Presentation On Related Party Transactions as applicable to Private Companies and Unlisted Public...

Definition of “Related Party” List of “Related Party Transactions” List of Circulars / Notifications / Orders applicable to related party

transactions Board Approval and Shareholders’ Approval Audit Committee Approval / No Central Government Approval Contents of agenda of board meeting and explanatory statement for

shareholders’ meeting Concept of “Interested Directors” and “Interested Shareholders” Treatment of Existing Contracts Concept of “arm’s length transaction” and “ordinary course of

business” Disclosure requirements Penalties for contravention Impact of Companies (Amendment) Bill, 2014 on related party

transactions

Outline

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Definition

• Clear definition of “Related Party” in Section 2(76), with reference to a company, it means:

(i) a director or his relative;

(ii) a KMP or his relative;

(iii) a firm, in which a director, manager or his relative is a partner;

(iv) a private company in which a director or manager or his relative is a member or director;

(v) 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;

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Definition

(vi) any body 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;

(vii) any person on whose advice, directions or instructions a director or manager is accustomed to act;

(viii) provided that nothing in (vi) and (vii) shall apply to the advice, directions or instructions given in a professional capacity;

(ix) any company which is a holding, subsidiary or an associate company; a subsidiary of a holding company to which it is also a subsidiary;

(x) director other than independent director or KMP of the holding company or his relative.

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List of Related Party Transactions

• Clear list of “Related Party Transactions” provided in Section 188, as under:

(a) sale, purchase or supply of any goods or materials;

(b) selling or otherwise disposing of, or buying, property of any kind;

(c) leasing of property of any kind;

(d) availing or rendering of any services;

(e) appointment of any agent for purchase or sale of goods, materials, service or property;

(f) such related party's appointment to any office or place of profit in the company, its subsidiary company or associate company;

(g) underwriting the subscription of any securities or derivatives thereof, of the company.

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List of Circulars/ Notifications /Orders

Circulars

Circular No. & Date Subject Matter

14/2014 dated June 9, 2014

• In view of the provisions of section 188 which take away transactions in the ordinary course of business at arm’s length price from the purview of related party transactions, an independent director will not be said to have ‘pecuniary relationship’ under section 149(6)(c) in such cases

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Circulars


30/2014 dated July 17, 2014

• Related party has to be construed with reference only to the contract or arrangement for which the said special resolution is being passed. Thus, the term related party in the above context refers only to such related party as may be a related party in the context of the contract or arrangement for which the said special resolution is being passed

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Circulars


30/2014 dated July 17, 2014

• Transactions arising out of compromises, arrangement and amalgamation will not attract section 188

• Contracts entered in compliance of section 297 of Companies Act, 1956 which already came into effect before the commencement of section 188 will not require fresh approval under section 188 till the expiry of the original term of such contracts, provided there is no modification. If there is any modification after April 1, 2014, it will require compliance with section 188

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Circulars


32/2014 dated July 23, 2014

• Clarification regarding transitional period for resolutions passed under Companies Act, 1956

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Notifications

Notification No. & Date

Subject Matter

GSR 507 (E) dated July 17, 2014

• Exclusion of independent directors

GSR 590 (E) dated August 14, 2014

• Substitution of sub-rule (3) of Rule 15 of Companies (Meetings of Board and its Powers) Rules, 2014

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Orders

Order No. & Date Subject Matter

S.O.1820 (E) Companies (Removal of Difficulties) Fifth Order, 2014 dated July 9, 2014

• Substitution of word “or” with “and” in sub-clause (v) of sub-section (76) of Section 2

S.O.1894 (E) Companies (Removal of Difficulties) Sixth Order, 2014 dated July 24, 2014

• Insertion of words “or his relative” after the word “manager” in sub-clause (iv) in sub-section 76 of Section 2

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Board and Shareholders’ Resolution

• Board resolution required for all cases except for the following cases for which shareholders’ approval is also required

• Special Resolution of shareholders required only in the following cases of contracts or arrangements exceeding certain value:

• sale, purchase or supply of any goods or materials directly or through appointment of agents exceeding 10% of the turnover or Rs. 100 crores, whichever is lower, as mentioned in clause (a) and clause (e) respectively of sub-section (1) of section 188;

• selling or otherwise disposing of, or buying, property of any kind directly or through appointment of agents exceeding 10% of net worth or Rs. 100 crores, whichever is lower, as mentioned in clause (b) and clause (e) respectively of sub-section (1) of section 188;

