A brief analysis on Related Party Transaction (RPT)

With the growing participation of investors and other stakeholders in companies, the question of transparency in arrangements with related parties often becomes a topic of debate and discussion. Section 188 of the Companies Act, 2013 (‘the Act') aims to increase transparency and to determine the exact financial position of the Company by placing the onus on the Board of Directors to review, approve, explain and recommend such related party transactions to shareholders for their approval.

Definition of Related Party Transactions ('RPTs') in the Act covers a wide range of transactions. Thus, it is absolutely necessary to understand the concept of identification, approval and disclosure of RPTs. It is also advisable to formulate and implement a Policy which shall unambiguously define the roles and responsibilities of Board, communication, disclosure and monitoring requirements.

Identification of RPT

- Can be done by answering two simple questions:

1. Whether the opposite party is a Related Party as per Companies Act, 2013?
2. Whether the proposed transaction falls under the ambit of Related Party Transaction as per Companies Act, 2013?

Reference to section 2 (76) of the Act should be made in order to answer the first question. This section defines Related Party with reference to a company as:

• a director or his relative;
• a key managerial personnel or his relative;
• a firm, in which a director, manager or his relative is a partner;
• a private company in which a director or manager or his relative is a member or director;
• a public company in which a director or manager is a director and holds along with his relatives, more than two percent of its paid-up share capital;
• any body-corporate whose Board of Directors, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager;
• any person on whose advice, directions or instructions a director or manager is accustomed to act;
• any body-corporate which is-

1. holding, subsidiary or an associate company of such company;
2. subsidiary of a holding company to which it is also a subsidiary; or
3. an investing company or the venturer of the company;

• a director other than an independent director or key managerial personnel of the holding company or his relative with reference to a company, shall be deemed to be a related party

Note:

1. Points (vi) and (vii) are not applicable for any advice, directions or instructions given in professional capacity.
2. In the sub-point (c) of point (viii), the investing company or the venturer of a company means a body corporate whose investment in the company would result in the company becoming an associate company of the body corporate.

While answering the second question Section 188 of the Act comes into use. This section provides that any contract or arrangement with a related party for the following transactions will be termed as related party transactions:

1. sale, purchase or supply of any goods or materials;
2. selling or otherwise disposing of, or buying, property of any kind;
3. leasing of property of any kind;
4. availing or rendering of any services;
5. appointment of any agent for purchase or sale of goods, materials, services or property;
6. such related party's appointment to any office or place of profit in the company, its subsidiary company or associate company; and
7. underwriting the subscription of any securities or derivatives thereof, of the company.

Note: The expression "office or place of profit" means any office or place-

• where it is held by a director, if the director holding it receives from the company anything by way of remuneration salary, fee, commission, perquisites, any RFA or otherwise over and above the remuneration as a director;
• where it is held by an individual other than a director or by any firm, private company or other body corporate, if the individual, firm, private company or body corporate holding it receives from the company anything by way of remuneration, salary, fee, commission, perquisites, any RFA, or otherwise;

Approval mechanism of RPT

It is a three layered mechanism requiring approvals from following authorities within a Company.

Audit Committee Approval

All the listed public companies and other which are required to constitute an Audit Committee in accordance with section 177 of the Act shall also be required to comply with the requirements of Section 177 (4) (iv) of approving transactions with related parties.

Board Approval

In pursuant to sub-section (1) of section 188 of the Act, every company needs to seek approval from the Board of Directors for entering into RPTs.

Note: A director who has an interest in the contract with such related party must not be present at the meeting during the discussions concerning the contract or arrangement.

Shareholders/Members Approval

In pursuant to the first proviso of sub-section (1) of Section 188 of the Act, prior approval of the company by way of a resolution is be required for entering into RPTs, if transactions meet the following threshold limits as prescribed in the rules:

Note:

1. It is clarified that the limits specified for points (i) to (iv) shall apply for transactions to be entered into either individually or taken together with the previous transactions during a financial year.
2. For calculation of net worth and turnover in the above thresholds will be based on the audited financial statement of the preceding financial year.
3. For entering into a transaction between the wholly-owned subsidiary and holding company resolution passed by the holding company will hold good.
4. A member who is a related party shall not vote on any resolution approving RPTs. Further this rule shall not apply to a company in which ninety per cent. or more members, in number, are relatives of promoters or are related parties.
5. In case of Listed Companies, All material related party transactions shall be approved by the shareholders /members.

The expression "material related party transaction" means a transaction with related party having value, individually or taken together with previous transactions during the financial year, exceeding 10% of annual consolidated turnover, as per latest audited financial statements, of the Company.

Exemptions

1. The board/member's approval will not apply to the transactions entered into by the company in its ordinary course of business which is on arm's length basis.

The expression "arm's length transaction" means a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest.

2. The requirement of member's approval will not be applicable for transactions that are entered between a holding company and its wholly-owned subsidiary whose accounts are consolidated with such holding company and placed before the shareholders at the general meeting for approval.

Additional compliances required under the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 ("listing Regulation"), AS-18 and Ind AS-24 are as following:

Expansion of definition of Related Party

In addition the Companies Act, 2013, following entities are identified as related party under AS-18, Ind AS-24, and Listing regulations respectively:

According to AS-18

1. Individuals owning, directly or indirectly, an interest in the voting power of the reporting enterprise giving them control or significant influence over the enterprise
2. relatives of any such individual
3. Enterprises over which any person described in (i) is able to exercise significant influence.

