[Opinion] Analysis of Related Party Transactions

CS Sheshank Dubey – [2024] 159 taxmann.com 138 (Article)

Background

On January 22, 2020, Securities Exchange Board of India (“SEBI”) issued a report on Related Party Transactions (“RPT”) to review process of RPTs under the Listing Regulations. further, SEBI issued a circular on November 09, 2021, to incorporate the changes suggested in the report. The rationale of the proposed changes suggested in the Report is to tackle structures consisting of shell or apparently unrelated companies that have been used to siphon off large sums of money by circumventing the existing regulatory framework of RPTs.

Introduction

RPTs is a transfer of resources, services or obligations between two parties, irrespective of whether a price is charged or not. With respect to a corporate entity, related parties would broadly consist of its executives, directors or promoters, who are responsible for making decisions for the corporate entity. RPTs are inclined to abuse by persons in control of the decision making of the corporate entity for personal gains and are therefore, strictly regulated under most regimes. RPTs, if misused, will cause significant loss of value of the corporate entity entering into the RPT. In India, where the existence of promoter driven and closely held companies is prevalent, the risk of abuse by way of RPTs is relatively high.

RPTs can be regulated either by way of a substantive review or a procedural review. Substantive review of RPTs would involve examining the terms of the transaction and evaluating the fairness of the transaction. Procedural review of RPTs would involve judging the fairness of the transaction on the basis of the procedure through which the RPT was executed. In India it is a combination of both, substantive and procedural review.

Legislative History

Clause 49 of listing agreement – Under the erstwhile listing agreement, several disclosure requirements with respect to RPTs were mandated and the audit committee of a listed entity was required to review the disclosure of related party transactions in the annual financial statements with the management of the entity before submission to the board of directors for their approval.

Companies Act, 1956 – The concept of related party transactions was not explicitly defined in the Companies Act, 1956 (“1956 Act“). However, restrictions were imposed on certain kinds of transactions with certain related parties by way of Sections 294, 294A, 294AA, 297 and 314 of the 1956 Act.

Companies Act, 2013 – In 2005, the report of the J.J. Irani Committee on Company Law stated that it would be appropriate to have a ‘shareholder approval and disclosure-based regime’ in India for regulating transactions in which directors or their relatives are interested as opposed to the ‘government approval based regime’ as existing in 1956 Act. Committee further suggested that transactions between a company and director or persons connected with the director with regard to the sale or purchase of goods, materials or services above a certain materiality threshold should require mandatory shareholders’ approval by way of a special resolution. These recommendations were later reflected in the Companies Act, 2013 (“Companies Act“).

While taking note of some of the recent issues in relation to RPTs, the SEBI Working Group observed that one commonality in major corporate wrongdoings was that they were allegedly carried out by persons with the ability to influence the decisions of the company. Shell or apparently unrelated companies, controlled directly or indirectly, by such persons were purportedly used to siphon off large sums of money through the use of certain innovative structures, thereby circumventing the regulatory framework of RPT.

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