Column: The investor-unfriendly RPT norms

Updated: Aug 20 2014, 09:34am hrs
A key feature of the Companies Act 2013 is that it relies on rules to regulate: two-thirds of the provisions of the new Act are regulated through the Rules. The Act provides for substantial delegation of powers to the ministry of corporate affairs (MCA) to frame rules for implementation of the new law. All along corporates feared that the MCA would misuse its rule-making powers. With the clarification on related party transactions issued last month, it is the investors who are feeling short-changed.

Indian companies are characterised by the presence of owner-managers. This works well, because the manager has skin in the game. It also allows owners to take a generational view of the business: what is good for one has to be good for all. The downside is that the controlling shareholders can push through resolutions that benefit them in the short- to medium-term, at the expense of minority investors: royalty payments and payment for brands and merging unlisted companies which they own with listed companies, at valuations that would not pass muster. Shareholders have looked helplessly on, as these transactions were pushed through.

Click here for graph

The 2013 Act made such transactions a focus area. It recognised shareholder democracy could not be at the expense of shareholder value and legislated that all transactions with related parties which are not in the ordinary course of business and which are not at arms length required the consent of its Board; those above a certain threshold needed shareholder approval. The Act identified typical ways in which promoters benefit themselves (in addition to the items listed above, it includes selling or otherwise disposing of, or buying, property of any kind; leasing of property; appointment of any agents for purchase or sale of goods, materials, services or property; appointment to an office of profit, in the company, its subsidiary or associate). The Act also defines who is a related party.

On July 17, the MCA clarified that a shareholder will be considered a related party only with reference to a contract/arrangement for which the said special resolution is being passed. This has led to a more aggressive interpretation being applied by corporates who now take it to mean interested parties. This enables a large set of shareholders who are likely to benefit, but are not related in a legal sense, to vote their shares.

How this can impact outcomes can be seen in the case of the two JSW group entities that put a related party resolution to vote. The first on July 23, before the full import of the MCA clarification was clear, and the second on July 31, after the advantage of these clarifications had been absorbed. On July 23, the promoters voted only 0.1% of their holding. By July 31, this had gone up to 85.4%. What was this resolution The promoter group was seeking approval to pay R150 crore in aggregate annually as brand royalty, to one of its own.

The 2013 Act has been over 10 years in the making: the MCA followed an extensive consultation process with companies, industry and professional bodies. Since the passage of the Act and the notification of the rules in April this year, the MCA has issued 34 clarifications, with more to come. These address issues relating to drafting errors or clarifications or ironing out lapses. Changing the interpretation of related party to mean interested party, knowing that it facilitates egregious behaviour, is indefensible.

In sharp contrast, Sebi, mindful of the concern of investors, has proposed that as far as related party transactions are concerned, these checks need to be put in place. These again vary from transactions being approved by the audit committee to these being put to shareholders to vote. Sebi has proposed a more stringent definition than the MCA, of what constitutes a related party transaction. And like the MCAs original proposal, it has proposed that all related (and not just the more narrowly defined interested party), abstain from voting on these resolutions.

The MCA, for now, seems to weigh in on the ease of doing business. Sebi, as market regulator, is focused on the healthy development of the markets, which can happen only if investors trust companies they invest in. Investors have taken comfort with what Sebi has proposed.

In passing the 2013 Act, the MCA promised to raise the bar on corporate governance, with related party transactions being an area of focus. This tweak tilts the balance significantly against investors and away from the goals that the MCA set for itself. The ministry needs to review its current stance, and renew its promise to investors.

Amit Tandon

The author is with Institutional Investor Advisory Services India Ltd