Will related-party transaction norms work?

Apr 04 2014, 03:02 IST
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SummaryClause 188 of the Companies Act will bring transparency but compliance would be a troublesome affair

The Companies Act, 2013, in line with the theme of raising the bar on governance, places a lot of emphasis on investor protection and on related-party transactions. This is in line with Sebi’s focus on curbing abusive related-party transactions. Accordingly, both the Companies Act and the recent decision of Sebi to amend the listing agreement bring in certain onerous requirements and some newer conditions for companies to comply with as they undertake related-party transactions together with disclosures to enable more transparency. The previous requirement for central government approvals have been done away with and instead a self-regulatory mechanism has been introduced.

Under the Companies Act, all related-party transactions, whether covered under Clause 188 of the Act or not, are mandatorily required to be pre-approved by the audit committee; this is a baseline approval requirement. Further, Clause 188 of the Companies Act, 2013, along with the relevant rules, which has come into effect from April 1, 2014, requires the Board and the minority shareholders’ pre-approval for all related-party transactions that are not in the ordinary course of business or not at arm’s length, where companies either have paid share capital in excess of R10 crore or where the transactions meet certain monetary thresholds.

The Sebi requirements go a little further and require all material related-party transactions, even if they are at arm’s length, to be subject to a minority shareholder approval.

These provisions put the onus on the Board to justify the related-party transactions and hence management needs to provide basis of pricing and other commercial terms, as well as factors considered in determining the price and other aspects considered irrelevant by them. This will compel management to maintain details and rationale in relation to determining the pricing and other terms of every transaction in order to demonstrate whether prices are at arm’s length. In addition, the Board will now have to report every contract or arrangement with related party along with the justification of entering into the contract.

The corporate affairs ministry took into account the comments on the draft rules and made changes to the final rules on the definition of ‘relatives’ and on related-party transactions. Key changes to the final rules include:

l Related-party definition rationalised. Directors and key managerial personnel of subsidiary and associate companies are not included any more. Further, senior management personnel (such as functional heads) are no longer part of the related parties definition under the final rules.

l Relatives

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