Amidst growing concerns regarding extensive abuse of related party transactions ("RPT(s)") in Indian listed companies, in November, the Securities and Exchange Board of India ("SEBI") constituted a working group (the "SEBI Panel") to review the policy space pertaining to RPTs in India. The SEBI Panel was chaired by Mr. Ramesh Srinivasan, Managing Director and CEO of Kotak Mahindra Capital Company Limited, and the SEBI Panel's report1 (the "Panel Report") was released for public comments on January 27, 2020. The Panel Report proposes several extensive changes to, and explicitly recognizes the need for fortification of, the current RPT regulatory regime in India.
The Panel Report has proposed a gamut of comprehensive recommendations that seek to overhaul the corporate governance regime for RPTs, including recommendations in relation to disclosure requirements, and monitoring and enforcement of regulatory norms. Perhaps the most significant, amongst the recommendations of the SEBI Panel, are certain recommendations that are geared towards ensuring that a broader range of transactions are brought under the purview of the corporate governance regime applicable to RPTs. The SEBI Panel has proposed significant additions to the definitions of 'related party' and 'related party transaction' in the listing and disclosure requirements prescribed for listed companies under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (the "LODR"), which seek to plug regulatory loopholes that have previously allowed listed companies to indirectly circumvent the regulatory requirements applicable to RPTs.
Scope of 'related party' widened.
Seeking to expand the scope of the entities that constitute related parties of a listed entity, the SEBI Panel has proposed the following changes to the definition of 'related party' under the LODR:
- All Promoters are proposed to be included in the definition of 'related party.'
- The SEBI Panel has recommended that all persons / entities that are promoters or members of the promoter group of a listed entity ("Promoter(s)") be considered as related parties of such listed entity, irrespective of their shareholding.
- As per the existing definition under the LODR, a Promoter of a listed entity is considered to be a 'related party' of the listed entity, only if such Promoter holds 20% or more shareholding in such listed entity.
- This proposed expansion in the scope of the definition of 'related party' takes into account that a Promoter may exercise control over, and consequently, influence the decision making of, a listed entity, regardless of the extent of its shareholding. Since a large percentage of Indian businesses are structured as intrinsically linked group entities that operate as a single economic unit, with the Promoters exercising influence over the entire group, this policy recommendation can be expected to have an especially substantial impact on transactions entered into by Promoters with listed entities.
- Significant non-Promoter shareholders are proposed to be included in the definition of 'related party.'
- The SEBI Panel has also recommended that shareholders who are not classified as Promoters of a listed entity, but who hold 20% or more of the total equity shareholding of the listed entity (whether directly or indirectly, including with their 'relatives'), be considered as related parties of such listed entity. Based on an examination of the current legal position, the SEBI Panel was of the view that a shareholding of 20% is sufficient to allow a shareholder to exercise 'significant influence' over the decisions of the listed entity, by virtue of its shareholding. With regard to the proposed clubbing of shareholding of shareholders, with their relatives' shareholding, the SEBI Panel has recommended for the scope of the term 'relative' to remain unchanged (the existing definition of 'relative,' with reference to a person, refers to their spouse, parents, siblings, children, children's spouses and members of their Hindu undivided family).
- Further, this recommendation of the SEBI Panel is aligned with the position under law in several sophisticated jurisdictions (including the United Kingdom, Italy and Korea), in which shareholders with shareholding above certain thresholds are deemed to be related parties, based on their ability to influence the decisions of the company.
Broadening of the range of transactions regulated by RPT norms.
The SEBI Panel has proposed that transactions entered into by subsidiaries of listed companies, as well as transactions undertaken by a listed company or its subsidiary (whether directly or indirectly), with the intention of benefitting related parties, be brought within the purview of the regulatory approval requirements applicable to RPTs.
- Transactions by subsidiaries of listed entities are proposed to be regulated.
- The SEBI Panel has proposed including transactions entered into by subsidiaries of a listed entity within the scope of the definition of 'related party transactions' under the LODR. Further, transactions between a listed entity or its subsidiaries on the one hand, and a related party of the listed entity or its subsidiaries on the other, are also proposed to be included within the scope of this definition.
- This is a deviation from the current scope of 'related party transactions' under the LODR, which solely includes transactions between a listed entity and its related party. Under the present regulatory regime, neither the LODR (except for sale, disposal or leasing of 20% or more of the assets of a material subsidiary), nor the Companies Act, 2013, specifically requires any approvals to be obtained at the level of the listed entity, in respect of transactions undertaken by a subsidiary of a listed entity, or in respect of transactions undertaken by a listed entity with a related party of a subsidiary.
- Transactions that benefit related parties are proposed to be regulated.
- The SEBI Panel has also recommended broadening the definition of 'related party transaction' under the LODR, to include transactions undertaken by the listed entity or its subsidiaries, for the purpose of, and having the effect of, benefiting a related party of the listed entity or its subsidiaries.
Accordingly, pursuant to these proposed changes, the corresponding approval and disclosure requirements under the LODR, including the requirements for audit committee and shareholders' approval (with certain specified exemptions) will become applicable to this broader range of transactions that are proposed to be included within the scope of the definition of 'related party transactions.'
Given their propensity for potential abuse by controlling shareholders for personal gain, transactions between related parties are generally strictly regulated in most jurisdictions. Further, the risk of exploitation of RPTs by circumvention of the applicable regulatory framework, and the consequential significant loss of value of a listed entity, is relatively high in India, given the prevalence of promoter-driven and closely held companies in the country. As pointed out in the Panel Report, it is not uncommon for Indian group companies to regularly engage in RPTs (including inter-corporate loans, cross collateralization and significant influence arrangements), and such inter-linkages in business, operations and management are rife with the potential for misuse by controlling shareholders, to the detriment of the public shareholders of listed companies.
While RPTs may often, in fact, have sound business rationale and contribute much economic value, recent examples, such as certain RPTs entered into by Infrastructure Leasing & Financial Services Limited, point at the inability of the current RPT regulatory framework to sufficiently regulate the misuse of subsidiaries as conduits to transfer assets and value out of listed entities. In this context, the changes proposed by the SEBI Panel for strengthening the laws for regulation and oversight of RPTs undertaken by a subsidiary of a listed entity, are both, relevant, and in line with the 2017 Kotak Committee Report on Corporate Governance, which emphasized the necessity of ensuring that good governance trickles down the entire business structure of listed entities.
Moreover, the SEBI Panel's proposal to expand the scope of both, the entities, as well as the transactions, to which the RPT governance norms would extend, may serve to stave off commonly observed scenarios of listed companies using innovative structures to avoid classification of transactions as RPTs and dodging the associated regulatory, compliance and disclosure requirements. Having said that, while expansive modifications to the definitions of 'related party' and 'related party transaction' have been proposed by the SEBI Panel, it is significant to note that the Panel Report has expressly clarified that certain corporate actions, which by their very nature treat all shareholders equally (such as payment of dividend, sub-division / consolidation of securities, buy-back, rights issue and bonus issue), and which are subject to procedures specifically laid down by SEBI in its other regulations (such as preferential allotment), are specifically excluded from the purview of RPT norms.
At present, the recommendations of the SEBI Panel are open to public comments. Given SEBI's historical commitment to continuously strengthening RPT corporate governance norms in India through periodic review, it is expected that upon receipt of public comments, SEBI will accept and incorporate a substantial portion of the SEBI Panel's recommendations into the applicable listing regulations.
1. Report of the Working Group on Related Party Transactions, issued by SEBI for public comments on January 27, 2020 (See, link).
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