Are requirements of the Companies Act, accounting standard and Sebi norms with respect to related party aligned?

Are requirements of the Companies Act, accounting standard and Sebi norms with respect to related party aligned?
No, they are not.

Companies Act 2013 requires disclosure at the time of entering into contract or arrangement whereas accounting standard requires disclosure at the time of entering into a transaction

Clause 49 adds new class of related parties to the definition thereof given under the Act and includes close family members, fellow group entities, joint ventures of same third party and combinations thereof, which are not in accounting standard or the Companies Act.

Revised clause 49 requires shareholders’ approval for all material related party transaction with no exception for transactions in ordinary course of business or at arms-length. Definition of material transactions differs.

In case of deviation, as a thumb rule, provision of the stricter of the applicable regulations shall be followed.

A corporate group has several foreign subsidiaries. Will provisions in relation to related parties apply to foreign companies as well?
The term ‘company’, as defined under the Companies Act 2013, is a company incorporated under this Act or any previous company law. Company incorporated under the relevant legislation of a foreign country is not a ‘company’ under Companies Act 2013. However, transactions by Indian company with a foreign company, which is a subsidiary, associate, fellow subsidiary, joint venture of the same venturer or company under control of same promoter, would be covered, based on understanding of combined reading of revised clause 49 and Companies Act 2013.

In case of Companies Act, is the board required to approve all related party transactions?
The Companies Act 2013 prescribes that a company needs approval of the audit committee on all related party transactions and subsequent modifications thereto. This is irrespective of whether they are in the ordinary course of business and consummated at arm's length price or they are below prescribed thresholds. Further, for listed companies, clause 49 prescribes audit committee approval for all related party transactions and shareholders’ approval of all material RPTs. For normal transactions, if company has a well laid down policy framework which explicitly lays down terms of contract/transaction and which are approved by audit committee then a separate approval will be unwarranted for each such transaction.

However, any modification/ transaction, which was not contemplated in the framework and approved by the audit committee in its initial approval, would require fresh approval of the audit committee. Legal evaluation or a clarification from lawmakers would be necessary considering the difficulties such an approval might impose.

What assessment is required of the existing RPTs, if any?
All companies are required to comply with requirements in relation with RPTs, prospectively from the date of applicability of underlying regulation. Any default will be regarded as non-compliance and may attract penal provisions under the Companies Act 2013. Following actions are recommended to avoid any risk of default:

* Companies should carefully review its related parties under the regulations and identify all existing and new related parties together with all existing and new contracts, arrangements and transactions, etc. Amongst other matters, the manner of dealings shall cover aspects relating to determination of key terms including arm’s length price.

* An immediate dialogue needs to be initiated with the audit committee to assess and confirm their expectations from the policy and review/approval protocols. A careful evaluation of existing and proposed RPTs is not unwarranted.

* Company shall develop process and methodology and make necessary changes in systems and procedures adapting to the new set of regulations.

Which types of transactions will be regarded as “ordinary course of business”?
The phrase “ordinary course of business” is not defined under the Companies Act 2013 or rules made thereunder. It seems that the ordinary course of business will cover the usual transactions, customs and practices of a business and of a company. In its guidance to auditors, the Institute of Chartered Accountants of India has included following few examples of transactions that are considered outside the entity’s normal (or ordinary) course of business:

* Complex equity transactions, such as corporate restructurings or acquisitions.

* Transactions with offshore entities in jurisdictions with weak corporate laws. ? The leasing of premises or the rendering of management services by the entity to another party if no consideration is exchanged.

* Sales transactions with unusually large discounts or returns.

* Transactions with circular arrangements, for example, sales with a commitment to repurchase.

* Transactions under contracts whose terms are changed before expiry.

The assessment of whether a transaction is in ordinary course of business is very subjective, judgmental and can vary on case-to-case basis giving consideration to nature of business and objects of the entity. The purpose of making such assessment is to determine whether the transaction is usual or customary to the company and/ or its line of business. Companies should consider variety of factors like size and volume of transactions, arms-length, frequency, purpose, etc, to make this assessment.

