<p>Regulators in India as they have in advanced economies, begun to crack down on practices they consider worrisome, in the interests of robust governance. Related party transaction is one such issue that SEBI is currently grappling – where a special relationship between two entities undermines the interests of the company or its minority shareholders through what the law would define as a conflict of interest. A related party could, according to the guidelines, be an individual, a company, a partnership firm, local authorities or even entities that are not registered in India.</p><p>All of this at first glance would seem reasonable. However, the amendments proposed expand the previous scope of what would be described as a related party and this expansion covers several areas. First, any person being a promoter or part of the promoter group or holding 10% or more of the common stock of the company would be deemed a related party. Consequently, a transaction would be subject to the principles of an arms-length relationship and seek approvals from the audit committee and the board. The second amendment concerns the materiality of a transaction. The previous regulatory provisions on materiality thresholds were concerned only with turnover. But this has now been offered a wider latitude on interpretation. A transaction with a related party shall be considered material, if it individually or collectively, with previous transactions during a financial year, exceeds rupees one thousand crore or ten per cent of the annual consolidated turnover of the company, whichever is lower.</p><p>There is an extensive list of individuals and entities that are considered related parties by law. These include the company’s directors, key managerial persons and their relatives. The list also contains firms or private companies in which directors, managers or their relatives are partners or directors. Included in this are holding companies, subsidiaries and associate companies. In all fairness, the guidelines do not prohibit related party transactions but rather lay down measures to adopt while dealing with them. Transactions must be disclosed to the Board and shareholders and explained in the Annual Report to shareholders with a justification in support.</p><p>All of this may seem reasonable. However, the devil is in the detail and subject to interpretation, especially of certain clauses that may offer regulators a wide spectrum of discretion. The burden of compliance falls not only on executive management – CEOs and CFOs – but inconveniently on independent directors specifically those that sit on the audit committee. Effectively, therefore, board meetings will now have to allow for a lot more time on the nitty-gritty of compliance requirements and less on strategy, giving directors a new set of headaches.</p><p>The laws have been crafted with habitual offenders in mind, but will encompass everybody – with criminal repercussions. Even minor slip ups can be construed as fraud. The courts have, in recent times, not taken kindly even to unintentional errors as, according to law, it is the duty and obligation of top management and independent directors to ensure compliance with the utmost care in the wording and spirit of the law. Independent directors that are up to the mark professionally, will consequently become much harder to come by and cost much more. When a slip can result in criminal prosecution, people wonder whether large sums of money or the professional challenge is worth it.</p>
<p>Regulators in India as they have in advanced economies, begun to crack down on practices they consider worrisome, in the interests of robust governance. Related party transaction is one such issue that SEBI is currently grappling – where a special relationship between two entities undermines the interests of the company or its minority shareholders through what the law would define as a conflict of interest. A related party could, according to the guidelines, be an individual, a company, a partnership firm, local authorities or even entities that are not registered in India.</p><p>All of this at first glance would seem reasonable. However, the amendments proposed expand the previous scope of what would be described as a related party and this expansion covers several areas. First, any person being a promoter or part of the promoter group or holding 10% or more of the common stock of the company would be deemed a related party. Consequently, a transaction would be subject to the principles of an arms-length relationship and seek approvals from the audit committee and the board. The second amendment concerns the materiality of a transaction. The previous regulatory provisions on materiality thresholds were concerned only with turnover. But this has now been offered a wider latitude on interpretation. A transaction with a related party shall be considered material, if it individually or collectively, with previous transactions during a financial year, exceeds rupees one thousand crore or ten per cent of the annual consolidated turnover of the company, whichever is lower.</p><p>There is an extensive list of individuals and entities that are considered related parties by law. These include the company’s directors, key managerial persons and their relatives. The list also contains firms or private companies in which directors, managers or their relatives are partners or directors. Included in this are holding companies, subsidiaries and associate companies. In all fairness, the guidelines do not prohibit related party transactions but rather lay down measures to adopt while dealing with them. Transactions must be disclosed to the Board and shareholders and explained in the Annual Report to shareholders with a justification in support.</p><p>All of this may seem reasonable. However, the devil is in the detail and subject to interpretation, especially of certain clauses that may offer regulators a wide spectrum of discretion. The burden of compliance falls not only on executive management – CEOs and CFOs – but inconveniently on independent directors specifically those that sit on the audit committee. Effectively, therefore, board meetings will now have to allow for a lot more time on the nitty-gritty of compliance requirements and less on strategy, giving directors a new set of headaches.</p><p>The laws have been crafted with habitual offenders in mind, but will encompass everybody – with criminal repercussions. Even minor slip ups can be construed as fraud. The courts have, in recent times, not taken kindly even to unintentional errors as, according to law, it is the duty and obligation of top management and independent directors to ensure compliance with the utmost care in the wording and spirit of the law. Independent directors that are up to the mark professionally, will consequently become much harder to come by and cost much more. When a slip can result in criminal prosecution, people wonder whether large sums of money or the professional challenge is worth it.</p>
