Business & Investment

How to deal with related party transactions of unlisted companies?

Alby Joseph

In Udai Kotak’s words in the Kotak Committee report, there are two main styles. Corporate governance India: “Raja” (monarch) model and “custodian” model. In the “Raja” model, the promoter’s interest precedes the “Plaja”, the interest of other stakeholders. The “custodian” model, on the other hand, works on the basis of Gandhi’s principle that promoters wear “trustee” hats and act in the interests of all stakeholders. More common is everyone’s guess, but the big question is how to correct the existing inequality that exists between the interests of promoters and stakeholders.

One of the most relevant aspects of corporate governance that makes this question very relevant Related Party Transactions (RPT). These are transactions between related parties, such as promoters and their relatives, as defined by the Companies Act 2013 (CA 2013) and are unavoidable in any business ecosystem. They are very common in India, where historically most corporate organizations are family-owned in informal business relationships. Many of the recent corporate controversies in India, including InterGlobe Aviation (Indigo), Jet Airways, IL & FS, DHFL, etc., have been related to allegations of misappropriation of funds to promoters, directors, or related parties such as their relatives. It was. While the above allegations are in the territory of listed companies, they provide justification for suspecting that such fraud could spread to the relatively less regulated and less transparent territory of unlisted companies. A good example is Firestar International Limited’s fraudulent RPT related to the Nirav Modi scam.

Misuse of RPT can short-change other stakeholders, such as (minority) shareholders and creditors. Transparent RPT, on the other hand, creates synergies and adds value. Therefore, an ideal regulatory framework will penalize fraudulent RPTs while at the same time encouraging them to increase their value. Despite living in a private “unicorn” era, there is not much literature on RPT by such companies.

Why is it important?
For greater financial stability, the importance of sound governance in unlisted public companies cannot be undermined for two reasons. First, large unlisted companies have a great public interest in that they are systemically important. In addition, we have a wide range of public stocks because we borrow a large amount of money from the financial system including banks. Second, without proper investor protection for unlisted companies, the stock market will not develop and banks will be the only source of funding.This is due to poor management Unlisted company We have no intention or ability to open up the capital markets through listing in the future. This undermines both corporate interests by adversely affecting access to non-debt-enhancing capital and investor interests by reducing the potential for increased transparency as a result of listing.

The RPT of unlisted companies is managed only by CA2013, and listed companies are further managed by CA2013. Sebi (Listing obligations and disclosure requirements) Regulations, 2015. For unlisted companies, the requirement for shareholder approval by ordinary resolution is only triggered if the statutory materiality threshold set out in the company rules is exceeded. For RPTs such as supply of goods and services, real estate leasing, the threshold is 10% of sales. In addition, from April 1, 2021, the definition of “listed company” has been narrowed down to exclude companies that list only bonds. As a result, even systemically important companies, such as IL & FS Limited, where only debt securities are listed, will be considered unlisted companies. Therefore, this amendment makes the role of sound governance in unlisted companies even more important.

Recognizing the importance of large private companies, the government recently added Section 129A to its CA in 2013. It requires additional financial disclosure from certain classes of unlisted companies.

The government has not yet announced the class of companies subject to this requirement, but is clearly aware of the potential systematic importance of unlisted companies.

Our goal
The legal framework is as good as its implementation. The World Bank ranks India in the impressive 13th place out of 190 jurisdictions when it comes to protecting minority investors. Despite their high ranks, systematic issues remain and many companies are adopting a “checkbox” approach that focuses only on letters rather than the spirit of law. Often, the resolutions provided to shareholders for RPT approval are of poor quality and do not provide shareholders with the appropriate information to make informed decisions. In some cases, RPTs are protected from shareholders using “normal business process” and “arm length” defenses.

As a first step, it may be necessary to revisit the threshold of importance for unlisted companies, especially in order to reform the RPT system for unlisted companies. This is to ensure that such a threshold properly brings a large RPT within that range for the purpose of shareholder approval. As it is today, many RPTs of large private companies have the potential to escape shareholder oversight. For example, a Rs 16,000 RPT by an unlisted company such as Reliance Retail Limited with sales of Rs 1,62,936 could escape shareholder oversight due to the CA 2013 threshold of 10%. Absolutely, it’s definitely a high-value deal. Second, it may be necessary to review the criteria for the appointment of independent directors. Hard-working independent directors have the potential to eliminate fraudulent RPT without compromising value-adding RPT. Valuable guidance could be derived from a recent SEBI consultation paper on independent directors, which proposes a “double approval” mechanism for the appointment of independent directors and gives minority shareholders more say in such appointments. there is.

Third, as the Kotak Committee has observed, market intelligence gathering and data analysis are potential tools for strengthening law enforcement and stopping fraudulent RPT. To do so, you need to allocate appropriate resources to such projects and take urgent action. SEBI’s recent decision to discontinue a proposed data analysis project due to lack of funding does not work for the country’s corporate governance standards.

Most importantly, there is an urgent need to improve investor education while at the same time promoting investor activists. In this way, “praja” itself becomes an efficient gatekeeper and can keep checking “Raja”.

(Alby Joseph is a Project Fellow of the Vidhi Center for Legal Policy in Delhi. Opinions are his own)

How to deal with related party transactions of unlisted companies? How to deal with related party transactions of unlisted companies?

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