Definition of related parties is very wide. What are the key actions which management should take to ensure a robust process for identifying related parties?

Some of the key action areas which management could consider:

* Make all covered parties accountable towards making disclosure of their interest - for e.g. relevant information should be captured from vendor/customer at the time of including their names in the master vendor/client database. This might require workshops with the covered parties so that they understand and appreciate requirements fully.

* Formalize the disclosure process through defined frequency, information and ownership

* Conduct one time exercise to identify current spectrum of related parties

* Set up a mechanism for ongoing updating of the related parties

* Specify responsibility for disclosure in the event of change of interest and define responsibility for administering the process

* Create comprehensive repository of all related parties with restricted access and monitoring/ updating procedure

* Define frequency for updating of related parties’ repository on a periodic basis (apart from updating based on event-based disclosures) along with approval matrix for making the changes and facility to maintain change logs.

* Integrate identification with the primary ERP to enable identification of transactions with related parties - customer master, vendor master, employee master, etc.

Companies normally engage in master service agreements (MSAs) to decide overall framework to avail services/ goods. Will approvals be required at the time of entering the MSA and also at the time of entering purchase orders?
Intention of regulators is that the audit committee/board approves terms and conditions of the contract and transactions. The MSA will satisfy definition of contract or arrangement, and hence, will require approvals, specified. Specific approval of purchase orders or sub-contracts may not be required if MSAs are not very general and lay down critical terms (nature of service, payment terms, pricing formula, timing and manner of revisions in terms, etc.) of arrangement based on which sub-contracts or purchase orders are placed.

Many companies have existing contracts or MOUs or other arrangement entered into, prior to introduction of these new regulations but the underlying transactions are likely to be operationalised in period after the introduction of the new regulations. Would such contracts require a review and approval of the audit committee/board or the shareholders, as the case may be, considering effective execution in the period after introduction of the new regulations?
MOUs are merely an understanding and not a definitive contract or arrangement. Clearly, these would require rigor of review under the new framework, prior to execution of definitive agreement. In relation to other contracts or arrangements, covered above, although differing views may exist when evaluating the manner of how regulations have been made, it would be improper to assume that such contracts or arrangements are not required to go through rigor of review now required considering these are operationalised only under the new regime of regulations.

What is meaning of arm's length? Is meaning of arm's length same as transfer pricing rules?
Arm's length tr

ansaction means a transaction between two related parties which is conducted as if they were unrelated, so that there is no conflict of interest. Most commonly used guidance in this regard under income tax provisions is given in international and domestic tax laws in context of transfer pricing regime. One may even refer to rules for registered valuers wherein valuation methodologies are prescribed for registered valuers. It should be noted that these guidelines are not conclusive and have only persuasive value. One may consider various qualitative and quantitative assessments to determine arm's length.

For example, let’s assume a bank whose normal course of business provides 9% rate to its customers for placing fixed deposit for a two-year tenure. It offers 9.25%, higher rate, to all its group employees. One may argue that the same is not at arm's length. Alternatively, one may argue that banks devise different strategies for various categories of customers. Employee population of entire group provide a significant customer-base for the bank and hence providing higher rate is in accordance with business strategy and meets the criteria of arm's length. The arm's length assessment is subjective exercise and requires judgment after considering various parameters.

Under the regulations, no member of the company is permitted to vote on a special resolution to approve any contract or arrangement which may be entered into by the company, if such a member is a related party. Does the bar from voting apply to all shareholders who are related parties or only those related parties who are conflicted?
In cases where shareholders are ‘related’ in some way or the other with the company (but are neither the intended transacting party nor interested in the transaction directly or indirectly that has been put up for approval) it will be inappropriate to interpret the law to say that all such shareholders are prohibited from voting. The principles of “majority of minority” voting must not result in any unfair advantage to the minority. However, plain reading of the regulations would suggest all related parties shall abstain from voting, whether related or unrelated. Consultation with legal experts might be required to ascertain intent of these provisions.