Introduction
Lately, abusive Related Party Transactions have become a common term used to signify the tactics adopted by majority shareholders, who in turn are related to the company, to divert the funds of the company. Thus, what rightfully should be used for enhancing the wealth of the shareholders gets diverted to benefit a handful of shareholders controlling majority of the decisions of the company. With the new Companies Act, 2013 and its Rules as well as the new Clause 49 of the Listing Agreement in force, an effort has been made to curb the abuse of Related Party Transaction for personal gain of majority shareholders. There has been a major change in the definition as well as compliances for Related Party Transactions. This article is your guide through the entire concept, compliances, disclosures and changes in the provisions of Related Party Transactions in the Companies Act, 2013 and Clause 49 of the SEBI (Securities and Exchange Board of India) Listing Agreement.
Who are Related Parties as per the Companies Act, 2013?
Related Party with reference to a company, means—
- 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 is a member or director;
- a public company in which a director or manager is a director or holds along with his relatives, more than 2% of its paid-up share capital;
- any 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:
- Provided that nothing in the above two points shall apply to the advice, directions or instructions given in a professional capacity;
- any company which is—
- a holding, subsidiary or an associate company of such company; or
- a subsidiary of a holding company to which it is also a subsidiary;
- such other person as may be prescribed.
Relative with reference to any person, means anyone who is related to another, if-
- They are members of a Hindu Undivided Family;
- They are husband and wife; or
- One person is related to the other in such manner as may be prescribed
Who are Related Parties as per SEBI?
An entity shall be considered related to the company if –
- Such entity is a related party as per the Companies Act (as above), or
- Such entity is a related party under the applicable accounting standards.
What is a Related Party Transaction?
Any contract or arrangement with a related party, with respect to-
- sale, purchase or supply of any goods or material;
- selling or otherwise disposing of, or buying, property of any kind;
- leasing of property of any kind;
- availing or rendering of any services;
- appointment of any agents for purchase or sale of goods, materials, services or property;
- related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company; or
- underwriting the subscription of any shares in or derivatives thereof
The transactions arising out of Compromises, Arrangements and Amalgamations dealt with under specific provisions of the Companies Act, 1956/Companies Act, 2013, will not attract the requirements of this section.
What is a Material Related Party Transaction Under SEBI?
A transaction with a related party shall be considered as material if the transaction to be entered into (individually or taken together with previous transactions) during a financial year > 10% of the annual consolidated turnover of a company as per the last audited financial statements of the company.
Approval of Related Party Transactions under Companies Act, 2013
Whose Approval is required
- The transaction is not in ordinary course of business or is not at arm;’s length or both
- Audit Committee Approval u/s 177(4)(iv)
- Board’s prior consent by a resolution at a meeting
- Shareholder’s approval by a special resolution (in certain cases)
- The transaction is in ordinary course of business and at arm’s length
- Audit Committee Approval
Only the member who is a related party in context of the contract/ arrangement under approval, shall not vote in such meetings.
Related Party Transactions that require prior approval of shareholders by Special Resolution under Companies Act, 2013
Following Related Party Transactions by any company require prior approval of shareholders
- Sale, purchase or supply of any goods or materials > 10% of annual turnover or Rs 100 crore, whichever is lower,
- Selling or otherwise disposing of, or buying, property of any kind > 10% of net worth or Rs 100 crore, whichever is lower,
- Leasing of property of any kind > 10% of turnover or Rs 100 crore, whichever is lower,
- Availing or rendering of any services > 10% of turnover or Rs 50 crore, whichever is lower,
- Such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company, where monthly remuneration > Rs 2.5 Lakh,
- Underwriting the subscription of any securities or derivatives thereof, of the company >1% of net worth.
* Turnover or net worth criteria shall be on the basis of the audited financial statements of the preceding financial year.
*The above limits shall apply to a transaction or transactions to be entered into either individually or taken together with the previous transactions during the financial year.
Approval of Related Party Transactions under SEBI
- All related party transactions shall require prior approval of the Audit Committee.
- Audit Committee may grant omnibus approval for proposed Related Party Transactions subject to following conditions:
- Audit Committee shall lay down criteria for granting omnibus approval,
- Such approval will be applicable for repetitive transactions,
- Such omnibus approval should be in interest of the company,
- The omnibus approval shall specify
- Name of related party,
- Nature of transaction,
- Period of transaction,
- Maximum amount of transaction that can be entered into,
- Indicative base price/ current contracted price, and
- Formula for variation in price.
- Where the need or aforesaid details of Related Party Transactions cannot be foreseen, Audit Committee may grant an omnibus approval provided their value <= Rs 1 crore per transaction.
- Quarterly review by the Audit Committee of the details of Related Party Transactions entered into pursuant to the omnibus approval.
- Validity period of omnibus approvals = 1 year.
- Shareholder’s approval through special resolution for Material Related Party Transactions
The above approvals will not be necessary for Related Party Transactions entered into between two government companies or between a holding company and its wholly owned subsidiary whose accounts are consolidated with the holding company.
These provisions are applicable to prospective related party transactions entered into on or after 1st October, 2014. However any existing material related party contracts or arrangements which are likely to continue beyond 31st March, 2015, should be placed for shareholder’s approval in the first general meeting after 1st October, 2014.
Disclosure under Companies Act, 2013
Details of related party contracts/arrangements/transactions not on arm’s length basis or not in ordinary course of business or both, along with their justification shall be disclosed in the Board’s report to shareholders.
Disclosure under SEBI
- Details of all material related party transactions shall be disclosed quarterly along with the compliance report on corporate governance.
- The company shall disclose the policy on dealing with Related Party Transactions on its website and provide a web link of the same in the Annual Report.
Consequences for non-compliance under Companies Act, 2013
- If any related party transaction is not ratified by the Board/shareholders, as the case maybe, at a meeting within 3 months from the date of the related party transaction, such transaction shall be voidable at the option of the Board.
- Penalties for non-compliance
- Company may proceed against a director/employee, who had entered into contract or arrangement in contravention of the provisions, for recovery of any loss sustained by it as a result of such contract or arrangement.
- Such a director shall be disqualified for a period of 5 years.
- In case of a listed company, such director/employee may be punishable with imprisonment for a term up to 1 year and/or with fine of Rs 25,000 – Rs 5,00,000.
In case of any other company, such director/employee may be punishable with fine of Rs 25,000 – Rs 5,00,000.
Comparison between the Old Act and the New Act
| Sr. No | Changes | Particulars |
| 1 | Definition of “Related party” expanded | Earlier meant
Now also includes
|
| 2 | Scope expanded | The following contracts/ arrangements have been added into the scope
|
| 3 | Removal of certain provisions |
|
| 4 | Addition of certain provisions |
|