RELATED PARTY TRANSACTIONS BY CS B CHANDRA COMPANY

RELATED PARTY TRANSACTIONS BY CS B CHANDRA COMPANY SECRETARY

What is RPT • Self-dealing transactions by corporate insiders = RPT • Economies have moved from controlling transactions to setting the general outlines of the approvals process and its disclosure. • RPTs considered (a) benign i. e on market terms, recurrent, etc • Potentially problematic (large transactions, non-recurrent, potentially not subject to a market test or only with difficulty

Familial disputes • Lack of succession planning by the elders • Decrease in value systems by younger generation • Lack of verticalisation of business • Lack of contractual agreement as to the Roles and responsibility

POSITION OF DIRECTORS Principle underlying this provision is that as fiduciaries, directors must not place themselves in a position in which there is a conflict between their duties to the Company and their personal interests. The law will not allow a fiduciary to place himself in a situation in which judgment is likely to be biased and then to escape liability by denying that in fact it was biased. The object of the Section is that the Board of Directors should be made aware of all contracts and arrangements in which any director has an interest whether direct or indirect so that the Board may be in a position to satisfy itself as to the fairness and reasonableness etc. of the contract from the point of view of the Company and then accord its consent therefore. Otherwise an unscrupulous director may evade the provisions of the Section by withholding information about contracts and arrangements brought about/ entered into by him with the Company, without the Board knowing the fact of his having an interest in the same. Palmer's Company Law states

"In other respects he is, like a trustee, disqualified from contracting with the company and for a good reason, the company is entitled to the collective wisdom of its directors, and if any director is interested in a contract, his interest may conflict with his duty, and the law always strives to prevent such a conflict from arising. The director may enter into a contract only if he makes full disclosure of all material facts to the members of the company, who then approve the contract. " Lord Cairns L. C. in Parker V. Mckenna said "No man can in this court, acting as an agent, be allowed to put himself in a position in which his interest and duty will be in conflict. "

Why Regulate RPT • Dr Irani says “Directors have the duty not to place themselves in a position when their fiduciary duties towards the company conflict with their personal interests. And in case it happens, directors have the duty to prefer interests of the company. Directors should not use company’s assets, opportunities or information for their own profit. ” • duty on every director to disclose to the company, the contracts or arrangements with the company, whether existing or proposed or acquired subsequently, in which he, directly or indirectly, has any interest or concern ( Sec 299)

Irani Recomendations • Manner, time limit extent of disclosure to be defined • General Disclosure as well as disclosure at the time of transaction. • Failure will result in default as well as vacation • Interested director should abstain from participating in the Board meeting • To maintain a register • Board approval & beyond a certain limit, approval of the share holders ( 297/314 CG approval deleted) • .

� "Directors of a limited company are the creatures of a statute and occupy a position peculiar to themselves. In some respects they resemble trustees, in others they do not. In some respects they resemble agents, in others they do not. In some respects they resemble managing partners in others they do not. � Principles of Equity by lord Kames. "Equity prohibits a trustee from making any profit by his management, directly or indirectly. Ultimately the issue in each case will depend upon facts of that case".

� Piery v. S. Mills & Co. Ltd. , (1920) l Ch. 77 & Punt v. Symons, (1903) 2 Ch 506 � "where the shares had been issued by the Directors, not for the general benefit of the company, but for the purpose of controlling the holder of the greater number of shares by obtaining a majority of voting power, they ought to be restrained from holding the meeting at which the votes of the new shareholders were to have been used

� Needle Industries � Directors are not entitled to their powers of issuing shares merely for the purpose of maintaining their control or the control of themselves and their friends over the affairs of the company, for merely or the purpose of defeating the wishes of the existing majority of shareholders

RPTs under the 1956 Act • Sections 299, 297, 314 and 294 AA of then law • AS 18 • Clause 49 of the listing agreement. • Introduction of Section 292 A – Audit committee in respect of public companies

Managing RPTs 1. Definition, 2. Regulation and disclosure, 3. Detection and monitoring approval processes 4. Sanctions

