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Related-Party Transactions: Do The Revised Rules Compromise Governance?

Ease of doing business or dilution of shareholders’ rights? The revised related party rules paint a mixed picture

(Source: BloombergQuint)
(Source: BloombergQuint)

A recent notification by the Ministry of Corporate Affairs has pitted ease of doing business against corporate governance. The ministry changed the approval threshold for certain related-party transactions. Some experts believe that this will enable faster decision-making by companies. Others say that since many transactions with related parties will now not need shareholder approval, it has lowered the governance bar for corporate India.

RPTs: What’s Changed?

Broadly, the ministry has done away with the numerical threshold for several related-party transactions such as sale and purchase of goods, lease transaction, etc. So far, if the value of any such transaction was above Rs 100 crore or 10 percent of the turnover, shareholder approval at a general meeting was mandatory. The ministry has now removed the monetary threshold. Specifically, the following related-party transactions will get affected:

Sale, purchase of any goods or material and leasing transactions with a related party will now require shareholder approval only if the transaction value exceeds 10 percent of the turnover. The earlier monetary threshold of Rs 100 crores has been removed.

A transaction involving buying, selling or disposing any property to a related party will need to be taken to shareholders only if the property value exceeds 10 percent of the company’s net worth. Here too, the Rs 100 crore value threshold has been done away with.

Transactions with a related party which involve availing or rendering services would require shareholders’ approval only if the value of such a transaction exceeds 10 percent of the company’s turnover. The earlier monetary threshold of Rs 50 crore has been omitted.

Under the earlier regime, companies had to obtain shareholder approval for RPTs breaching the standalone-monetary thresholds, which were invariably much lower than the thresholds linked to a company’s turnover or net worth, Mithun Thanks, partner at Shardul Amarchand Mangaldas, pointed out.

“This led to fallacious situations for large companies where they had to seek approvals even when it had no meaningful co-relation with the actual RPT volume, relative to the company’s financial parameters. This has now been rationalised,” Thanks added.

RPTs: Impact Of Change On Threshold

By doing away with the monetary threshold, the ministry has aligned its regulations to ones prescribed by market regulator SEBI for listed companies. Under the LODR (Listing Obligations and Disclosure Requirements) regulations, all material transactions with a related party need shareholder approval. SEBI has defined materiality to mean transactions whose value—individually or collectively—exceeds 10 percent of the annual consolidated turnover of the listed entity.

Linking the shareholder approval to the turnover will benefit companies, especially where unforeseen transactions had to be carried out with related parties, Madhu Kankani, partner at Deloitte India, told Bloomberg Quint.

Seeking shareholder approval can be a time-consuming process. Companies have indicated the difficulties in getting shareholder approval for unforeseen RPTs at periodic intervals given the time, cost and effort involved. The ministry has now addressed this challenge.  
Madhu Kankani, Partner, Deloitte India

But some experts worry about the impact on governance this change will have.

Ease of doing business is being used to dilute corporate governance standards. Indian markets will inspire the confidence of stakeholders only if regulators hold steady on their regulations and corporate governance standards keep improving, Hetal Dalal, chief operating officer at proxy advisory firm IiAS, said.

Shriram Subramanian, managing director of InGovern Research Services agreed.

Relaxation in threshold level for shareholder approval of RPTs is a regressive step for the interests of minority shareholders, Subramanian said. In many recent instances, like Zee Entertainment Enterprises Ltd. and Dewan Housing Finance Ltd., corporate governance failure is largely due to lack of transparency on related-party transactions.

“With this change in threshold, many RPTs in large groups won’t need shareholder approval. Add to that, with non-enforcement of existing regulations, governance standards will be diluted, and there would be more corporate scams in future,” he said.