Related Party Transactions
5 Lacunas That Weaken The Spirit Of Section 188 Of The Companies Act, 2013
![Related Party Transactions](https://lawwallet.in/wp-content/uploads/2021/07/Related-party-transactions.jpg)
The newspapers were flooded with news of Ramalinga Raju when one of the biggest scandals that is ‘Satyam scam’ broke out. The scam shook the nation by being one of the hugest scams in the country. It is ironic, how a company that won an award for corporate governance was later found to be itself full of corporate governance malpractices.
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But how such a big scam came into the picture? The scam came to light when Ramalinga Raju (Chairman of Satyam Computer Services Ltd.) tried to commit a transaction with his related parties. He surprisingly on one fine day announced to acquire stakes in Maytas companies. The Maytas companies were being headed by Raju’s sons. Many investors opposed the decision of acquisition, due to which the decision was reversed. Later, the company was banned by World Bank for 8 years from doing business. A few days later, Ramalinga Raju confessed of committing fraud of around 7,000 crores. He also admitted that the intention of buying stakes in companies headed by his son was to fill the gap accumulated due to frauds committed by him through the years.
He was awarded punishment of fine and rigorous imprisonment by the court.
Table Of Contents:
- The Satyam Scam
- Meaning of Related Party Transaction
- Section 188 of The Companies Act, 2013
- Related Party as per Companies Act, 2013
- Related Party Transaction and Corporate Governance
- Cases of Related Party Transaction
- Lacunas in Section 188 of the Companies Act, 2013
- Conclusion and The Way forward
Meaning of Related Party Transaction
A Related party transaction (hereafter referred to as RPT) is a transaction of an entity with its related party. A related party can be the director, manager etc. of the company.
For example– If a company named XYZ purchases certain goods from its director named A, then it is an RPT.
Both parties share a preexisting relation of transaction or have some common interest.
An increase in RPTs is a reason for worry for the corporate governance structure of companies across the globe. Huge scams in different parts of the globe have roots in RPTs. Enron, Satyam, Jet Airways, Kingfisher etc. are noticeable illustrations of the same.
RPTs can prove beneficial to buy goods and services at a cheaper rate. Thus, not all RPTs are bad.
According to Organisation for Economic Co-operation and Development (OECD), the rise of high-profile cases of RPT is making RPT a more serious and important issue.
Section 188 of The Companies Act, 2013
Section 188 of the Companies Act, 2013 provides for RPT. It enlists all the transactions which when entered between entities will be an RPT. The nature of transaction can be of sale, purchase, dispose of, lease etc. It contains important steps for a company to follow before an RPT transaction.
An approval from the Board and shareholders has to be taken, if the transaction amount exceeds 10% of the company’s turnover or net worth, as the case may be.
A related party is not allowed to vote in a transaction in which he has an interest. It also states that no approval is required if the company performs the transaction fairly in usual business routine.
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Figure 1- Related party Transactions as per Section 188 of Companies Act, 2013.
Related Party as per Companies Act, 2013
Now, the question is, how is it determined whether a person is a related party to the entity or not?
Well. The answer lies in Section 2(76) of the Companies Act, 2013.
The section enlists the parties that are considered as related party as per Companies Act, 2013.
Related Party Transaction and Corporate Governance
RPT’s are usually considered to be risky. Because, when a company enters into transactions with its director, manager etc., it gives room for doubt to investors.
Research on Indian companies confirmed that company’s good governance practices, can reduce the adverse impact of RPT’s on the future performance of the firm.
Cases of Related Party Transaction
In the case of Mohit Kumar Surana v. Healthadda Pvt. Ltd., the petitioner accused the Respondent of committing RPT as the company’s e-commerce website was sold to a related party.
The National Company Law Tribunal (hereafter referred to as NCLT) held that as the petitioner lacks evidence to prove its case, the transfer is not mismanaged.
In Comfort Intech Ltd. v. Ravi Kumar Distilleries Ltd., NCLT ordered an investigation of inspectors in Respondent company as its Annual Reports showed diversion of the funds to its related parties.