Financial Accounting Standards No. 57 USA • Must include disclosures of material RPT • The disclosures must include : - The nature of the relationships involved - A description of the transactions - The amount of the transactions & any changes - Amounts due from or to RP & the terms of settlement Disclosure of RPT that are eliminated in the preparation of consolidation financial statements is not required

SEC Release No. 34 -45321 USA • Should include a description of all elements of RPT necessary for an understanding of its business purpose: - The identity of RP - How the transaction price was determined - How any evaluation of fairness was made & whethere any ongoing commitments as a result of RPT The effect on the company’s financial statements and special risks or contingencies arising from RPT. It says “Registrants should consider describing the elements of the transactions that are necessary for an understanding of the transactions, business purpose and economic substance, their effects on the financial statements, and the special risks or contingencies arising from these transactions. ”

International Practices – USA “NYSE Listed Company • Disclosure of RPT required in the company’s annual report, proxy statements & SEC fillings • RPT is to be reviewed & evaluated by the Audit Committee or another comparable body • Some RPT require shareholder approval - NYSE Listing Company manual Section 312. 00 “Shareholder Approval Policy” should be considered - Exemptions: - Any public offering for cash; - Any bona fide private financing

UK FRS 8 “Related Party Transactions • • • Disclose the existence of RP & the nature and extent of any transactions with them Requires 2 parts of disclosure: 1) Disclosure of control 2) Disclosure of transactions Exemptions – Transactions with : - Group entities that are eliminated on consolidation - Providers of finance in the normal course of business - Utility companies, suppliers, customers (for huge volume of business) - Government bodies

• When entering into a RPT, the company must : - Make an announcement stating all elements of the - Furnish its shareholders with a circular - Obtain shareholders approval Exemptions include : - Companies without listed securities - Overseas companies with a secondary listing Transactions in the normal course of business Joint investment arrangement on normal terms Small transactions RPT

Chapter XI of UK listing Rules • (1) make a notification in accordance with (a) the name of the related party; (b) details of the nature and extent of the related party's interest in the transaction or arrangement; (c) send a circular to its shareholders (d) obtain the approval of its shareholders for the transaction or arrangement either: (a) before it is entered into; or (b) if the transaction or arrangement is expressed to be conditional on that approval , before it is completed (2) ensure that the related party: does not vote on the relevant resolution; and (b) takes all reasonable steps to ensure that the related party's associates do not vote on the relevant resolution.

Australia “Corporations Law” • (1) For a public company, or an entity that the public company controls, to give a financial benefit to a related party of the public company: • (a) the public company or entity must: • (i) obtain the approval of the public company’s members in the way set out in sections 217 to 227; and • (ii) give the benefit within 15 months after the approval • (iii) or governed by exceptions

Listing Regulations Australia • Prescribe disclosure of all RPT where control or significant influence exist • Disclosure requirements for transactions within the wholly owned group are less detailed than others • Required to disclose items eliminated on consolidation • Disclosure on an individual basis is required when the sum of the RPT is significant • Exemptions – transactions in the normal course of business

Singapore “SAS 21” • All RP relationship involving control should be disclosed regardless of whether RPT occurs • Requires disclosure of : - The nature, types & elements of RPT • Transactions with the following are exempted: - Common directorships - Provider of finance; Trade union - Public utilities; government department & agencies - A single customer, supplier (transacting huge volume of business)

SGX listing regulation • An issuer must make an immediate announcement of any interested person transaction of a value equal to, or more than, 3% of the group's latest audited net tangible assets. • If the aggregate value of all transactions entered into with the same interested person during the same financial year amounts to 3% or more of the group's latest audited net tangible assets, the issuer must make an immediate announcement of the latest transaction and all future transactions entered into with that same interested person during that financial year.

SGX contnd • An issuer must obtain shareholder approval for any interested person transaction of a value equal to, or more than: — • (a) 5% of the group's latest audited net tangible assets; or (b) 5% of the group's latest audited net tangible assets, when aggregated with other transactions entered into with the same interested person during the same financial year. • However, a transaction which has been approved by shareholders, or is the subject of aggregation with another transaction that has been approved by shareholders, need not be included in any subsequent aggregation.

