An In-Depth Analysis of SEBI's 2021 Amendments to Related Party Transactions (RPTs) Regulations in India

 

INTRODUCTION:

On September 28, 2021, the Securities and Exchange Board of India (SEBI) introduced significant amendments to the Related Party Transactions (RPTs) framework under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR). These changes, brought forth through the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements)(Sixth Amendment) Regulations, 2021, stemmed from the recommendations of a Working Group constituted in November 2019. The overarching objective of these amendments is to bolster the scrutiny of RPTs, particularly addressing potential abuses while safeguarding the interests of shareholders.

MAJOR MODIFICATIONS AND THEIR COMPREHENSIVE ANALYSIS:

1. Definition of "Related Party":

The core change lies in the broadening of the definition of a "related party." Previously, this term encompassed individuals or entities closely associated with the listed entity. However, the amendment now extends this definition to include entities within the promoter group of the listed entity and individuals or entities holding 20% or more equity shares directly or through beneficial interest under the Companies Act, 2013. This expansion brings promoter groups and significant shareholders within the ambit of LODR scrutiny.

This alteration marks a significant shift in regulatory intent. By including entities in the promoter group and major shareholders, SEBI intends to prevent situations where decision-making powers and substantial shareholdings could potentially influence RPTs to the detriment of minority shareholders. It aligns with the overarching objective of protecting shareholder interests.

2. Definition of "Related-Party Transaction":

The amendment to the definition of "related-party transaction" is a noteworthy development. Initially, it solely covered transactions between a listed entity and its related parties. However, the expanded definition now encompasses transactions between a listed entity or its subsidiary and related parties of either entity. This shift raises the threshold for shareholders' approval, potentially accelerating the need for such approval.

This extension brings foreign subsidiaries under scrutiny as well. The amendment raises concerns about conflicts of laws and jurisdictional issues when foreign subsidiaries engage in transactions with other companies. This move may also be subject to legal challenges on the grounds that it infringes on the principle of separate legal existence. To mitigate these potential issues, granting certain exemptions and providing clear guidance regarding foreign subsidiaries becomes crucial.

3. "Purpose and Effect" Clause:

A pivotal element of the amendment is the introduction of the "purpose and effect" clause. This clause includes transactions between a listed entity or its subsidiary and an unrelated party if the transaction has the "purpose and effect" of benefiting a related party. It is set to become effective on April 1, 2023.

Interpreting this clause presents challenges as it requires considering both purpose and effect jointly when evaluating the impact of a transaction. If a transaction unintentionally benefits a related party, it may not be deemed an RPT. The assessment of purpose may not always be straightforward and may necessitate a case-by-case examination based on facts and circumstances.

However, this provision is instrumental in preventing fraudulent and concealed transactions. It aligns with the "smoke test" principle articulated by the Supreme Court of India in the Phoenix ARC (P) Ltd. v. Spade Financial Services Ltd. case. This principle serves to detect collusive or sham transactions that create an illusion of money transfer while concealing ulterior motives. To maximize the effectiveness of this provision, regulatory authorities should offer guidance on investigating the "purpose and effect," providing clarity for companies.

4. Exclusions in the Definition:

Previously, companies formulated separate RPT policies and made exclusions in line with LODR and the Companies Act. However, the Sixth Amendment introduced exclusions within the definition of RPT itself. These exclusions include the issuance of specified securities on a preferential basis, certain corporate actions like dividend payments, and the acceptance of deposits by banks. Consequently, companies will have limited room for additional exclusions beyond what is specified in the provision.

THREEFOLD EVOLUTION IN MATERIAL RPT PROVISIONS

1. Prior Shareholders' Approval:

A critical change in the provisions related to material RPTs is the requirement for "prior" shareholders' approval before entering such transactions. This shift emphasizes the importance of shareholder oversight in ensuring transparency and fairness in RPTs.

2. Revised Materiality Threshold:

The threshold for determining the materiality of RPTs has been significantly altered. It is now contingent on either exceeding INR 1000 crores or 10% of the annual consolidated turnover of the listed entity, whichever is lower. This change aims to capture more substantial transactions, aligning with the objective of protecting shareholder interests.

3. Inclusion of Cross-RPTs:

The scope of RPTs has been expanded to include cross-RPTs. This expansion extends regulatory scrutiny to transactions involving subsidiaries, including foreign subsidiaries. While intended to enhance oversight, it raises concerns about conflicts of laws and jurisdictional issues. To mitigate these concerns, granting exemptions and offering clear guidance specific to foreign subsidiaries becomes imperative.

ISSUES PERTAINING TO SHAREHOLDERS' APPROVAL FOR EXISTING CONTRACTS/ARRANGEMENTS:

The changes in materiality thresholds have potential implications for ongoing contracts or arrangements if they include transactions post-April 1, 2022. Several questions arise:

- Do ongoing RPTs require reclassification and shareholder approval for continuation or ratification?

- Does Regulation 23(8) apply to existing material RPTs entered into before the notification of these amendments?

The application of Regulation 23(6) makes it clear that transactions executed after the end of FY 2021-2022 and crossing the revised materiality threshold require "prior" shareholders' approval. However, the requirement for reclassification and approval of ongoing contracts under these modifications remains ambiguous.

The interpretation of Regulation 23(8) poses challenges. Its language does not account for amendments to the regulation over time. Consequently, ambiguity arises regarding the date of notification mentioned in the regulation.

CONCLUSION:

SEBI's amendments to the RPT framework represent a significant step toward enhancing corporate governance and safeguarding shareholder interests. The broadening of the definition of RPTs holds the potential to significantly impact the number of transactions subject to scrutiny. It is intended to prevent fraud and ensure a check on concealed transactions. However, the interpretation of the "purpose and effect" clause requires further clarification through guidance notes and circulars.

By subjecting transactions by subsidiaries, including foreign subsidiaries, to scrutiny, the principles of separate legal entities and decision-making autonomy have been substantially affected. While the amendments align with the goal of protecting minority interests, they have imposed a substantial compliance burden on companies, particularly large corporate groups with numerous subsidiaries.

Furthermore, the lack of clarity on certain aspects, as discussed in this article, places companies in precarious positions, potentially leading to unintentional breaches of the amended provisions. Clarifications from SEBI addressing these concerns would be a welcome step to strike a balance between corporate interests and stakeholder protection.

In summary, SEBI's amendments signal a pivotal shift in the regulatory landscape surrounding RPTs in India. While they aim to ensure transparency and fairness, the complexity and potential ambiguities require careful consideration and guidance for companies to navigate these changes effectively.

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Article Compiled by:-

Mayank Garg

(LegalMantra.net Team)

+91 9582627751

Disclaimer: Every effort has been made to avoid errors or omissions in this material in spite of this, errors may creep in. Any mistake, error or discrepancy noted may be brought to our notice which shall be taken care of in the next edition In no event the author shall be liable for any direct indirect, special or incidental damage resulting from or arising out of or in connection with the use of this information Many sources have been considered including Newspapers, Journals, Bare Acts, Case Materials , Charted Secretary, Research Papers etc.

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