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• leasing of property of any kind exceeding 10% of the net worth or exceeding 10% of turnover or Rs. 100 crores, whichever is lower as mentioned in clause (c) of sub-section (1) of section 188;

• availing or rendering of any services directly or through appointment of agents exceeding 10% of the net worth or Rs. 50 crores, whichever is lower as mentioned in clause (d) and clause (e) of sub-section (1) of section 188;

• appointment to any office or place of profit in the company, its subsidiary company or associate company at a monthly remuneration exceeding Rs. 2,50,000 as mentioned in clause (f) of sub-section (1) of section 188; or

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• remuneration for underwriting the subscription of any securities or derivatives thereof of the company exceeding 1% of the net worth as mentioned in clause (g) of sub-section (1) of section 188

• The limits specified in first four bullets above apply for transactions to be entered into either individually or taken together with the previous transactions during a financial year

• “Turnover” or “Net Worth” shall be on the basis of the audited financial statement of the preceding financial year

• Rule 15(2) of Companies (Meetings of Board and its Powers) Rules, 2014 provides that in case of a wholly subsidiary, the special resolution passed by the holding company will be sufficient for a transaction between wholly owned subsidiary and the holding company

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Audit Committee Approval / No Central Government Approval

• Section 177(4)(iv) provides for approval or any subsequent modification of transactions of the company with related parties

• No approval of Central Government required – irrespective of any threshold of share capital or net worth or turnover

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Contents of Agenda of Board Meeting and Explanatory Statement for Shareholders’ Meeting

• Agenda of Board Meeting (Rule 15(1) of Companies (Meetings of Board and its Powers) Rules, 2014

• the name of the related party and nature of relationship

• the nature, duration of the contract and particulars of the contract or arrangement

• material terms of the contract or arrangement including the value, if any

• any advance paid or received for the contract or arrangements, if any

• manner of determining the pricing and other commercial terms, both included as part of contract and not considered as part of the contract

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Contents of Agenda of Board Meeting and Explanatory Statement for Shareholders’ Meeting

• whether all factors relevant to the contract have been considered, if not, the details of factors not considered with the rationale for not considering those factors

• any other information relevant or important for the board to take a decision on the proposed transaction

• Contents of Explanatory Statement • Name of the related party

• Name of the directors or KMP who is related, if any

• Nature of relationship

• Nature, material terms, monetary value and particulars of the contract or arrangement

• Any other information relevant or important for the members to take a decision on the proposed resolutions

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Concept of “Interested Directors” and “Interested Shareholders”

• Rule 15(2) of Companies (Meetings of Board and its Powers) Rules, 2014 provides that interested director shall not be present at the meeting during discussions on the subject matter of the resolutions relating to such contract or arrangement

• Second proviso to section 188(1) provides that no member shall vote on special resolution to approve any contract or arrangement which may be entered into by the company, if such member is a related party

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Treatment of Existing Contracts

• Refer Circular No. 30/2014 dated July 17, 2014

• Refer Circular No. 32/2014 dated July 23, 2014

• No ratification or approval required after April 1, 2014 if terms of contract are not modified

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“Arm’s Length Transaction” and “Ordinary Course of Business”

• “Arm’s length transaction” means a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest

• “Ordinary course of business” is not defined

• Transactions in ordinary course of business and at arm’s length are exempted

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Disclosure Requirements

• Section 134(3)(h) – particulars of contracts or arrangement with related parties to be provided in the board of directors’ report in the form prescribed in Rule 8 of Companies (Accounts) Rules, 2014 – Form AOC-2

• Section 188 (2) requires justification for entering into related party transactions in board of directors’ report

• Rule 16 (1)(c) of Companies (Meetings of Board and its Powers) Rules, 2014 provides maintenance of register of contracts or arrangement with a related party with respect to transactions to which section 188 applies – Form MBP-4 – such register shall be placed before the next meeting of the board and signed by all directors present at the meeting

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Disclosure Requirements

• Section 189(4) – the register to be produced at the commencement of every AGM and shall remain open and accessible during the meeting

• Section 189(5) – no requirement of maintaining register for contract or arrangement

• for the sale, purchase or supply of any goods, materials or services if the value of such goods and materials or the cost of such services does not exceed Rs. 5 lacs in the aggregate in any year; or

• by a banking company for the collection of bills in the ordinary course of its business.

