A key feature of the Companies Act 2013 is that it relies on rules to regulate: two-thirds of the provisions of the new Act are regulated through the Rules. The Act provides for substantial delegation of powers to the ministry of corporate affairs (MCA) to frame rules for implementation of the new law. All along corporates feared that the MCA would misuse its rule-making powers. With the clarification on related party transactions issued last month, it is the investors who are feeling short-changed.
Indian companies are characterised by the presence of owner-managers. This works well, because the “manager” has “skin in the game”. It also allows owners to take a generational view of the business: what is good for one has to be good for all. The downside is that the controlling shareholders can push through resolutions that benefit them in the short- to medium-term, at the expense of minority investors: royalty payments and payment for brands and merging unlisted companies which they own with listed companies, at valuations that would not pass muster. Shareholders have looked helplessly on, as these transactions were pushed through.
The 2013 Act made such transactions a focus area. It recognised shareholder democracy could not be at the expense of shareholder value and legislated that all transactions with related parties which are not in the ordinary course of business and which are not at arm’s length required the consent of its Board; those above a certain threshold needed shareholder approval. The Act identified typical ways in which promoters benefit themselves (in addition to the items listed above, it includes selling or otherwise disposing of, or buying, property of any kind; leasing of property; appointment of any agents for purchase or sale of goods, materials, services or property; appointment to an office of profit, in the company, its subsidiary or associate). The Act also defines who is a related party.
On July 17, the MCA clarified that a shareholder will be considered a related party only with reference to a contract/arrangement for which the ‘said special resolution’ is being passed. This has led to a more aggressive interpretation being applied by corporates who now take it to mean interested parties. This enables a large set of shareholders who are likely to benefit, but are not “related” in a legal sense, to vote their shares.
How this can impact outcomes can be seen in the