SEBI Raises the Bar on Related Party Transactions

If there is one issue in the new company law that has led to a lot of angst for India Inc, it is the aspect of the new governance framework around ‘related party transactions’ (RPTs).

This is because the new company law (enacted in 2013) and SEBI’s revised corporate governance framework to become effective from October 1, have clearly raised the bar on RPTs. But many corporate observers see this as a worthy effort, as it has enhanced the transparency quotient of such transactions. The new regime requires both board and shareholders’ approval in certain situations to conform to the new law.

Thrust on Governance

The thrust is now clearly on improving governance even as the Government withdraws from the approval process.

It is largely going to impact public companies as private corporates are proposed to be kept out of the new RPT regime. The big difference between now and the erstwhile regime (company law enacted in 1956) is that the Government will now have no role to play in the approval process for related party transactions. Under the new regime, RPTs will have to be approved by an audit committee (if a company is required to have such committee), the board of directors and also shareholders.

In some cases, shareholders’ nod is by a special resolution (these are cases where under the Companies Act 1956, government approval would be required).

‘Disinterested shareholder’

This task for India Inc is seen as being onerous, given that many companies have so far been keen to follow the letter and not the spirit of law. Only disinterested shareholders and directors are permitted to vote on RPTs. Importantly, an interested director cannot even attend the meeting when an RPT is being discussed and considered by the board.

Although this will strengthen corporate governance, it also runs the risk of being misused by disinterested shareholders, according to Lalit Kumar, Partner, J Sagar Associates, a law firm.

Also, while the concept of disinterested vote is very significant, the new company law has not considered the various situations where it could become difficult for disinterested shareholders to exercise their vote.

For instance, according to the new company law, it is not clear what will happen in a situation where there are only two shareholders (for instance, in a private joint venture company) and one of them is interested.

The remaining disinterested shareholder being only one in number does not have the quorum to approve RPT. Another situation that needs clarity is what will happen when an RPT is between two subsidiaries of the same parent.

SEBI view

While the new law has brought in several changes to RPTs, SEBI’s revised corporate governance framework has walked the extra mile to prescribe norms for RPTs. The new law stipulates that all RPTs that are not in the ordinary course of business or not at arm’s length basis should be approved by the board. However, SEBI requires that all material RPTs be approved by the shareholders through a special resolution.

Business Line, New Delhi, 28-06-2014