I. Background

Related party transactions (“RPT”) under Indian corporate laws are primarily governed by: (i) the provisions of Companies Act, 2013 and rules framed thereunder and; (ii) (for listed entities) the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR”). These have consistently been amended over the years, with the last round of amendments to several provisions dealing with RPT under LODR (“RPT Amendments”)^[1] bringing about a paradigm shift in the RPT regime governing listed companies. This post sets out practical challenges being faced by listed entities arising from the RPT Amendments, relating to a substantially wider ambit of “related parties” and “related party transactions”, in addition to absolute quantitative limits being imposed and procedural matters relating to audit committee approval.

II. Key amendments and practical challenges arising therefrom

1. Definition of related party:

The revised definition of ‘related party’ under Regulation 2(1)(zb) of LODR ^[2], now includes any person or entity which: (i) forms part of the promoter or promoter group (irrespective of the shareholding); or (ii) holds 10% or more in the listed entity (either directly or on beneficial interest basis) at any time during the immediately preceding financial year. A summary of some of the challenges faced by listed entities in this regard is set out below:

a.) Keeping track of each person whose shareholding reaches the prescribed threshold at any time during the immediately preceding financial year, especially for public shareholders.

b.) Shareholding of large public shareholders may fluctuate, and also vary materially across financial years – leading to a situation where a shareholder whose shareholding in the current financial year (when classified as a related party) may be low or nil, being classified as a related party for having held more 10% or more in the listed entity at any time in the preceding financial year.

c.) The definition of ‘promoter group’ is fairly wide – and especially for investors who may be classified as promoters, can lead to unintended consequences – as minority portfolio holdings could end up being classified as “related parties”.

2. Definition of RPT:

The definition of RPT has been expanded to include any transaction which involves a transfer of resources, services or obligations (regardless of whether a price is charged or not)^[3] between:

a.) a listed entity or any of its subsidiaries on one hand and a related party of the listed entity or any of its subsidiaries on the other hand; or

b.) a listed entity or any of its subsidiaries on one hand, and any other person or entity on the other hand – the purpose and effect of which is to benefit a related party of the listed entity or any of its subsidiaries^[4]

A summary of some of the challenges faced by listed entities in this regard is set out below:

a.) Subsidiaries of listed entities need not be wholly owned subsidiaries – and many of them are incorporated outside India for business/regulatory purposes. These subsidiaries may have other shareholder(s) (including strategic shareholders) who may be classified as a “related party” of such subsidiary, but may not otherwise have any association with the listed company – this could lead to any usual course business transactions between such subsidiary or any other subsidiary/the listed entity itself being classified as related party transactions.

b.) The list of exceptions to RPT is fairly restricted, and does not cover usual course matters – e.g. regular banking transactions with banks.

c.) The definition has introduced a ‘purpose and effect’ test which seeks to cover counterparties which are not related parties with the intent to prevent transaction whose ‘purpose and effect’ is to benefit a related party, even though such related party is not a party to the transaction. While this is in the nature of an anti-avoidance provision, absence of regulatory guidance on steps which listed entities need to take to demonstrate that management and boards have put requisite safeguards for compliance (coupled with the substantially widened definition of “related party” and “related party transactions”) creates uncertainty.

3. Threshold for material RPT:

Pursuant to the proviso to Regulation 23 (1), a transaction with a related party is considered material, if it exceeds the lower of: (i) INR 1,000 crore; or (ii) 10% of the annual consolidated turnover of the listed entity as per the last audited financial statements of the listed entity – with the quantitative threshold of INR 1,000 crore being introduced by the RPT Amendments.

Large, listed entities (especially those having significant intra-group transactions, including with subsidiaries that are not wholly owned) are having to seek shareholder approvals (which in some cases run into several resolutions) even for routine, ordinary course business transactions. These, given their size and scale, are often not material for such listed entities, but still need to be approved by a majority of public shareholders – and hence impose a compliance burden on listed entities.

4. Prior approval of audit committee of listed entity:

Pursuant to Regulation 23(2)(c) of LODR, from April 1 2023, prior approval of audit committee of the listed entity is required for transactions to which the subsidiary of a listed entity is a party but the listed entity is not a party, if the value of such transaction (whether entered into individually or taken together with previous transactions during a financial year), exceeds 10% of the annual standalone turnover, as per the last audited financial statements of the subsidiary. Especially for larger listed companies with several unlisted and non-material subsidiaries (often with very low turnover), the compliance burden (and role of the audit committee) has substantially increased – since they now need to track, review and approve transactions that exceed 10% of the turnover of such subsidiaries, which may otherwise be immaterial for the listed entity. The audit committee’s role under the LODR is already fairly wide on several material matters concerning inter alia financial statements and controls – and the effectiveness of having to review and approve non-material transactions involving non-material subsidiaries is unclear.

III. The Way Forward:

The above sets out some of the key issues being faced by listed entities- there are several others. Given that the RPT Amendments have been effective since April 2022/April 2023, SEBI may consider a consultation with industry to identify issues/concerns in the RPT Amendments being faced by them (including those set out above), pursuant to which it can consider requisite clarifications/changes – which, while continuing to give effect to the regulatory intent, can also address the industry’s concerns.

Footnotes:

[1] The LODR (Sixth Amendment) Regulations, 2021, (notified in November 2021 and came into effect in parts from April 1, 2022 and April 1, 2023)

[2] This definition shall not be applicable for the units issued by mutual funds which are listed on a recognised stock exchange(s)

[3] The definition excludes the following transactions from the ambit of RPT:

(a) the issue of specified securities on a preferential basis, subject to compliance of the requirements under the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018;

(b) the following corporate actions by the listed entity which are uniformly applicable/offered to all shareholders in proportion to their shareholding:

i. payment of dividend;
ii. subdivision or consolidation of securities;
iii. issuance of securities by way of a rights issue or a bonus issue; and
iv. buy-back of securities.

(c) acceptance of fixed deposits by banks/Non-Banking Finance Companies at the terms uniformly applicable/offered to all shareholders/public, subject to disclosure of the same along with the disclosure of related party transactions every six months to the stock exchange(s), in the format as specified by the Board.

[4] The purpose and effect test is effective April 1, 2023