Sum up • A related-party transaction (RPT) refers to a transaction between two parties who are joined by a special relationship prior to the transaction • potential to abuse RPTs is a cause for concern all over the world to both regulators as well as investors • RPTs not only reduce the returns to outside shareholder but also raise doubts on the effectiveness of corporate governance • all RPTs are not abusive or not vice versa • Many high-profile accounting frauds in recent years (such as Enron, Adelphia, Tyco, and Satyam Computers, to name a few) have involved RPTs in one way or the other.

Related party under Cos Act director or a key managerial person or their relatives a firm, private company in which the partner, director/ manager or his relative is a partner a private company or a public company in which a director or manager is a director and holds along with his relatives, more than 2% of its paid-up share capital.

includes a. anybody 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 and b. any person on whose advice, directions or instructions a director or manager is accustomed to act as related party transactions.

Includes any company which is— (A) a holding, subsidiary or an associate company of such company; or (B) a subsidiary of a holding company to which it is also a subsidiary; an investing company or the venturer of the company ( 2017 Act addition)

Who all are excluded? Director or KMP of associate and JV companies Public companies where directors hold less than 2% share capital Any person appointed in senior management in -the company or its holding, or subsidiary or associate company

As per Section 2(77) of Act, a person shall be treated as a “Relative” to another if (i) they are member of HUF (ii) they are husband wife (iii), they are related to each other in any of the following manner: 1. 2. 3. 4. 5. 6. 7. 8. Father (including step-father) Mother (including step-mother) Son (including step-son) Son’s wife Daughter (including step-daughter) Daughter’s husband Brother (including step-brother) Sister (including step-sister)

Section 184 of the Act Disclosure in the first board meeting after the appointment, in every first BM of the FY, first BM after a change Form MBP 1 Any contract in which a director interested directly or indirectly, with a Body corporate in which he is holding more than 2% or with a firm – to disclose again his interest. Shall not participate If violated voidable at the option of the party. Private Companies exempted

MBP 1 9. Disclosures by a director of his interest. -(1) Every director shall disclose his concern or interest in any company or companies or bodies corporate (including shareholding interest), firms or other association of individuals, by giving a notice in writing in Form MBP 1. GAP in the form. Substance over form. Sl. No. Names of the Companies/bodies corporate/ firms/ association of individuals Nature of interest or concern / Change in interest or concern Shareholding Date on which interest or concern arose / changed

Section 188 of the Act • Except with the consent of the Board of Directors at a meeting of the Board no company shall enter into any contract or arrangement with a related party with respect to—(a) sale, purchase , supply, lease of any goods or materials, property, avail/render any service, or appointment to any office or place of profits either in the Company or in subsidiary • Beyond the threshold, except with the prior approval of the share holders.

Transactions covered under Sec 188 Sale, purchase or supply of any goods or materials; Note- “goods” means every kind of movable property other than actionable claims and money; and includes stock and shares, growing crops, grass, and things attached to or forming part of the land which are agreed to be severed before sale or under the contract of sale. (Sec 2(7) of the Sale of Goods Act*, 1930 Selling or otherwise disposing of, or buying, property of any kind; Leasing of property of any kind Appointment of any agent for purchase or sale of goods, materials, services or property Underwriting the subscription of any securities or derivatives thereof, of the company Availing or rendering of any services appointment to any office or place of profit in the company, its subsidiary company or associate company

Exemptions to sec 188 • Transactions in the ordinary course and at arm’s length. • No approval required from members for transactions between holding & WOS. • Not applicable to corporate restructuring • No voting by related party members if the member is the relevant related party. • Transactions which are not in the ordy course/not at arm’s length needs to be disclosed in the Dir’s report. AOC-2

explanation • Arm’s length- transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest. • Serdia Pharmaceuticals (India) (P. ) Ltd. V. CIT • there is no priority of methods or order that needs to follow by the assessed as no method can be claimed to be more reliable than the other. • There is no single Indian Bare Act that defines Arm’s length price compliance in totality or explains how this compliance is demonstrated. There are various Acts though such as the Companies Act, 2013, the Income Tax Act, 1961 and the AS 18 that make a mention of it. It is together with these legislations, various circulars, and notifications from the concerned statutory bodies such as the RBI or SEBI along with customary practice that one can grasp what the principle states and how its compliance is demonstrated.

