Revisit the related-party regulations

Adhering to a’ one size fits all’ approach could end up making an insignificant transaction appear as ‘material’, which clearly could not have been the intent behind the regulations. It would be meaningful to have a materiality threshold based on a percentage of net worth or turnover.

Sebi on related-party regulations
Under the Companies Act, voting restriction applies to a related party only when it is a part of a transaction. Harmonisation of Sebi regulations and Companies Act would go a long way towards creating a robust regulatory regime and ease of doing business.

By Pankaj Tewari

Related party transactions are in spotlight once again. This time the reasons for upheaval are sweeping changes announced by Sebi. Related party transactions are not per se prohibited. They are regulated. In infrastructure and several other businesses, companies invest in subsidiaries, joint ventures and associates, to have assurance of quality, volume and scale, which in turn helps in ensuring uninterrupted flow of business operations. Such arrangements are essential to ensure business continuity. Equally related party transactions should be on fair terms and not be prejudicial to the interest of public shareholders.

One of the golden principles to interpret a provision of law is to look at the mischief for which the law was enacted. This could be a good barometer to check the effectiveness of a law—whether it is able to mitigate the risk for which the law was enacted in the first place. In that light, are the new regulations onerous or counter-productive? Do they strike the right balance among multiple factors like governance, protection of public shareholders and ease of doing business?

One size fits all—Numerical threshold for material transactions

Pursuant to the recent amendment in Sebi Listing Regulations, a transaction with a related party is material, if it individually or taken together with previous transactions during a financial year, exceeds Rs 1,000 crore or 10% of the annual consolidated turnover of the listed entity, whichever is lower. The concept of materiality is intrinsically connected with the size of the business. A uniform threshold creates parity between two unequal and different companies and is in conflict with the very concept of materiality. Under the amended regulations, a transaction which constitutes just a minuscule percentage of turnover could be deemed as ‘material’ as it breaches the threshold of Rs 1,000 crore. Adhering to a ‘one size fits all’ approach could end up making an insignificant transaction appear as ‘material’, which clearly could not have been the intent behind the regulations.

It would be meaningful to have a materiality threshold based on a percentage of net worth or turnover. In fact, fixed monetary threshold for related party transactions has been done away with in the Companies Act. Replicating the same approach under the Sebi Listing Regulations would ensure harmonisation of two sets of laws.

Voting restrictions on material transactions

Under the current regulations all the related parties are disenfranchised from voting whether or not they are involved in a particular transaction. Under the companies Act and Listing regulations there is a prescribed list of parties which are related to company. It is unreasonable to presume that all the related parties are interrelated and perpetually have a common interest. There are occasions where one related party would have nothing to do in a transaction between the company and another related party. A blanket restriction on voting by all related parties unfairly deprives them of their legitimate right to vote in the affairs of the company. A related party should be barred from voting only if it is a party to a proposed transaction. Further, transactions which are in ordinary course of business and at an arm’s length should also be outside voting restrictions.

The above stringent provisions have also been made applicable to high value debt listed entities. These are entities which have only listed their debt securities and are not public listed entities in the real sense. There could be a situation when such entities comprise only two joint venture partners, both of which by definition, would be ‘related parties’. Since the regulations do not allow related parties to vote, irrespective of their interest or involvement in a transaction, this could lead to impasse and undesirable disruption in business operations.

Under the Companies Act, voting restriction applies to a related party only when it is a part of a transaction. Harmonisation of Sebi regulations and Companies Act would go a long way towards creating a robust regulatory regime and ease of doing business.

Requirement of approval by the Audit Committee of listed company, for the transactions done by its subsidiaries, is contrary to the concept of a separate legal entity—a time-tested principle of company law. This is akin to performing management and governance function of the subsidiary company. It is not aligned with the expected level of oversight, as stipulated under Sebi Listing Regulations, which only require significant transactions / minutes of unlisted subsidiaries to be placed before the board of the listed entity. Approval of transactions done by subsidiaries is outside the ambit of duties of directors as mandated under Sebi regulations. There is a need of alignment between different provisions of Sebi regulations.

Approval of related party transactions only by Independent Directors, may seem to be higher form of governance. But in effect, it undermines the collective responsibility of Audit Committee as an Institution. Audit Committee is an empowered committee established by the Board with a broad mandate. It is expected to discharge its duty as a body. Creating a higher authority within an institution would serve no meaningful purpose. On the flip side, it can create lack of collective accountability.

Sebi has played an exceptional role in regulating the Indian Capital Market and increasing its credibility. The Related Party Transaction regulation requires a relook to serve its intended objective. Good governance and ease of doing business must co-exist.

(The author is group Company Secretary, Bharti Airtel. Views are personal)

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