In context, where around 70% of listed entities are owned or controlled by promoters, SEBI faces a daunting task in curbing the concerning trend of abusive RPTs. The question that arises is:
Are these regulations sufficient to prevent the diversion of resources from the listed entity to entities within the promoter group?
Starting from April 1, 2022, SEBI introduced new rules for Related Party Transactions (RPTs) in a bid to enhance corporate transparency. These rules mandate that all RPTs must be approved by the Board of Directors, unless they’re part of regular business activities and conducted fairly between related parties. However, the broad scope of these rules raises questions about their practicality and potential unintended consequences.
The rules set a limit of 1 crore per transaction for blanket approval of RPTs. This approval, valid for a year, applies to repetitive transactions. But the wide-ranging nature of these regulations could lead to implementation challenges and unforeseen outcomes. For instance, the regulations define a ‘fair’ transaction as one where the price applied is the same as it would be between unrelated parties. However, this definition might be open to interpretation and misuse.
According to the ICSI Guidance note on RPTs, several factors are considered to determine whether an activity is in the ‘ordinary course of business’. These include whether the activity is covered in the objects clause of the Memorandum of Association, whether it is in furtherance of the business, whether it is normal or routine for the particular business, whether it is repetitive/frequent, and whether the income earned from such activity is treated as business income in the company’s books of account. Other factors include whether the transactions are common in the particular industry, whether there is any historical practice to conduct such activities, the financial scale of the activity with regard to the operations of the business, the revenue generated by the activity, and the resources committed to the activity. This has been observed by the courts in various cases, including M/S Bharti Televentures Ltd. v. Addl. Jt. Commissioner of Income Tax, where the Delhi High Court held that the Memorandum and Articles of Association is not conclusive for deciding whether an activity is in the ordinary course of business of the company.
Furthermore, the requirement for a company-wide vote when transactions exceed 10% of the company’s turnover or net worth adds another layer of complexity. This could potentially lead to significant impacts for both the listed entity and the subsidiary company involved if any of these RPT resolutions do not come into fruition because of the actions of minority shareholders.
The regulations also consider a transaction significant if it exceeds 1000 crores or 10% of the company’s annual consolidated turnover. While this rule aims to prevent misuse, it might unintentionally hinder legitimate business transactions within large corporations. For instance, legitimate business transactions carried out at an arm’s length basis within a large business conglomerate involving holding, subsidiary, or associate companies, would require approval of the audit committee.
The new rules have expanded the definitions of ‘Related Party’ and ‘RPTs’ to include any person or entity that holds 20% or more shares in the listed entity. This expansion, while aiming to increase transparency and accountability, raises concerns about potential over-regulation. The potential risk of disenfranchisement increases significantly when the 20% threshold is lowered to 10%, starting from April 1, 2023.
The lowering of the threshold for shareholder approval from 10% of annual consolidated turnover to a fixed limit of INR 1000 crore is another contentious issue. This new limit, while aiming to ensure greater scrutiny of RPTs by shareholders, might unintentionally stifle regular operational transactions. For instance, the revised threshold has created scenarios where prior approval from shareholders is necessary even for ordinary operational transactions between the listed entity and all its subsidiaries or the companies within the group.
In conclusion, while the new rules for RPTs aim to enhance transparency and accountability, they might have unintended consequences. A more nuanced approach, considering the unique characteristics of the Indian corporate landscape, might be necessary to ensure these regulations don’t hinder legitimate business transactions or lead to over-regulation.”