In Deccan Chronicle Holdings Ltd. v. Registrar of Companies, certain funds were transferred by the applicant company to its related entity, without taking any approval and interest amount. The NCLT asked the applicant company to pay penalty for the offence committed by it.
Lacunas in Section 188 of the Companies Act, 2013
- Ordinary Course of Business not defined
Section 188 of the Companies Act requires no approval from Board or Shareholder’s if the transaction is in Ordinary Course of Business and at arm’s length.
But the Act remains silent upon what would come within the purview of the term Ordinary course of business. Nor it provides any guidance to determine which transactions should be included and excluded from it.
This leaves room for misinterpretation of the term by directors and companies.
Mr Shriram Subramanian, Founder and MD of Ingovern Research, stated that ‘the Regulators must assure that the absence of definition is not misused by the companies, to enter in transactions without making their disclosure’.
- Definition of Arm’s Length Transaction is uncertain
As stated above, section 188 of the Companies Act, 2013 does not require approval of the Board and shareholders if the transaction is in the ordinary course of business and is at arm’s length.
The Act provides for the definition of arm’s length transaction. It defines it as a transaction between two parties who are related to each other, but conduct the transaction in such a way as if they are not. This avoids any vested interest of the two in the transaction.
The definition provided by the Act seems to be very subjective. There is no proper approach given to determine whether the entered transaction is at arm’s length or not.
Bharat Vasani, Partner of Cyril Amarchand Mangaldas, calls this as a gateway that allows many RPTs to escape from shareholder’s approval.
- High Materiality Requirement
Section 188 of the Companies Act, 2013 requires approval for RPT when the transaction is more than the prescribed limit. This limit is prescribed in Rule 15 of Companies (Meeting of Board and its Powers) Rules, 2014.
Earlier according to Rule 15 of Companies (Meeting of Board and its Powers) Rule, 2014, shareholders’ approval for an RPT was required when the transaction was more than Rs. 100 crores or more than 10% of the turnover of the company.
But the Ministry of Corporate Affairs later removed the threshold limit of Rs.100 crores.
Now, approval is necessary only when the transaction is of 10% or more of the turnover or net worth of the company.
This threshold is very huge. Many companies can enter in RPT by keeping their transaction amount below this threshold limit. It will help them to commit RPTs without taking any approval.
According to Bharat Vasani, Partner of Cyril Amarchand Mangaldas, this threshold is a very high limit. He further stated that many RPT’s are now easily committed by the companies. And shareholders are not getting the opportunity to look into the transaction, as the transaction amounts are below this huge threshold amount.
- Requirement of Ordinary Resolution compromises Corporate Governance
Earlier approval of shareholders for an RPT was taken through a special resolution. But later this requirement of special Resolution was changed to ordinary resolution by the Ministry of Corporate Affairs.
Thus, now an RPT can be easily approved by the shareholders through an ordinary resolution.
Some experts see it as a move to achieve ease of doing business. But many experts also call it a threat to Corporate Governance.
- The Anomaly between Companies Act and Listing Obligations and Disclosure Requirements
Companies Act 2013 and Listing requirements both govern RPT in India for listed companies. But in many instances, they both hold different positions in connection with RPT.
For example, Section 188 of the Companies Act 2013 and Regulation 23 of Listing Requirement, both, prohibited related party from voting in transactions, irrespective of whether the party is a related party to that particular transaction or not.
But later, the Ministry of Corporate Affairs clarified that only the party related to the instant transaction will have to abstain from voting.
Due to this change, both the 2013 Act and Listing Requirements hold different stands on voting by a related party.
So, what will be a promoter’s position, who is a Related party under both laws?
Conclusion and The Way Forward
By analyzing the history of Section 188 of the Companies Act, 2013, it can be observed that it is amended various times to make it more relevant with time. But, still, many loopholes exist in it which are necessary to be urgently filled.
Certain guidelines should be given for determining what comes in the Ordinary Course of Business and Arm’s length transaction.
The threshold for approval of shareholders for RPT should be reduced.
MCA and SEBI should take care, that their RPT provisions work in harmony with each other.
It is necessary to conduct workshops to make shareholders more vigilant towards their rights.
Training to Independent directors is necessary, as they occupy an important place in a company.