Related Party Transactions – ‘CA 2013’ vis-à-vis ‘SEBI LODR’

The Companies Act, 2013 was enacted to encourage businesses to adopt the “Jet Set Go” philosophy, with compliance and openness being crucial. Among the various difficulties addressed by this legislation, there has been a revolution in Related Party Transactions, a word that has made all businesses uncomfortable for many years due to the complexities involved. The definition of ‘Related Party’ in the Companies Act, 2013 (‘CA 2013’) is extremely broad and attempts to include relationships on the basis of common directors, important managerial figures, and so on. It serves as the model definition of ‘Related Party’ in the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘SEBI LODR’). In this article we will discuss Related Party Transactions – ‘CA 2013’ vis-à-vis ‘SEBI LODR’ in brief.

Short Glimpse

Prior to SEBI LODR, entities belonging to the promoter or promoter group of a listed entity and owning 20% or more of the shares of the listed entity were considered related parties. With effect from April 1, 2022, this definition has been updated, and anyone or any entity that is a promoter or promoter group of a listed entity will now be considered to be a “Related Party,” regardless of shareholding, with some deeming fiction to cover entities holding equity shares of 10% or more (effective from April 1, 2023) in a listed entity, either directly or indirectly, at any time during the immediately preceding fiscal year, as defined in Section 89 of the Companies Act, 2013. In order to provide proper disclosure to the pertinent stakeholders, the term of “Related Party” has been greatly enlarged overall.
Let us first take a brief overview of Related Party Transactions, before we shall be discussing its relation with SEBI LODR and Companies Act, 2013.

Meaning of Related Party Transactions

A “Related Party Transaction” is a deal or agreement between two parties who have a previous professional connection or shared interest. Companies frequently look to do business with people they know or with people with whom they have interests. Related Party Transactions may produce conflicts of interest or result in other unlawful circumstances, despite the fact that they are lawful in and of themselves. These transactions must be disclosed by a public company.
An agreement between two parties with an established commercial connection is referred to as a Related Party Transaction. Regulatory authorities carefully review Related Party Transactions because some of them, but not all of them, have an inherent potential for conflicts of interest. Abuse of Related Party Transactions might result in fraud and total financial catastrophe for all parties involved if it is not controlled.
Let us understand the concept of Related Party Transaction in relation to the Companies Act, 2013, and SEBI LODR Regulations.

Related Party Transactions under Companies Act, 2013

According to Section 188 of the Companies Act, 2013 read with Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014 (the “CA Rules 2014”), a company is not permitted to enter into a contract or other agreement with a related party without the Board’s or the shareholders’ prior approval, as applicable:

• Shareholder approval is necessary for Related Party Transaction that represents 10% or more of the company’s revenue when it comes to the sale, acquisition, or supply of any products or materials, whether directly or via the appointment of any agent.
• Selling, giving away, or buying any sort of property, either directly or by designating a representative, will require shareholder approval if the Related Party Transaction is worth 10% or more of the company’s net value.
• Any type of property leasing requires shareholder approval if the Related Party Transaction is worth 10% or more of the company’s annual revenue.
• In order to receive or provide any services, either directly or through the appointment of an agent, shareholder approval is necessary if the Related Party Transaction represents 10% or more of the company’s annual revenue.
• If the related party’s monthly compensation exceeds INR 2.5 Lacs, shareholder approval will be necessary before the related party may be appointed to any office or position of profit inside the company, its subsidiary, or associate company.
• Shareholder approval will be required for Related Party Transaction worth 1% of the Company’s net worth in order to fund or underwrite the subscription of any securities or derivatives owned by the Company.

Approvals for Related Party Transactions under Companies Act, 2013

Prior permission of the following is necessary whenever a Company participates in any Related Party Transactions:

Board of Directors: Every Related Party Transaction that a Company engages in is subject to prior Board of Directors approval under Section 188 of the Companies Act, 2013. With the proviso that if a director has any interest in a transaction or arrangement with a linked party, they must abstain from the meeting while it is being considered.
However, if a director is engaged in a contract or arrangement that is covered by Section 184(2) of the Companies Act, 2013 and is not covered by Section 188(1) of the Companies Act, 2013, the director may participate in the Resolution under the following situations:

• After interest declaration in the case of a private company or specific IFSC company.
• When a Section 8 Company is involved and the transaction value is less than INR 1 lakh.

Shareholders: Any Related Party Transaction that a company engages in that is more than the aforementioned restrictions requires shareholder approval through a special resolution. However, a related party company member is not permitted to cast a vote at the general meeting on a motion to approve the Related Party Transaction unless:

• It is a private company with a specified IFSC; or
• A company in which 90% or more of the members are relatives of the promoters or related parties.