Determination of transaction to be at arm’s length- Illustrative tests • prices/ discounts/ premiums and on such terms which are offered to • • • unrelated parties of similar category/ profile commercially negotiated transaction pricing is arrived at as per the rule/ guidelines that may be issued by or acceptable for the purpose of Ministry of Corporate Affairs, Government of India/ Income Tax Act, SEBI, terms of contract/arrangement other than pricing are generally on a basis similar to those as may be applicable for similar category of goods and services or similar category/ profile of counterparties may also apply the most appropriate method from any of the following methods as prescribed under Section 92 C(1) of the Income Tax Act, 1961 read with Rule 10 B of the Income Tax Rules, 1962 May seek professional opinion

Ordinary course of business � SA 550 gives examples � Examples of transactions outside the entity’s normal course of business may include: � Complex equity transactions, such as corporate restructurings or acquisitions. � Transactions with offshore entities in jurisdictions with weak corporate laws. � The leasing of premises or the rendering of management services by the entity to another party if no consideration is exchanged. � Sales transactions with unusually large discounts or returns.

Contnd • many of the companies are adopting a position that transaction covered in main objects (or incidental to main objects) in their constitution documents • pattern of frequency, and common commercial practice for businesses are considered key factors • whether a transaction is in ordinary course of business or not may be highly subjective, judgmental and will vary from case-to-case basis

Board meeting Agenda reg RPT • (a) the name and nature of relationship; • (b) the nature, duration of the contract and particulars of the contract; • (c) the material terms of the contract , value; • (d) any advance paid or received • (e) the manner of determining the pricing • (f) whether all factors relevant to the contract have been considered • Similar disclosure in the 102 statement also

Loans to Directors etc • Major changes by the Amendment act 2017 • no scope of any carve out or any route to apply to Central Government’s approval for non-applicability of such restrictions • Deletion of the non obstante clause in Section 185 • The new provisions of section 185 is partly restrictive and partly prohibitive

Sl As per Act, 2013 No. 2017 Prohibition on giving of loan/ guarantee/ Continues to be 1 security to the director of the Company prohibited Prohibition on giving of loan/guarantee/ security Continues to be 2 to the director of the holding company prohibited Prohibition on giving of loan/ guarantee/ Continues to be 3 security to any partner or relative of any prohibited such director Prohibition on giving of loan/guarantee/security Continues to be 4 to any firm in which any such director is a prohibited relative or partner Requires Prohibition on giving of loan/guarantee/security passing of a 5 to any private company of which any such special director is a director or member resolution

6 7 8 Prohibition on giving of loan/guarantee/security to any body corporate at a general meeting of which not less than twenty-five per cent. of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together Prohibition on giving of loan/guarantee/security to any body corporate, the Board of directors, managing director or manager, whereof is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company No parallel provision Requires passing of a special resolution Loans to be utilised by the borrower for its principal activities

Particulars As per Act, 2013 As per Act, 2017 Any loan made by a holding company to its wholly owned subsidiary company. loans made are to be Exempted utilized by the wholly owned subsidiary company for its principal business activities. Continues to be exempted Any guarantee/security provided by a holding company in respect of any loan made to its wholly owned subsidiary company. Provided that the loans made are utilized by the wholly owned subsidiary company for its principal business activities. Exempted Continues to be exempted Not exempted Continues not to be exempted Any loan made by a holding company to its subsidiary company. Any Guarantee given orsecurity provided by a holding company in respect of loan made by any Exempted bank or financial institution to its subsidiary company. Continues to be exempted

Who is RP & what is RPT under LODR • related party‖ means a related party as defined under sub- section (76) of section 2 of the Companies Act, 2013 or under the applicable accounting standards. • transfer of resources, services or obligations between a listed entity and a related party, regardless of whether a price is charged and a "transaction" with a related party shall be construed to include a single transaction or a group of transactions in a contract.

Clause 23 of LODR • To formulate a policy on materiality of RPT • Material RPT – more than 10% of the consolidated turn over. • All related party transactions shall require prior approval of the audit committee • Audit committee to lay down criteria for transactions requiring omnibus approval- repetitive in nature- valid for a period of one year • All material related party transactions shall require approval of the shareholders through resolution and the related parties shall abstain from voting on such resolutions

Exemptions • (a) transactions entered into between two government companies; • (b) transactions entered into between a holding company and its wholly owned subsidiary whose accounts are consolidated with such holding company.

