One of the many changes to the corporate governance norms introduced through the new Companies Act, 2013, was in the manner that the companies were required to handle related-party transactions. The Act defined related parties to include directors, key managerial personnel, their relatives, companies in which they hold 2% shares, companies they are directors of, firms they are partners of and companies that are holding companies or wholly-owned subsidiaries of related parties.
Section 188 of the Act, read along with the rules framed thereunder, makes it mandatory for companies with share capital of over R10 crore to get shareholders’ approval by special resolution before entering into any contract with a related party. The Act also states that the related parties cannot vote on such a resolution. This provision created so much confusion that the ministry of corporate affairs (MCA) had to come out with a general circular in July 2014 clarifying that only such related parties that are parties to the contract or arrangement for which the said special resolution is being passed cannot vote on that special resolution. Other related parties of the company who are not connected with the contract or arrangement in consideration could still vote on the resolution.
But, on September 15, Sebi amended the agreement to state that with respect to shareholders’ approval for related-party transactions, no related party of a listed company could vote on the resolution regardless of whether it is connected to the transaction put up for approval, taking a stance contrary to the MCA’s.
While this move is aimed at empowering minority shareholders and protecting the interests of ordinary investors, what it does is it makes the company’s freedom to contract subject to the whims and fancies of a few. Since all the related parties are excluded, it leaves shareholders holding only a minority of the total share capital eligible to vote upon a special resolution to approve a related-party transaction. Since a special resolution requires 75% or more affirmative votes to pass, shareholders holding 26% of the shares are eligible to vote, which constitutes an even smaller portion of the total shareholding of the company, and can block any related-party transaction.
This provision also disenfranchises small shareholders who happen to be related parties but are entirely unconnected to the transaction being voted upon. They cannot express their approval or disapproval of the same though the transaction impacts their interests as shareholders just as much as it impacts shareholders who are allowed to vote. These shareholders would be allowed to vote on the resolutions if the company had not been a listed company. Thus, Sebi seems to have taken an unnecessarily more stringent stance that seems to be based on an assumption that a related-party transaction shall usually not be beneficial to the company and its shareholders when, in fact, many a times related companies can benefit mutually by finding synergies in collaboration.
Against this backdrop, it seems a positive step that the Companies (Amendment) Bill, 2014, as has been passed in the Lok Sabha, amends Section 188 of the Companies Act to require shareholders’ approval for a related-party transaction by just an ‘ordinary resolution’ rather than a ‘special resolution’, thus reducing the threshold of affirmative votes to just 50% of the votes cast. This move shall allow small shareholders to block a related-party contract if a majority of the unrelated shareholders find it to be unfair while at the same time it shall no longer allow a small minority to block it. It could bring relief to companies such as United Spirits Ltd which disclosed to exchanges that its special resolutions for approval of related-party transactions could not pass since the affirmative votes, though a majority, fell short of the 75% mark.
The passage of the Bill shall make no difference for listed companies unless Sebi makes corresponding amendments to its listing agreement which, through the clause 49(VII)(E), mandates shareholders’ approval by means of a special resolution. If the amendment Bill becomes an Act, Sebi should take the opportunity to bring the listing agreement in line with the Act by allowing approval by simple resolution and allowing related parties which are unrelated to the contract in question to vote on the resolution. The MCA could also adopt Sebi’s stance of excluding all related parties from voting since the threshold for approval would be reduced to a simple resolution. By either of the two ways, uniformity should be sought to be achieved.
The current regime of the Act being clarified through a general circular and the opposite rule being adopted by Sebi is confusing. If the amendment Bill is passed, Sebi and the MCA could bring some uniformity regarding approval of related-party transactions which would be in the interest of both the companies as well as their shareholders.
The author is a student at the Gujarat National Law University