INTRODUCTION

The term 'related-party transaction' can be understood as a deal or arrangement made between two parties or entities who are joined by a pre-existing business relationship or common interest. A company enters into a business deal with that party with whom it is either familiar or shares some mutual interest. In the Indian context, the statute which deals with the Related Party Transactions (RPTs) is the Companies Act, which does not bar the Related Party Transaction but lays down certain safety measures that are required to be followed while dealing with RPTs. As per Section 188 of the Companies Act which lays down certain conditions for the regulation of Related Party Transactions, the making of disclosure of the transaction to the Board and shareholders forms the primary pre-requisite. This year, SEBI has made amendments1 to the RPT regime based on the Working Group Report on Related Party Transactions (which comes into force from April 1st, 2022). This article explains the major amendments made by SEBI with their possible impact on future transactions.

"PROMOTER" UNDER THE AMBIT OF "RELATED PARTY"

The issue of transaction by a person or entity belonging to the promoter/ promoter group not constituting a related party under Section 2(76) has been one of the major lacunae which have been misused by parties on numerous occasions over the past few decades. SEBI has addressed this void by including any person/entity belonging to the promoter/ promoter group within the definition of "related party" which is a significant step towards curbing such entities from escaping regulatory mechanisms.

Prior to the amendment the anomaly which remained unanswered in the definition of a related party under section 2(76) of the Companies Act, 2013 (Act") was that of exclusion of promoter [as defined under Section 2(69)] or a person or entity belonging to the promoter/ promoter group from the definition of "related party". Besides, the definition shall also include a person/ entity holding equity shares of 20% or more from April 1st, 2022, and 10% or more from April 1st, 2023.

Therefore, with the introduction of this amendment, any person or entity can be considered as Related Party if it belongs to the promoter or promoter group of the listed entity or if it holds more than or equivalent to 20% of equity shares either directly or on a beneficial interest basis as per section 89 of the Companies Act, 2013 at any time during preceding Financial Year and effective from 1st April 2023, it will apply to any person or entity holding 10% or more equity shares.

APPROVAL OF AUDIT COMMITTEE VIS-À-VIS TRANSACTIONS UNDERTAKEN AT SUBSIDIARY LEVEL

Over the past few years, several corporate scams arising from transactions at the subsidiary level have managed to escape the necessary regulatory scrutiny. As per the regulatory regime prior to the amendment, the Audit Committee approval shall be mandatory if the value of the transaction between two or more subsidiaries of the listed entity exceeds 10% of the annual turnover.

As per the amendment, if the provisions of Regulation 23 and 15(2) are applicable on the listed subsidiary(s), the approval of the audit committee shall not be required for transaction(s) entered into between them and a related party.

Another contemplative amendment on the issue of a subsidiary is the inclusion of an overseas subsidiary under Section 2(87) of the Companies Act. Further, an Indian holding company will be required even for transactions undertaken between two or more overseas subsidiaries of the listed entity. 

However, amendment relating to the overseas subsidiaries of the listed entity may result in a conflict of laws with a view of foreign and Indian jurisdictions on the issue of approval from the Audit Committee. There have been several Indian judgments2 that reiterate the fact that a parent company exercising shareholders' influence on its subsidiaries cannot obliterate or over-shadow the authority or decision-making power of the subsidiary's directors while emphasizing that the directors of a subsidiary do not owe a duty to the parent company but only to the subsidiary3. Thus, it will result in making the Boards of such overseas subsidiaries "functus officio" when it comes to the approval of Related Party Transactions due to overarching extraterritorial application of Regulation 23 of the SEBI (Listing Obligations and Disclosure Requirements). This scenario may also attract judicial scrutiny on the ground of Regulation 23 being extra-territorial with a view of tests slated in GVK Industries v. Income Tax Officer4 discussing the application of Article 245 of the Indian Constitution.

MATERIALITY THRESHOLD

A transaction with a Related Party where the parties entering the transaction individually or in combination with previous transactions exceeds the 10% of Annual Consolidated Turnover as per Regulation 23(1) of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, can be defined as a Material Related Party Transaction. After the introduction of the sixth Amendment of 2021, any "material modification" in the Related Party Transaction shall be granted prior approval by the Audit Committee which has been entrusted with this additional obligation.

With the present Amendment, to cover transactions that exceed Rs. 1000 Crore or 10% of the annual consolidated turnover (whichever is lower), the apex regulator, SEBI, has revised the materiality threshold to obtain the approval of the shareholders.

However, the amendment is silent as to what would be covered under the ambit of the definition of "material modification" and highlights that the same shall be defined by the Audit Committee which will disclose it in the policy for Related Party Transactions of the listed entity. Nonetheless, as a caveat, it is also important to point out that the sole determinant of what constitutes "material modification" by the Audit Committee may prove to be counter-productive due to the absence of any rules or tests for reaching this conclusion.

CONCLUSION

The above-mentioned amendments are a significant step towards regulating related party transactions and ironing out some creases which have existed since the past few decades. Such detailed disclosure even at the subsidiary level provides much-needed transparency to all the involved parties and especially minority shareholders. However, some amendments may pose a serious threat to the present corporate governance scenario, for instance; the absence of any rules or tests for the Audit Committee to determine "Material Modification" and exponential compliance increase on the part of listed companies.

Footnotes

1. Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) (Sixth Amendment) Regulations, 2021

2. (2011) 4 SCC 36.

3. (2012) 6 SCC 613

4. Ibid.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.