RPT under AS 18 • one party has the ability to control the other party or exercise significant influence over the other party in making financial and/or operating decisions • Control – (a) ownership, directly or indirectly, of more than one half of the voting power of an enterprise, or • (b) control of the composition of the board of directors in the case of a company or of the composition of the corresponding governing body in case of any other enterprise, or • (c) a substantial interest in voting power and the power to direct, by statute or agreement, the financial and/or operating policies of the enterprise • Significant influence - participation in the financial and/or operating policy decisions of an enterprise, but not control of those policies.

Considered related if at any time during the reporting period one party has the ability to control the other party or exercise significant influence over the other party in making financial and/or operating decisions • enterprises that directly, or indirectly through one or more intermediaries, control, or are controlled by, or are under common control with, the reporting enterprise including holding companies, subsidiaries and fellow subsidiaries

Not related parties- Companies having merely common directors unless the director is able to affect the policies of both companies in their mutual dealings a single customer, supplier, franchiser, distributor, or general agent with whom transaction of a significant volume of business merely by virtue of the resulting economic dependence • Parties in the course of their normal dealings with an enterprise by virtue only of those dealings providers of finance; trade unions; public utilities; government departments and government agencies including government sponsored bodies

Ind AS 24 • A few major additions • NED may also be considered KMP if NED is involved and is having a • • • significant influence may be said to be KMP. Change in the definition of control AS 18 - ownership, directly or indirectly, of more than one half of the voting power of an enterprise. Ind AS 24 - Combination of all the below (a) power over the investee; (b) exposure, or rights, to variable returns from its involvement with the investee; and (c) the ability to use its power over the investee to affect the amount of the investor’s returns.

• The entity and the reporting entity are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others). • Group - The entity and the reporting entity are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others • Associate or JV of member of a group is an addition

• Both entities are joint ventures of the same third party- If A ltd has JV 1 (formed by A & B) and JV 2 (formed by A & C) then JV 1 and JV 2 are related parties. • One entity is a joint venture of a third entity and the other entity is an associate of the third entity- If A ltd has JV 1 (formed by A & B) and A ltd holds 25% in Z Ltd then JV 1 and Z Ltd are related parties. • Post employment benefit plan

Cost Audit Report- 21. Related Party Transaction Sl. NO Name & Address of the Related Party Nature of Transaction (sale, purchase etc. ) Good(s)/s ervice(s) Amo Normal unt Price Qu Transfer anti Price ty Basis adopted to determine the Normal Price

Are requirements of 2013 Act, Accounting Standard and SEBI requirement with respect to related party aligned? � 2013 Act requires disclosure at the time of entering into contract or arrangement whereas accounting standard requires disclosure at the time of entering into a transaction. � Revised clause 49 requires shareholders’ approval for all material related party transaction with no exception for transactions in ordinary course of business or at arms-length. Definition of material transactions differs.

A corporate group has several foreign subsidiaries. Will provisions in relation to related parties apply to foreign companies as well? transactions by Indian company with a foreign company which is a subsidiary, associate, fellow subsidiary, would be covered based on understanding of combined reading of revised clause 49 and 2013 Act

Some interesting case laws Where applicant company transferred certain funds to its related concern without taking approval of concerned authority and thereby contravened provisions of section 297 of 1956 Act, even though said amount was received back from related concern after 3 years without charging any interest, yet it caused substantial loss to shareholders of company and, therefore, applicant's application seeking compounding of offence was to be allowed subject to payment of huge compounding fee

Contnd Where defaults by MD were incurable and not done due to any bona fide omission, and offences committed, if compounded, would demolish and prejudice prosecution, MD would not be entitled to compounding of offences

Section 295 against Ro. C Where transactions were conducted at arm's length and accounts being maintained, merely because company did not refer totality of transactions would not preclude it from later disclosing entire range of its business and it could not be presumed that loans were made available in guise of trade advances alleging violation of section 295(1)(e). Where plausible interpretation to any provision for treatment of account or Accounting Standard by company or its officer fell foul with Registrar's understanding of same provisions, same would not amount to violation of provisions of section 211

Breach of duty If the company suffers any loss on account of breach of duty on the part of a director, he is liable to reimburse the company to the extent of such loss. Where a company had realisable debts which were allowed to become timebarred as the director did not take any action for realization. Held that since the breach of duty on the part of the respondents was apparent, they were liable to reimburse the company.

