Related Party Transactions - SEBI LODR, 2015

INTRODUCTION

In the modern business landscape, companies often engage in transactions with their related parties, such as subsidiaries, affiliates, directors or key management personnel. These related party transactions ("RPT") can lead to significant advantages, including operational efficiency and cost-effectiveness. However, if not properly managed, they may also give rise to conflicts of interest, potential exploitation or unfair benefits to certain parties at the expense of the company's shareholders. RPT under Indian corporate laws are primarily governed by:

1. Companies Act, 2013 and Rules framed thereunder;
2. SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 ("SEBI LODR 2015"); and
3. Accounting Standards.

This article outlines the key provisions governing related party transactions as per SEBI LODR, 2015 focusing on the regulatory framework, approval processes and disclosure requirements. Before we delve into the detailed regulatory requirements let us understand 'What is a Related Party?' and 'What are Related Party Transaction?' as per LODR.

As per Regulation 2(1)(zb) of SEBI LODR, 2015 Related Party means a Related Party as defined u/s 2(76) of the Companies Act, 2013 or under applicable accounting standards

Related Party

[Section 2(76) of the Companies Act, 2013]

1. Director or his relative
2. Key Managerial Personnel or his relative
3. Firm where a Director, Manager or their relative is a Partner
4. Private Company where a Director, Manager or their relative is a Member or Director
5. Public Company where a Director or Manager, along with their relative, holds more than 2% of its Paid-up share capital
6. Any Body Corporate whose Board, Managing director or manager acts according to the advice, directions or instructions of a director or manager
7. Any Person whose advice, directions or instructions a director or manager is accustomed to follow
8. Any Company which is (a) holding, subsidiary or an associate; or (b) a subsidiary of the holding company to which it is also a subsidiary; or (c) an investee company or venturer company

Deemed Related Party

[Regulation 2(1)(zb) of SEBI LODR, 2015]

1. Person or Entity forming part of the promoter or promoter group of the listed entity
2. Person or Entity, holding 10% or more equity shares in the listed entity either directly or on a beneficial interest basis as provided u/s 89 of Companies Act, 2013, at any time, during immediately preceding financial year

Related Party Transactions

[Regulation 2(1)(zc) of SEBI LODR, 2015]

Related Party Transaction ("RPT") means a transaction involving a transfer of resources, services or obligations, regardless of whether price is charged, between-

1. A listed entity or any of its subsidiaries AND a related party of the listed entity or any of its subsidiaries
2. A listed entity or any of its subsidiaries AND any other person, the purpose and effect of which is to benefit a related party of the listed entity or any of its subsidiaries (W.E.F. April 01, 2023)

Provided following shall not be considered as RPT:-

• Issue of specified securities on a preferential basis, by complying with SEBI(ICDR), Regulations, 2018;
• Corporate actions by listed entity that apply equally to all shareholders in proportion to their shareholding:
  • Payment of dividend
  • Subdivision or consolidation of securities
  • Issuance of securities by way of rights or bonus issue
  • Buy-back of securities
• Banks or NBFCs accepting fixed deposits on terms applicable to all shareholders, subject to disclosure of same along with disclosure of RPT every six months to the stock exchange.

With reference to above mentioned definitions,

1. "Relative" shall mean a relative as defined in Section 2(77) of the Companies Act, 2013.
2. The definitions shall not apply to units of Mutual Funds, listed on a recognized stock exchange(s)

Further, the Listed entities often encounter several challenges when identifying Related Party(ies). Some of the key issues include:

1. Tracking Shareholder Changes: It can be difficult to monitor individuals whose shareholding exceeded the prescribed threshold during the previous financial year, particularly when it comes to public shareholders.
2. Fluctuating Shareholdings: The shareholding of large public investors can vary significantly from year to year. As a result, a shareholder who holds a relatively small or no stake in the current year could still be categorized as a related party if they had 10% or more ownership at any point during the previous year.
3. Broad Definition of 'Promoter Group': The definition of the 'promoter group' is extensive, which can lead to unexpected consequences. For example, investors with minority portfolio holdings might be incorrectly classified as related parties if they fall within this broad scope.

Regulation 23 Of SEBI LODR, 2015

Any transaction with a Related Party shall be considered material if the transaction(s) to entered either individually or together with previous transactions during a financial year exceeds below limits:

The listed entity must establish a Policy on the materiality of RPT and its dealing, including defined threshold limits approved by the Board. This policy should be reviewed by the Board at least once every 3 years and must be updated accordingly.