The Audit Committee: Transactions involving related parties must be approved in line with Section 177(4) (iv) of the Companies Act, 2013, and Rule 6A of the Companies Act Rules 2014. Furthermore, in the company’s interest, the Audit Committee may provide omnibus approval for Related Party Transactions presented by the company, subject to the following conditions:

• The Audit Committee will describe the criteria for making the omnibus approval after gaining permission from the Board of Directors.
• The Audit Committee will consider the following aspects while formulating the criteria for omnibus approval: –
  • The nature of the transactions (past or present); and
  • The reasoning for the omnibus request.
• The following items must be included or indicated in the omnibus approval: –
  •  The names of the parties involved;
  •  Transaction kind and duration;
  •  The maximum number of transactions that can be conducted;
  •  Any price-variation mechanism, as well as the indicative base price, presently contracted price, and
  • Any additional material deemed appropriate by the audit committee.
• When the need for Related Party Transactions cannot be foreseen and the aforementioned information is not available, the Audit Committee may issue omnibus clearance for such transactions with a value not exceeding INR 1 Crore per transaction.
• Because an omnibus approval is only valid for one fiscal year, a new approval will be required after the end of the fiscal year. The Audit Committee, on the other hand, cannot provide omnibus approval for transactions involving the sale or disposal of a company’s undertaking.

Exemptions for Related Party Transactions under the Companies Act, 2013

Under the Companies Act, 2013, the following exemptions are allowed for Related Party Transactions:

• If the company enters into a transaction in the ordinary course of business and on an arm’s length basis, neither the board nor the shareholders must authorize it.
• Transactions between a holding company and its wholly-owned subsidiary whose accounts are consolidated do not require shareholder approval, even if they exceed the limit; instead, the holding company’s resolution will suffice for the transaction’s purposes.
• Even if the limitations are exceeded, no shareholder approval is required in the case of a Government company where:
• Contracts or agreements it has signed with any other government agency, whether state or central or a combination of the two; or
• The appropriate ministry grants permission and the company is a government entity that is not publicly traded.

Related Party Transactions under SEBI LODR

The term “Related Party” now refers to more than only transactions involving listed companies and subsidiaries and their related parties. This implies that even if a listed company is not a party to a subsidiary’s RELATED PARTY Transactions, it must nevertheless comply with the approval and disclosure responsibilities.

Starting on April 1, 2023, the term now covers certain kinds of unrelated transactions as RELATED PARTY Transactions, i.e., transactions whose objective is to benefit a related party of the listed companies or any of its subsidiaries. Related Party Transaction is defined as any transfer of assets, liabilities, or services between a listed entity and a related party, whether or not a price is imposed, under Regulation 2(1) (zc) of the modified SEBI LODR.

The inclusion of transactions that directly or indirectly benefit a listed entity elevates the idea of RELATED PARTY TRANSACTIONs under the modified SEBI LODR above the definition under the Companies Act, 2013. This concept might be developed to oppose the use of complex arrangements to move monies from listed entities to parties that look unconnected but are actually designed to benefit the listed entity or its linked parties. As a result, because the updated SEBI LODR do not offer such an exemption, transactions conducted in the usual course of business and at arm’s length and subject to the restrictions of the Companies Act, 2013 will now be scrutinized.

Exemptions for Related Party Transactions under SEBI LODR

Under the SEBI LODR, the following exemptions are allowed for Related Party Transactions:

• Priority issuance of certain securities in compliance with the SEBI (Capital and Disclosure Requirements) Regulations, 2018;
• Dividend offers, subdividing or consolidating securities, awarding rights or bonuses, or stock buybacks issued uniformly to all shareholders;
• Banks and NBFCs accept fixed deposits at consistently applicable conditions.

Importance of Related Party Transactions

A transaction was formerly considered substantial during a fiscal year if it exceeded 10% of the listed entity’s yearly consolidated turnover as stated in its most recent audited financial statement. However, under the amended definition, Related Party Transactions would be considered large only if the total value of all transactions completed within a fiscal year, whether conducted separately or in combination, exceeded INR 1,000 crores or 10% of the listed entity’s annual consolidated sales, whichever was lower. This financial barrier intends to include high-value business transactions that might otherwise fall below the 10% mark.

Challenges before Listed Entities 

Due to the link between company size in terms of turnover and the number of approvals required from shareholders and the Audit Committee, listed entities may soon encounter a number of practical challenges related to strict scrutiny, which could result in increased costs and a significant increase in compliance burden.

The Audit Committee is now required to define “Material Modification” (a term that is not defined in the modified rule) and evaluate Related Party Transactions even when the party is not a listed company but a subsidiary, adding to its already extensive list of responsibilities.

There isn’t a clear description of what this test of the purpose of benefit would entail, despite the fact that SEBI has determined that any transactions with third parties that have the goal of benefiting a related party or that have that consequence are Related Party Transactions. Determining the purpose and impact of any such transaction that would benefit a connected party of the listed company or any of its subsidiaries will be difficult, though.

Takeaway

As the economy becomes more globalized, more and more of the various operations involved in the production, sale, and distribution of goods or services are handled by independent entities within a multinational group, and the flow of goods and services through intercompany transactions frequently involves two or more nations. In these situations, related party transactions become extremely significant for a company, especially given the wide-ranging ramifications they have.

If you want to learn more about Related Party Transactions, contact our experts at Legal Window.