Related party transactions: Govt, Sebi at the table to cut inconsistencies

The Act itself follows a “principle of arm’s length in normal course of business”.
The Ministry of Corporate Affairs (MCA) is holding consultations with the Securities and Exchange Board of India (Sebi) to iron out inconsistencies between the Companies Act and the Sebi (Listing Obligations and Disclosure Requirements, or LODR) Regulations over related-party transactions (RPTs). 

“There is some difference in yardsticks between the Act and LODR, which can lead to a situation where a listed company has to comply with the both. It may leave the company in a very awkward situation,” a senior government official said.

The government wants to remove certain complexities, and make both the guidelines consistent with one another. “Sebi can be the gold standard. But we have to have a common approach,” the senior official said.

To begin with, the scope of a related party is much larger under Sebi’s rules. As an extension to Companies Act norms, LODR states that any person or entity belonging to the promoter or promoter group of the listed entity and holding 20 per cent or more of shareholding in the listed entity shall be deemed to be a related party.

The Act itself follows a “principle of arm’s length in normal course of business”. The MCA is of the opinion that a principle-based approach is better than a definition as it keeps the law simpler. “If anyone is found to be in contravention of the principle, he can be investigated or prosecuted,” the senior official said. 

Last year in November, the MCA in an order revising the rules for RPTs did away with monetary threshold and kept it at 10 per cent of the turnover, to bring the law to parity with Sebi’s.

Some differences still remain. While Sebi counts the related party share as part of the consolidated turnover, the MCA takes only the share in a single legal entity into account.

Moreover, in the Act, transactions on the basis of arm’s length and ordinary course of business will not require shareholder approval even if they breach threshold limits. But as per LODR all such transactions require shareholders’ nod.

Also, the Companies Act prescribes different thresholds for different nature of transactions. Under LODR, a single threshold has been prescribed for all nature of transactions.

These loopholes in the current provisions under the Act, experts say, give leeway to corporations to escape approvals.

“A particular RPT may require shareholders’ approval under LODR, but not under the Act, and vice-versa, therefore there is a need to bring parity... the MCA should also consider reviewing the subjectivity in the board and shareholders’ approval process under the Act,” said Ankit Singhi, partner, Corporate Professionals.

Sebi has proposed to tighten the norms governing RPTs at listed companies in order to prevent their misuse, and safeguard the interests of minority shareholders. The regulator has proposed widening the definition of related party and RPTs, changing the threshold for determining RPTs, and tighter disclosures and approvals.

A nine-member expert panel led by Ramesh Srinivasan, managing director of Kotak Mahindra Capital, recommended a change in the definition of related party to cover any person or entity that directly or indirectly exercises control, irrespective of shareholding.

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