Column: RPTs, both diluted & strengthened!

Updated: Aug 19 2014, 10:06am hrs
By now it should be obvious even to those of you who dont follow law and policy developments closely. The new company lawthe Companies Act 2013has introduced a raft of governance boosting measures. The three key ones are Auditor Rotation, Independent Director Rotation & Related Party Transaction (RPT) scrutiny and approval!

All three have prompted India Inc into an unending whine, about the implementation difficulties and compliance burdens. Some of the pain can be attributed to the reluctance to change. Some changes are burdensome but desirable nonetheless. And, admittedly, in some cases, companies are justifiably cranky. This weekend then gave companies reason to smile.

Why India Inc dislikes Section 188

For the uninitiated, Section 188 requires specified RPTs entered into by a company, and not at arms length or in the ordinary course of business, to be approved by the board/audit committee. The Rules accompanying the section specify certain categories of these RPTs that also need shareholder approval via a special resolution (75% approval). Section 188 also prohibits the interested related party from voting on such a special resolution. So, in cases where the promoter is an interested related party, it cannot vote and the special resolution needs approval from a majority of the minority (public shareholders).

This is the first time company law has gone so far to regulate RPTs and raise the governance standard. The vigilance is borne out of years of watching promoters undertake abusive RPTs in which companies transacted with promoter and related entities with little or no need for shareholder approval or oversight. Section 188 promises to check these malpractices.

But many companies say the law has gone too far. The M&M CFO, V Parthasarathy, indicated that his companys RPTs would cover approximately 20 pages of single line entries. The Tata Group General Counsel, Bharat Vasani, said one group company has over a 1,000 related parties, thanks to a wide definition of the term. Imagine minority shareholders having to scrutinise such large numbers of transactions and decide whether to approve them or not. Many well meaning CFOs believe this will hinder shareholders from focusing on the more material, possibly abusive, RPTs!

Armed with that complaint, India Inc has been lobbying hard with MCA to relax the Rules that determine which transactions need shareholder approval. This weekend they succeeded.

Section 188 rules amended

The MCA amended the Rules, deleted one threshold and diluted the provision. But it also reduced transaction thresholds and thereby strengthened the provision at the same time. To elaboratethe earlier Rules said special resolution approval is needed:

>For all RPTs entered into by a company with a paid up share capital of R10 crore or more;

>For transactions that exceed specified limits.

Most listed companies and many private companies would easily exceed the first threshold, thereby needing shareholder approval for all their RPTs!

So, the new Rules delete the first threshold, i.e., the company size related threshold. But they also reduce the transaction thresholds considerably.

So, if yours is a company with a paid-up share capital of R25 crore, under the earlier Rules, all RPTs that are not at arms length and in the ordinary course of business need special resolution approval. Under the new Rules, only those transactions which are not at arms length and in the ordinary course of business, and that cross the new transaction thresholds, need special resolution approval. This amendment reduces the number of transactions going to shareholders for approval.Now to the transaction thresholdstake sale of goods, for instanceunder the earlier Rules, a sale of goods exceeding 25% of annual turnover needed special resolution approval. Similar thresholds were laid out for rendering of services, leasing of property, etc.

Under the new Rules, a sale of goods exceeding 10% of annual turnover or R100 crore, whichever is lower, needs special resolution approval. Thresholds for all types of transactions have been reduced. So, this amendment increases the number of transactions going to shareholders.

The net effect is that fewer transactions will go to shareholders for approval. But they may not be as few as India Inc had hoped. Because the amended transaction thresholds ensure that all RPTs (not at arms length and not in the ordinary course of business) exceeding R100 crore will need shareholder approval. In a way, MCA has tagged R100 crore as a materiality benchmark of sorts. That means, fewer but more material transactions will need special resolution approval.

Speaking of materiality, Sebi measures RPTS differently, even though its new Clause 49 was, in fact, prompted by the new company law. Sebis new Clause 49 says all material RPTs need shareholder approval via special resolution and defines material to mean a transaction exceeding 5% of annual turnover or 25% of net-worth. Thats a lower threshold than MCAs and hence higher standard RPTs need to meet.

For a listed company, compliance with both MCA and Sebi is necessary. That means an RPT must tick all these boxes to avoid needing shareholder approval via a special resolution:

>At arms length and in the ordinary course of business;

>Less than MCA specified transaction threshold, i.e. for sale of goods, less than 10% of annual turnover and less than R100 crore;

>Less than 5% of annual turnover or 25% of net-worth.

And, by the way, both Sebi and MCA safeguard against creative structuring by providing that the thresholds apply to a transaction or a series of transactions in a financial year. That means a company cannot break up a transaction into smaller ones in order to avoid the specified thresholds and hence a shareholder vote.All this amounts to some relief for companies (fewer shareholder approvals needed) and some relief for shareholders as well (only material transactions to scrutinise). That said, for any of these new provisions to work, shareholders need to read, analyse, object and defeat. The law can only empower shareholders need to do the hard work of wielding it.

By Menaka Doshi

The author is executive editor at

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