If A is related to B, does it mean that B is related to A? No. If A is related to B, this does not essentially mean that B is also related to A. One has to refer to the definition of ‘related party’ under the Act, 2013 to establish the relationship of related party. For instance, Company A is accustomed to act according to the directions of Company B, however, Company B is not accustomed to act according to the directions of Company A. In this case, though B is a related party to A, A is not a related party to B.

By having a common director of two private companies , they become related parties? Yes. Section 2 (76) (iv) of the Act, 2013 provides that if a director or manager of any company (private or public) is a director or member in private company, then the private company would be a related party to the other company. Whether by virtue of having a common director of two public companies, they become related parties? No, by virtue of merely being common directors, since section 2 (76) (v) of the Act, 2013 provides that if a director or manager of any company is a director AND holds along with his relatives more than 2% of the paid up share capital of a public company, then such public company would be treated as a related party to the other company.

A director in company A does not hold any shares in public company B but his relatives hold more than 2% paid up share capital in B. Will A & B still be related? Director he alongwith his relatives is still holding more than 2% of the paid up share capital in B. Here the expression alongwith will have to be seen in an expansive sense and not in a restrictive sense. It will not serve the purpose of the definition if a director could get away with the impact of the section merely by parking his interest in B in the name of his relatives. Therefore, A and B will be related parties under the Act, 2013.

A is a member of company B, and is also a related party to B. In this scenario, can A vote on the resolution to be passed by B for entering into a RPT? Voting is prohibited only to the particular contract in which he is a related party. MCA vide circular dated 17 th July, 2014 has clarified What will be the position in case of a wholly owned subsidiary company, where the holding company is the only member of the subsidiary and is also a related party? In terms of the 3 rd proviso to section 188(1), transactions between holding and wholly owned subsidiary company need not require approval of members.

A is a related party to B but is not interested in the resolution of members for RPT. Can A vote on the resolution to be passed for entering in a RPT? Clarified vide MCA Circular dated 17 th July, 2014. But not for listed Companies if the approval is also under Clause 23 of LODR Will RPTs which are on an arms’ length basis but does not take place in the ordinary course of business be covered by the provisions of Section 188 (1) of the Act, 2013? RPT to be exempted from the provisions of Section 188 (1) of the Act, 2013 must necessarily be in the ordinary course of business. It is prerequisite for availing the exemption.

B is the daughter of A who is a Director of a Listed Company. It is proposed to appoint her as a HR Head of a WOS of the listed Company , which is incorporated outside India on a salary exceeding Rs 2. 5 Laks p. m To examine whether a related party, criteria for appointment to decide if it is in Arm’s length. No guidance under the new law. Can rely on the Rules made under erstwhile Section 314 of the Act 1956.

Two Listed Companies. Relatives of each other are Directors of the Listed Companies. One listed Company plans to invest upto the permitted % of shares in the other Company by buying in the open market. Is there any compliance as RPT?

Listed Company. Whether the following transactions are RPTs under the Companies Act/ LODR? 1. Loan to its Subsidiary 2. Purchase/sale with its WOS regd outside India- quantum more than 10% of the consolidated turnover 3. Expenses incurred on behalf of the WOS. No margin intended while recovering.

Company is appointing a CFO. Remuneration above the limits mentioned in Section 188? Is it RPT?

Last one Listed Coy- Director pledges his investments in the Company to bank for the loan availed by the Coy. Is it RPT?

CONCLUSION • Not all RPT are necessarily disadvantageous to issuer • Accounting standards tend to focus on identification and measurement of RPT not disclosure • Over reliance on management and principal owners to identify RP and RPT • Proactive role of Audit Committee, Board and major shareholder • Check and balance • Strong regulatory framework, active watchdogs and effective enforcement are key success factors • Rule based procedures no substitute for honesty and integrity