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Penalties for contravention

• Section 188(3) – if contract or arrangement not ratified within 3 months; such contract voidable at the option of the board

• Section 188(3) – if the contract or arrangement is with related party to any director or is authorised by any other director, the directors concerned shall indemnify the company against loss incurred by it

• Section 188(4) – the company is free to proceed against a director or any other employee who had entered into such contract or arrangement in contravention for recovery of any loss sustained by it as result of such contract or arrangement

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Penalties for contravention

• Section 188(5) – contravention by director or any other employee

• in case of listed company – imprisonment up to 1 year or with fine from Rs. 25,000 to Rs. 5 lacs or with both

• in case of any other company – fine from Rs. 25,000 to Rs. 5 lacs

• Section 189(6) – failure to maintain the register and comply with the provisions applicable to register – penalty of Rs. 25,000

• Section 164(1)(g) – a person shall be disqualified to be appointed as a director if he has been convicted of the offence dealing with related party transactions under section 188 at any time during the last preceding 5 years

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Some interesting issues!

• Whether foreign holding company is a related party?

• Transactions between two public companies which were exempted under Companies Act, 1956 are now covered

• What about transactions between two government companies?

• Does a party need to be a signatory to a related party contract to be a related party?

• A related party shareholder though not related to the transaction- is the shareholder entitled to vote on the resolution for that transaction?

• Whether transaction of “shares” and “other securities” covered under section 188? If yes, then whether both primary and secondary transactions covered?

• Whether loan transactions covered under section 188?

• Whether payment of royalty for technical know-how covered under section 188?

• Whether limits under Rule 15(3) are for each transaction or for aggregate transactions?

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Some interesting issues!

• What is the time to test the related party – whether only at the time of entering the contract?

• Appointment of managing director is not office or place of profit

• All kinds of situations other than holding company and wholly owned subsidiary are not provided

• Meaning of implementation of resolution before April 1, 2014 for the purposes of General Circular No. 32/2014?

• What prevails Companies Act, 2013 or Clause 49?

• Additional accountability of independent directors, audit committee and directors

• Whether recording in register of contract also required for exempted transactions on arm’s length basis?

• Concept of urgent necessity as was under section 297 of Companies Act, 1956 is not applicable now

• Whether section 149(6)(e) also exempted for independent director’s transactions at arm’s length in ordinary course of business?

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Companies (Amendment) Bill, 2014

• Bill No 185 of 2014• Passed by Lok Sabha on December 17, 2014• Still to be passed by the Rajya Sabha• Then it will require assent of the President

of India• Shall come into force on such date as the

Central Government by notification in Official Gazette notify

• Supposedly for ease of doing business! Lets see if that really happens!

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Amendments affecting Related Party Transactions

• Section 177 deals with audit committee – The following proviso shall be inserted in sub-section (4)(iv):

“Provided that the Audit Committee may make omnibus approval for related party transactions proposed to be entered into by the company subject to conditions as may be prescribed.”

Impact: The need to obtain approval for each and every related party transactions will be dispensed with just like it is provided in Clause 49 of the listing agreement for listed companies

• Section 188– The words “special resolution” in sub-section (1) and sub-section (3) shall be substituted by “resolution”

Impact: Approval of shareholders for related party transactions wherever required will be by an ordinary resolution and not special resolution. The jury is still out whether it is good or a bad amendment. The real beneficiary of this amendment will be public unlisted companies unless SEBI also amends Clause 49 of the listing agreement

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Amendments affecting Related Party Transactions

• Section 188 – The following fourth proviso to be inserted under sub-section (1):

“Provided also that the requirement of passing the resolution under first proviso shall not be applicable for transactions entered into between a holding company and its wholly owned subsidiary whose accounts are consolidated with such holding company and placed before the shareholders at the general meeting for approval

Impact: Shareholders approval will not be required for related party transactions between a holding company and its wholly owned subsidiaries provided the accounts of the wholly owned subsidiary are consolidated with the holding company and placed before the shareholders at the general meeting for approval. Same exemption as is currently provided by Clause 49 of the listing agreement. Consequently, Rule 15(2) of the Companies (Meetings of Board and its Powers) Rules, 2014 which provides for passing of special resolution by the holding company as sufficient for related party transactions between wholly owned subsidiary and the holding company will be deleted / modified

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Thank You

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Disclaimer:This presentation has been compiled for general information and does not constitute professional guidance or legal opinion. Readers should obtain appropriate professional advice.

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