RELATED PARTY TRANSACTIONS AND ITS NEFARIOUS USAGE
Author: Pranav Singh, IV year of B.A.,LL.B. from Army Institute of Law
Businesses are often linked through a pre-existing relationship or tend to have a common goal for achieving their joint objective certain transactions are made between the parties such transactions are known as Related Party Transactions (“RPT”). The parties to these transactions are mainly subsidiaries, business partners and shareholders of the company. Related Party Transactions in India comes under the ambit of Companies Act, 2013. The Act does not declare Related Party Transactions illegal but lays down certain regulatory provisions which are to be followed when these transactions take place. Securities and Exchange Board of India (“SEBI”) has made certain amendment pertaining to RPT’s rules in accordance to the Working Group Report on Related Party Transactions. These amendments aim to scrutinize regulatory norms in relation to Related Party Transactions. These Transactions are often used by the companies or investors for mismanagements and diversion of funds. The article talks about the financial irregularities occurred through RPT’s and the effect, recent amendments by SEBI would have on the capital markets.
UNDERSTANDING RELATED PARTY TRANSACTIONS
The term Related Party is defined under Section 2(76) of Companies Act, 2013. A Related Party can be a) key management person or their relative (b) a firm in which a director, manager, or his relative (c) a private company in which a director or manager or his relative is a member or director. Section 188 of the Companies Act, 2013 encompasses the Related Party Transactions. It states a list of major Related Party Transactions such as extending loans or investments, sale, purchase or supply of goods, sale or purchase of property of any kind, leasing of properties, use of any service either by appointing an agent or directly. Whether the Transaction is on arm length basis or is done in usual course of business it requires the approval of shareholders as per the Listing Rules. Section 177 of Companies Act, 2013 makes the approval of Audit Committee compulsory for all transactions. These Listing Regulations, works as a mechanism for approval of audit committee.
FRADULENT USE OF RELATED PARTY TRANSACTIONS
The primary goal of the commercial transactions is to ease the business doing so that it can ultimately benefit the Country and its people. One such type of commercial transaction is Related Party Transactions. Sadly, in India this area has stayed unnoticed from the eyes of regulators and remained unmonitored. If we look at the past records of financial mismanagements in India, Related Party Transactions comes out to be the principal cause for it. There’s a large list of frauds due to which banks have to suffer high value losses. The famous examples being the Satyam- Matyas Fraud, Bhushan Steel, Indigo – Bhatia Group deal and IL&FS.
There are various ways through which a company enters into a Related Party Transactions. Some of them which are mentioned under the Act are (1) sale, purchase or leasing of any kind of property (2) Transfer for managerial expenses to subsidiary companies (3) sale/purchase of market investments (4) Financial Transactions made to associate companies. During the audit procedure regulators often look for these transactions. If the non-compliance of Section 188 and listing agreements is found during the audit process the director indemnifies the loss company has occurred and company is allowed to take action against the director.
In numerous corporate frauds it can be seen that the expenses of the company has increased significantly where the Related Party Transactions were used for diversion and mismanagement of funds. On the complaint by Rakesh Gangwal, co-promoter of the Indigo Airlines SEBI started investigating and found that Rahul Bhatia, promoter of Indigo Airlines benefitted his private company through several RPT’s which were not approved by the audit committee and the permission from shareholders was also not taken. Later, the dispute was settled for an amount of Rupees 2.1 crores. In the case of Inter Globe Finance Limited (“IGFL”) it was found that IGFL has invested in its six subsidiaries however later it was found with the help of fillings in Ministry of Corporate Affairs, India that IGFL became shareholder in the companies after the investment was made. IL&FS (Infrastructure Leasing & Finance Services) a leading name in the finance sector, the company repeatedly changed its RPT Policy for easy distribution of loans to the related parties. Ultimately the company was held liable as it acted as a source for illegal movement of funds. It was proved in the case of Venmax Drugs and Pharmaceuticals Ltd. that the company has purchased properties from related parties on a rate which is higher levels and entered false data in their annual report.
Related Party Transactions are slowly becoming a tool for promoters to divert the funds for their personal use. Funds are being transferred and the details are not disclosed under the name of subsidiaries or shell companies. Approval of board is often skipped by stating that the transaction being on arm’s length or is for ordinary course of business. These frauds mainly get noticed when some other key managerial person who is not a party to the transaction interferes or the company is left with no other way to move further.
A report by TARI, states that in 51% of the corporate frauds that took place between 2012-2018, Related Party Transactions were used. These transactions have always been a matter of concern for the regulators. Recently, SEBI via its notice made certain amendments to laws pertaining to related party transactions as an attempt to fulfill the shortcomings so the RPTs can be better regulated.
Various notable changes have been made to RPT regime by the regulator for instance changes are done to the definition of promoter; changes have been made to the materiality threshold. If the transaction is of more than 1000 crores or 10% of the turnover, permission of the shareholders is much needed. These changes will provide the transparency which was needed but on the other hand it also hinders the ease of doing business. Many big organisations like India Inc., CII have opposed these amendments and are demanding for a review. 1,000 crores do not amount to even 1% of major NIFTY 50 Companies. These amendments are already being reviewed by the Market Advisory Committee of SEBI.
The need of the hour is to find a mid way out so that the problem of non-disclosure and lack of transparency can be overcome. This can be only done by filling the various lacunae present in the regime. Firstly, there are various terms which are very under defined for example, arm-length basis. This term is used by promoters at various instances for obtaining permission from the shareholders. Under the company law there are no guidelines through which arm length can be identified. Secondly, the methods which are more likely to be used like sale and purchase of property, these transactions should be disclosed at the board level and should be made in the presence of the board members. However, now continuous efforts are being made by regulators for scrutinizing the Related Party Transactions. Very soon India will have set of rules which will provide transparency to these transactions and will help in improving the quality of corporate governance.