Related party transactions have once again found themselves the subject of public scrutiny due to occurrences at InterGlobe Aviation Limited (“Interglobe“), which runs and operates the low-cost airline Indigo. Interglobe has been facing stormy weather following a dispute between its promoters, Rakesh Gangwal and Rahul Bhatia. Since mid-2018 the feud between both promoters has snowballed into a very public feud. While there are several contentious issues on which the promoters disagree, one of the main reasons for their public fallout has been over related party transactions. In 2018, Rakesh Gangwal flagged and alleged that Interglobe has entered into related party transactions with several companies associated with Rahul Bhatia, a charge that the latter insists is mala fide.
Who is a Related Party?
There is a long list of persons and entities that are considered related parties by the law. These include the company’s directors, key managerial persons, and their relatives. Also, firms or private companies in which such directors, managers, or their relatives are partners or directors fall under the ambit of related parties. So also, are holding companies, subsidiaries and associate companies — among others that can exercise influence on the company. The Companies Act, 2013 (“Act“) states that a related party with reference to a company, means:
- A director or a key managerial personnel or their relatives;
- a firm, in which a director, manager or his relative is a partner;
- a private company in which a director or manager or his relative is a member or director;
- a public company in which a director or manager is a director and holds along with his relatives, more than two per cent of its paid-up share capital;
- anybody corporate whose Board of Directors, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager;
- any person on whose advice, directions or instructions a director or manager is accustomed to act:
Provided that nothing in sub-clauses (v) and (vi) shall apply to the advice, directions or instructions given in a professional capacity.
- any body corporate which is (a) a holding, subsidiary or an associate company of such company;(b) a subsidiary of a holding company to which it is also a subsidiary; (c) an investing company or the venturer of the company.
What are Related Party Transactions?
Related Party Transactions (RPT) are just that — transactions that a company does with parties related to it. An RPT is an arrangement between two entities which share a preexisting business relationship. So, if Company ABC buys goods or services from its director XYZ, it counts as an RPT. Similarly, if Company ABC takes on rent premises owned by XYZ, a relative of its director, it is also an RPT.
The reason why RPTs are subject to stringent norms is because there is an attached risk that the related party may be favoured with terms that could harm the interests of the company’s shareholders.For instance, if Company ABC rents office premises from XYZ, a relative of its director, and pays higher than market rent, it benefits XYZ and indirectly the director of Company ABC, but harms shareholders of Company ABC. That said, RPTs have been used by corporations across the globe, especially in cases where the business interests of Board members overlap with that of companies in which they have a stake. In many cases, RPTs make commercial and operational sense for the company.
How are RPTs regulated?
The Act has not prohibited RPTs as a whole but instead lays down safety measures that need to be followed while dealing with RPTs. RPTs are regulated by certain conditions as provided in Section 188 of the Act, by the means of which they are to be disclosed to the Board and shareholders for them to ratify. Section 188 of the Act also states that if the transactions fall within the meaning of Section 188, then these need to be disclosed in the Board Report to the shareholders along with a justification in support of the transactions.
Section 188 includes within its ambit any contract or arrangement with a related party with respect to:
- sale, purchase or supply of any goods or materials;
- selling or otherwise disposing of, or buying, property of any kind;
- leasing of property of any kind;
- availing or rendering of any services;
- appointment of any agent for purchase or sale of goods, materials, services or property;
- such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company; and
- underwriting the subscription of any securities or derivatives thereof, of the company.
Section 188 further states that if the transactions are beyond certain threshold limits or if the company has a paid-up share capital of not less than the prescribed amount, then details of the RPTs such as name of related party, nature of relationship, nature and term of contract, material terms etc. need to be disclosed in the General Meeting of the company for approval by special resolution.
Transactions that are on an arm’s length basis – a transaction when conducted as if they were unrelated, so that there is no conflict of interest, do not fall under the ambit of Section 188 and require no Board or shareholder ratifications.
Threshold Limits for RTPs
Rule 15(3) of the Companies (Meetings of Board and its Powers) Rules, 2014 (“Rules“) specifies the threshold limits for transactions beyond which RPTs would require shareholders’ approval. On November 18, 2019 the Companies (Meetings of Board and its Powers) Second Amendment Rules, 2019 (“Amendment Rules“) amended certain threshold limits prescribed by the Rules. The table below sets forth the threshold limits as well as any amendment to the same by the Amendment Rules:
|Nature of Related Party Transactions
|Earlier Threshold Limit*||Amended Threshold Limit*|
|Sale, purchase or supply
of any goods or material (directly or through an agent).
|Amounting to ten percent (10%) or more of turnover or Rs. 100 Crore, whichever is lower.
|Amounting to ten percent (10%) or more of the turnover of the company.|
|Selling or otherwise
disposing of, or buying, property of any kind (directly or through an agent).
|Amounting to ten percent (10%) or more of net worth or Rs. 100 Crore, whichever is lower.||Amounting to ten percent (10%) or more of the turnover of the company.|
|Leasing of property of
|Amounting to ten percent (10%) or more of net worth or 10 percent (10%) or more of turnover Rs. 100 Crore, whichever is lower.
|Amounting to ten percent (10%) or more of the turnover of the company.
|Availing or rendering of any services (directly or through an agent)
|Amounting to ten percent(10%)or more of turnover or Rs. 50 Crore, whichever is lower||Amounting to ten percent (10%) or more of the turnover of the company|
|*limits specified above shall apply for transaction or transactions to be entered into either individually or taken together with the previous transactions during a financial year.
|Appointment to any
office or place of profit in the company, subsidiary company or associate company
Rs. 2,50,000 per month
subscription of any securities or derivatives of the company
one percent (1%) of net worth
Consequences of Irregular RPTs
Non-compliance with the Act and Rules could render RPTs void and entail penalties for the violator. A RTP which has been entered into without the consent of the Board or approval by a resolution in the general meeting and if not ratified by the Board or the shareholders within three (3) months from the date on which such contract or arrangement was entered into, can be voidable at the option of the Board or shareholders, as the case maybe. Furthermore, if the contract or arrangement is with a related party to any director, or is authorised by any other director, the director concerned is required to indemnify the company against any loss incurred by it.
The company also has the option to proceed against a director or any other employee who had entered into such contract or arrangement in contravention of the Act for recovery of any loss sustained by it as a result of such contract or arrangement. A director or any other employee of a company, who enters into a irregular RPT is liable to:
- imprisonment for a term which may extend to one year or with fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees, or with both in case of listed company; and
- a fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees, in case of any other company.
As is evident, the conduction of RPTs in the manner laid down by the Act is crucial to ensure rigorous corporate governance in any company. Companies should be especially cautious of not allowing any lapses in corporate governance in this atmosphere of heightened regulation surrounding the same.