shareholders approval in the Companies Bill is a step in the right direction, particularly keeping in mind that India needs to reduce discretionary powers of the Government, at a time when corruption is at an all time high. But that does not mean that the Government does not have any role in the administration of RPT’s. Government should function as a watchdog and ensure that laws are meaningfully enforced. Thus, in enforcing the requirements of the Companies Bill, the Government will have to ensure that the company in question has done the following (a) interpreted meaningfully what is an arm’s length transaction (b) provided adequate and sufficient disclosure of the proposed RPT to the shareholders (c) clearly identified the related parties and the disinterested parties on the transaction, and (d) followed the right practices and an effective voting system to seek a special resolution of the disinterested parties.

Government should ensure that there is an effective voting system. Shareholder meetings and proxy voting practices in India like many parts of Asia lack efficiency and accountability. Voting processes need to be modernised to reflect best market practices and the growing global interest in active share ownership. Some investors strongly recommend conducting voting on all resolutions at AGMs and EGMs by poll rather than by a show of hands that often occurs at present, and allowing proxies to speak at meetings, irrespective of whether the company law is amended on this point.

Section 179 of the Companies Act states that “any member or members present in person or by proxy” may call for a poll if they hold shares in the company giving them not less than 10 per cent of total voting power. However, in practice it is often far from straight forward since in part, some custodian banks will not do so, i.e. request a poll on the basis of proxies received. Under the Companies Bill important matters are voted by postal ballots, allowing investors to have their shares counted on issues of significance. However, at the time of writing this article the bill was not yet enacted and the rules were not yet exposed; therefore it was not clear what important matters government would require postal ballot on.

The problem of enforcement is a more general one in India. Currently there are more than 3 crore cases pending in various courts in India. Decade long legal battles are commonplace in India. In spite of having around 10,000 courts (not counting tribunals and special courts) India has a serious shortfall of judges. A dispute contested until all appeals are exhausted can take up to 20 years for disposal. Automatic appeals, extensive litigation by government, underdeveloped alternative mechanisms of dispute resolution like arbitration, and the shortfall of judges all contribute to the state of affairs in Indian courts. Most important, since the same courts try both civil and criminal matters, and the latter gets priority, economic disputes suffer even greater delays.

In order to improve efficiency of enforcement actions, the MCA proposed to change the CLB to a Tribunal staffed by commercial professionals such as lawyers and accountants. However, due to certain provisions with regard to eligibility conditions and qualification requirements for Chairpersons/member of the Tribunal, the proposal was successfully challenged before the Supreme Court in 2010. The directions given by the Supreme Court have been taken into account in the proposed new Company Bill. If it is passed as planned a Tribunal will be established. Tribunals will speed up the justice system, but critics argue that the quality of justice system could fall further.

Compliance with Clause 49 has been enforced by both the Bombay (BSE) and National (NSE) Stock Exchanges. The chosen method appears to be through suspensions either of a short term nature or in some cases for a considerable period. De-listing is rarely used as that may not be in the interest of the minority shareholders. The bulk of the problem appears to be PSU’s and smaller companies, with the top companies mostly compliant. The issue for the PSU concerns independent director requirements since SEBI had earlier ruled that government nominees on PSU boards are not independent per Clause 49’s requirements.

SEBI has been more effective in blocking IPOs if companies fail to meet the required standards, including those relating to RPT’s and loans/guarantees to group companies. In cases of violation of the Listing Agreement, SEBI has the power to appoint adjudication officers to levy penalties. However, until recently even serious offences were consented under SEBI’s consent mechanism scheme. Only recently SEBI decided not to consent serious offences such as insider trading or fraudulent and unfair trade practices, and expose them to the regular justice system. However, in the absence of any significant powers, such as “wire-tapping”, SEBI has found it extremely difficult to prove insider trading cases.

The Special Appellate Tribunal (SAT) is a statutory body set up to hear appeal against orders passed by SEBI. The post of presiding officer of the SAT has been lying vacant since November 2011 due to non availability of a suitable candidate. This was hampering the smooth functioning of SAT. However, the selection norms for the presiding officer have been eased and this issue may be soon resolved. Another interesting perception is that a large number of SEBI decisions are over ruled by SAT. This perception also needs to be addressed by SEBI.

Multiple regulators in India is a thorny issue. The RBI, MCA, SEBI & IRDA have frequent spat with each other. These turf battles provide regulatory arbitrage to the wrong doers, besides weakening the legislation and its implementation. The Financial Sector Legislative Reforms Commission (FSLRC) was constituted by the Government of India, Ministry of Finance in March 2011, to look into the legal and institutional structures of the financial sector in India. The institutional framework governing the financial sector has been built up over a century. There are over 60 Acts and multiples rules and regulations that govern the financial sector, some of which are outdated. The RBI Act and the Insurance Act are of 1934 and 1938 vintage respectively. The main result of the work of FSLRC is a single unified and internally consistent draft law that replaces a large part of the existing Indian legal framework governing finance. This is work in progress and even if accepted would take several years to implement. Besides critics believe that a unified regulator in the financial sector will not solve India’s problem. What may work in India small and incremental steps, which cumulatively could have a significant impact.

ConclusionsRPT’s that treat shareholders inequitably is no different from “sophisticated stealing”. Some investors believe that more needs to be done about the heart of the problem in India: the accountability of controlling shareholders (i.e. promoters) to other shareholders. There is not just one silver bullet that will serve to protect minority rights in the presence of powerful insiders and potentially abusive RPTs.

India has done a great deal to develop a sound corporate governance framework both under the Companies Act and Clause 49 of the listing requirements. The Companies Bill imposes far greater and onerous responsibility on companies and independent directors to ensure that the abuse of RPT’s is minimised. It is a significant step in the right direction and is a significant improvement over the existing Act. However, there are still some loose ends that need to be tightened. The definition of related parties and relatives for one is a problem. The definition should be sufficiently harmonised with respect to different bodies of law such as accounting standards and income-tax law to avoid misunderstandings and an excessive regulatory burden, thereby underpinning better implementation and enforcement. Besides the Bill is not clear on which related parties are not allowed to vote on a RPT resolution.

Under the Companies Bill, the role of the board and its independent directors is underpinned by the right of shareholders to have a say on certain material RPT’s. In addition, it will be essential to improve the efficacy of AGMs by ensuring the effective possibility to call for a poll vote rather than a show of hands as is being done currently. Providing minority shareholders right to approve RPT’s s might need to be accompanied by safeguards to avoid potential hold-ups by a small number of investors. At the same time appropriate regulatory intervention is required to ensure that companies interpret the term “arm’s length transaction” sensibly and that all transactions where arm’s length price is questionable are brought to the AGM/EGM for approval.

Finally, lack of meaningful enforcement, multiple-regulators and an overburdened judicial system remain significant concerns. While laws and regulations are in place, effective means of redress is lacking. Steps need to be taken to strengthen law enforcement by both the MCA/CLB/Tribunal and SEBI and especially to remove civil cases from the overwhelmed court system. The Companies Bill should not be seen as a panacea for all the current problems with regards to minority rights and abusive RPT’s. To avoid circumvention, continuous and close monitoring by the regulator is absolutely necessary.