Category: Corporate And Other Laws

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.

Conclusions
RPT’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.