Note: The following classes of Listed Entity are exempted from complying the provisions of Regulation 23 of SEBI LODR, 2015:

- Listed entity having paid up equity share capital not exceeding rupees ten crore and net worth not exceeding rupees twenty five crore, as on the last day of the previous financial year.

- Listed entity which has listed its specified securities on the SME Exchange

Ratification of RPT by Audit Committee under SEBI L ODR, 2015

The members of the audit committee, who are independent directors, may ratify related party transactions within three months from the date of the transaction or in the immediate next meeting of the audit committee, whichever is earlier, subject to the following conditions:

1. the value of the ratified transaction(s) whether entered into individually or taken together, during a financial year shall not exceed rupees one crore;
2. the transaction is not material in terms.
3. rationale for inability to seek prior approval for the transaction shall be placed before the audit committee at the time of seeking ratification.
4. the details of ratification shall be disclosed along with the disclosures of related party transactions to the stock exchange.
5. any other condition as specified by the audit committee:

Provided that failure to seek ratification of the audit committee shall render the transaction voidable at the option of the audit committee and if the transaction is with a related party to any director, or is authorised by any other director, the director(s) concerned shall indemnify the listed entity against any loss incurred by it.

Omnibus Approval of RPTs [Regulation 23(3)]

An Omnibus approval from the Audit Committee is required for transactions that a listed entity or its subsidiary proposes to enter, subject to the following conditions:

• The committee must establish criteria for entering into such transactions, in line with its policies.
• This approval is only applicable to transactions of repetitive nature.
• The Audit Committee must satisfy that the approval is necessary and in the best interest of the entity.
• The Omnibus approval must include the following details:
  • The name of the related party, nature and duration of the transaction, and the maximum number of transactions to be entered into.
  • The indicative base price or current contracted price, along with any formula for price variation.
  • Any other conditions deemed appropriate by the committee.

In cases where the need for the transaction cannot be determined, and the above-mentioned details are unavailable, the Audit Committee may approve transactions with a value not exceeding Rs. 1 crore per transaction.

Validity of Omnibus Approval

Such omnibus approvals shall be valid for a period not exceeding one year and shall require fresh approvals after the expiry of one year:

Review on Quarterly Basis

The audit committee shall review, at least on a quarterly basis, the details of related party transactions entered into by the listed entity or its subsidiary pursuant to each of the omnibus approvals given.

Note: Where listed subsidiary is party to the transaction and RPTs as per SEBI LODR, 2015 are applicable to Listed Subsidiary, then prior approval of listed entity is not required for the listed entity.

Exemption from "Prior Approvals for the following transactions" [Regulation 23(5)]

• Entered into between two public sector companies.
• between a holding company and its wholly owned subsidiary or between two wholly owned subsidiaries whose accounts are consolidated with such holding company and placed before the shareholders at the general meeting for approval
• nature of payment of statutory dues, statutory fees or statutory charges entered into between an entity and Government.

Arm's Length Principle: According to SEBI regulations, related party transactions must be carried out at arm's length. This means that the transaction's terms should be similar to those that would be agreed upon between independent, unrelated parties operating in a competitive environment. This ensures fairness and prevents any preferential treatment or manipulation of terms that could unfairly benefit related parties, potentially harming the company or its minority shareholders.

Disclosure Requirements [Regulation 23(9)]

• Listed entity shall submit to Stock exchange disclosures of RPT in format specified by the Board, every Six months on the date of publication of its standalone and consolidated financial results.
• Provided 'High Value Debt listed entity' submit such disclosures along with its standalone financial results for half year.
• Such disclosures shall also be places on the website of the listed entity.

CONCLUSION

Related party transactions (RPTs), while often beneficial and necessary for business operations, can pose significant risks if not managed properly. SEBI's regulatory framework ensures that these transactions are conducted transparently and fairly, protecting the interests of both the company and its shareholders, particularly minority shareholders. The framework requires clear approval processes through the Audit Committee, Board, and shareholders, coupled with detailed disclosures to ensure accountability. By mandating that RPTs be carried out at arm's length and subject to proper scrutiny, SEBI aims to prevent undue advantages for related parties.

Strict adherence to SEBI's regulations is essential, as penalties for non-compliance emphasize the critical need for compliance. Ultimately, these provisions are designed to foster sound corporate governance, enhance transparency, and preserve the integrity of financial transactions within listed entities.

Disclaimer: This article provides general information existing at the time of preparation and we take no responsibility to update it with the subsequent changes in the law. The article is intended as a news update and Affluence Advisory neither assumes nor accepts any responsibility for any loss arising to any person acting or refraining from acting as a result of any material contained in this article. It is recommended that professional advice be taken based on specific facts and circumstances. This article does not substitute the need to refer to the original pronouncement.