According to Ind AS-24

1. A person who has control or joint control or significant influence over the reporting company or a close member of that person's family;
2. Both entities are joint ventures of the same third party or associate of such third party.
3. The company is a post-employment benefit plan for the benefit of employees of either the reporting company or an company related to the reporting company. If the reporting company is itself such a plan, the sponsoring employers are also related to the reporting company.
4. The company is controlled or jointly controlled or significantly influenced by a person identified in (i).

According to Regulation 2 (1) (zb) of Listing Regulation

‘Related party' means a related party as defined under section 2 (76) of the Companies Act, 2013 or under the applicable accounting standards including any person or company belonging to the promoter or promoter group of the listed company and holding 20% or more of shareholding in the listed Company.

Expansion of list of transactions, which are considered as Related Party Transactions

According to listing regulations, AS-18 and Ind AS-24, any transfer of resource, service or obligation between related parties is a related party transaction

No exemptions

Unlike Companies Act, 2013, Listing Regulations, AS-18 and Ind AS-24 do not provide any exemption to any transaction.

Policy formulation

All listed Companies are required to formulate a policy on materiality of related party transactions and on dealing with related party transactions including clear threshold limits duly approved by the board of directors and the board of directors are required to review such policy at least once every three years and updated accordingly.

Explanation - A transaction with a related party shall be considered material if the transaction(s) to be entered into individually or taken together with previous transactions during a financial year, exceeds ten percent of the annual consolidated turnover of the listed company as per its last audited financial statements.

Approval

As per Listing Regulations, shareholder's approval is required for all ‘material related party transaction (defined in above point).

AS-18 and Ind AS-24 do not require any approval as the standards only deal with the disclosures aspects of a transaction.

Disclosures required under the Companies Act, 2013 are explained here-in-below

Board Meeting

The agenda of the board meeting in which a resolution relating to RPT is to be passed should consist of the following information:

1. Name and nature of the relationships with the related party
2. Nature, duration, and particulars of the contract
3. Material terms of the arrangement or contract
4. Any advance has been paid or received for the arrangement
5. The manner of determining the price and commercial terms
6. Any other relevant or vital information

General Meeting

In pursuant to the Rule 15 of Companies (meeting of the board and its powers) Rules 2014, the explanatory statement is to be annexed to the notice of the general meetings in pursuant to section 101 of the Act and should consist of the following information:

1. Name of the related party
2. Name of the related director or KMP
3. Nature of relationship
4. Nature, material terms, monetary value and particulars of the contract
5. Any other relevant or vital information

Disclosure by Interested Directors

Every director of a firm who has any direct or indirect interest involved in the contract or entered into or about to be entered should disclose the nature of the concern at the meeting of the board in which such contract or arrangement is discussed.

Disclosure in the Board's Report

Every related party transaction shall be disclosed in Form AOC-2 which shall be a part of the board`s report.

Disclosure in Register

Every Company has to maintain one or more registers in Form MBP 4 and will enter the particulars of the contract or arrangements with a related party.

Additional disclosures required under the Listing Regulations and/or AS-18 or Ind AS-24 are as following

According to AS-18, following disclosures should be made in a company's annual report:

• Name of related parties and nature of the relationship should be disclosed irrespective of whether or not there have been transactions between the related parties
• If there have been transactions with related parties:
• the name of the transacting related party;
• a description of the relationship between the parties;
• a description of the nature of transactions;
• volume of the transactions either as an amount or as an appropriate proportion;
• any other elements of the related party transactions necessary for an understanding of the financial statements;
• the amounts or appropriate proportions of outstanding items pertaining to related parties at the balance sheet date and provisions for doubtful debts due from such parties at that date; and
• amounts written off or written back in the period in respect of
• debts due from or to related parties

Indian Accounting Standard (Ind AS)-24 requires disclosure of related party relationships, transactions and outstanding balances, including commitments, in the consolidated and separate financial statements of a parent, venturer or investor presented in accordance with Indian Accounting Standard (Ind AS) 27 Consolidated and Separate Financial Statements. This Standard also applies to individual financial statements.

According to Listing Regulations, the listed company shall make following disclosures

1. Disclosures according to the applicable Accounting Standard on "Related Party Disclosures";
2. Details of related party transactions in the corporate governance section of the annual report;
3. Materially significant RPTs that may have a potential conflict of interest with the Company;
4. The listed Company shall submit disclosures of related party transactions on a consolidated basis, to the stock exchanges and publish the same on its website within 30 days from the date of publication of its standalone and consolidated financial results for the half year,
5. Details of all material transactions with related parties shall be disclosed along with the a quarterly compliance report on corporate governance submitted by the listed Company.

There is a Practical issue that frequently arises due to such restriction on Related Party Transactions.

Voidable contracts or arrangements

In case where approval of the Board or of the shareholders of the company is required to enter into a transaction, but a director or any other employee of the Company enters into a contract or arrangement, on behalf of the company, and the same is not been ratified by the board or at the shareholders meeting within 3 months from the date of such contract or arrangement, such contract or arrangement shall be voidable at the option of the Board or as the case may be of shareholders.

If any loss is incurred by the Company owing to such transaction with related party to any director, the directors concerned shall indemnify the Company against the same.

It is at the discretion of the company to proceed against a director or any other employee, who had entered into such a contract or arrangement, for recovery of any loss sustained by it as a result of such contract or arrangement.

Note: This article is purely for academic purpose and shall not be acted upon as a professional advice. The provisions of law referred to in this article may be amended at any time. Thus, I assume no responsibility for the consequences of use of such information without any professional advice. In no event, shall I be liable for any direct, indirect or incidental damage arising in connection with the use of information here in contained.