By : Swetha Dasu, Associate, assisted by Atluri Sri Vidya
A “Related Party Transaction” (“RPTs”) is an agreement between two individuals who have previously worked together or have a common interest. Businesses generally favour conducting transactions with individuals with whom they have a personal relationship or common interests. The SEBI regulations allows RPT which may result in conflicts of interest or unlawful circumstances and the company that is listed on the stock exchange shall reveal the transactions. In simple words, it involves an agreement between two connected parties to trade goods where the regulatory agencies would closely examine specific transactions involving RPT to uncover possible conflicts of interest, though not all of these transactions are evaluated. However, the abuse of RPT’s may lead to fraud and severe financial outcomes for all involved parties.
As per the regulations introduced under SEBI (“Listing Obligations and Disclosure Requirements”) (“LODR”) it was determined that a promoter or promoter group would be classified as a related party if their stake in the listed company exceeded 20%. These Amendment Regulations are anticipated to bring about a shift in this scenario. In the April 1, 2022, the individuals connected to promoter or promoter group of a listed company will now be classified as related parties, irrespective of their ownership stake. Furthermore, the individuals who have more than 20% ownership in the company listed, either through direct ownership or beneficial interest as per Section 89 of the Companies Act, 2013, in the previous financial year, will now be classified as RTPs. However, the amended regulations have reduced the threshold to 10% with immediate effect in April 1, 2023 and has broadened it to cover all individuals or groups involved in the promotion, regardless of ownership level.
The scope of RPTs consists of those with a publicly traded company or its affiliated entities, as well as related parties of the company or its affiliates. This means that deals between a publicly traded business and its affiliate’s RPTs, as well as deals between a publicly traded company’s subsidiary and a related party of the business, are now classified as RPTs. From the effect of April 1, 2023, RPTs involves the transactions between a publicly traded company or its affiliated entities and any person offering advantages to a related party of the company or its affiliate. This indicates the transaction which benefits the RPT’s whether directly or indirectly. Further, due to far-reaching impact of these changes, the publicly traded companies shall disclose a greater range of dealings and secure approval from their shareholders. The publicly traded companies must thoroughly assess these changes and guarantee they adhere to the new regulations in order to prevent potential fines and harm to their reputation.
The Company that is publicly traded and governed by SEBI (“Issue of Capital and Disclosure Requirements”) (ICDR) Regulations shall follow uniform corporate processes for all shareholders when issuing securities via preferential allotment. These may include paying out dividends, dividing or combining securities, offering stock options, giving bonuses, and buying back shares. Additionally, the thresholds for RPTs have been adjusted to conform with Regulation 23 of the LODR which mandates publicly traded companies to seek shareholder consent for transactions above ₹1,000 crore or 10% of the annual consolidated turnover, whichever is less, despite being routine business activities during the fiscal year. Since the listed companies are typically not greatly affected by these factors because of their substantial size, they are still required to seek approval from the majority of their public shareholders, presenting a compliance hurdle.
Audit committee:
The regulations regarding RPTs have been amended in order to enhance transparency and accountability in corporate governance. The amendment to Regulation 23(2) now mandates that the audit committee of the listed company must authorize all significant related party transactions and any subsequent significant modifications. This amendment encompasses transactions involving subsidiaries, broadening the audit committee’s supervision. These material changes ensures that the authorized transactions are subjected to same level of examination, providing additional safeguards against conflicts of interest and ensuring that these transactions are beneficial to the company and its stakeholders.
The transactions between two fully owned subsidiaries of a publicly traded company do not require prior approval as per Regulation 23(5), even though Regulations 23(2), 23(3), and 23(4) mandates for the RPT’s. This exemption is important when the financial records of the subsidiary companies are merged with those of the publicly traded company, and the consolidated outcomes are presented to shareholders at a shareholder gathering. This adjustment acknowledges the internal structure of company-owned subsidiaries, which may exhibit varying levels of risk in their dealings as opposed to transactions between separate entities. The SEBI ensures that corporate group financial statements are transparent by combining transactions in the listed company’s accounts, with no unnecessary procedural hurdles.
Approval from audit committee:
In accordance with the amendment of Regulation 23(2) has been made, which specifies two important changes. The audit committee of the public company needs to define what qualifies as a “material change” in an RPT and include this in the company’s policy for overseeing RPTs and assessing their importance. This ensures a consistent and clear process for identifying transactions that need to be examined. Furthermore, if a listed company’s transactions with its subsidiary qualify as RPTs and surpass 10% of the listed company’s yearly consolidated revenue, they require approval from the audit committee, regardless of the listed company’s direct involvement. From April 1, 2023, the criterion will be modified to 10% of the subsidiary’s annual standalone revenue to take into account the subsidiary’s financial situation as a crucial aspect in assessing significance.
The amendments under the Regulation 23(4) of the LODR Regulations to align shareholder approval criteria with the revised materiality standards. The shareholders are required to provide consent for any significant transactions or modifications involving related parties, leading to greater stakeholder involvement in crucial corporate choices. The approval from shareholders is not needed for transactions with related parties if a listed subsidiary adheres to Regulation 23 and Regulation 15(2). The appropriate group for approving transactions in privately owned subsidiary companies is the stakeholders, simplifying the approval process for lower-level employees in the organization.
The Section 188 of the Act mandates the inclusion of all RPT in the company’s board report, with further information disclosed in Form AOC-2, irrespective of whether the transaction was conducted at arm’s length. Similarly, the LODR requires the audit committee to receive detailed information, which includes the reasoning behind the transaction and its impact on the company. Furthermore, it is necessary for businesses to disclose their dealings with affiliated entities to the stock market every six months in order to uphold transparency with shareholders and the general market. Further, the Companies Act imposes penalties for non-compliance with RPT regulations. If an RPT is entered into without proper approval, directors, employees, and the company itself may face penalties for non-compliance with disclosure requirements may result in substantial fines. These penalties can reach INR 25,00,000 for listed entities and INR 5,00,000 for others. In order to ensure the compliance, companies must file regular six-monthly disclosures on RPTs, detailing the transactions, their terms, and any external assessments.
Conclusion:
Therefore, the RPTs are crucial in the realm of corporate governance, specifically for publicly traded firms, as they consist of interactions between related parties that may result in conflicts of interest or abuse of authority. The revisions to the Companies Act, 2013, along with modifications to SEBI’s LODR regulations, have enhanced the regulatory framework for transactions, highlighting the significance of transparency, accountability, and neutrality. In today’s world, businesses must seek approval from audit committees, boards, and shareholders for major transactions, particularly involving subsidiaries or significant changes, as the limit for related party ownership has been lowered to 10% and now includes promoter groups and affiliates in its criteria. The consistent reporting of related party transactions is essential for enhancing transparency, and the penalties for failing to comply with this mandate have been significantly heightened to deter violations. The aim of these changes is to safeguard shareholders, enhance corporate governance, and ensure that related party transactions are conducted fairly and taking all stakeholders into account, in order to prevent potential fraud and protect the financial stability and reputation of the company
[1] Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015.
[1] Regulation 2(1) (zc), Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) (Sixth Amendment) Regulations, 2021, (Notification No. SEBI/ LAD-NRO/GN/2021/55) (w.e.f. 01.04.2022) (“2021 Amendments”).
[1] Ibid.
[1] Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018.
[1] Regulation 23, Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015.
[1] Regulation 23(2), Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015.
[1] Regulation 23(5), Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015.
[1] Ibid.
[1] Regulation 23(4), Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015.
[1] Section 188, Companies Act, 2013. [1] Ibid.
