http://www.thehindubusinessline.com/opinion/out-with-it/article6268528.ece?homepage=true
Companies cannot hide related party deals
The new companies Act is so replete
with words such as arrest, imprisonment, fraud and penalty that many
joke it was composed by the CBI! So lengthy and complex is the new law
that even an offender will be caught unawares by the clause he is
breaching. That said, the impact of the new Act is already being felt.
Take
the recent disclosures on related party transactions. The rigorous
disclosure requirements of Section 188 of the new Act has brought to
light something that was hidden in the balance sheet of Cairn India — a
₹7,500 crore loan it had given to a
unnamed related party.
At
the next opportunity, shareholders are bound to ask tough questions
about the rationale behind the deal — the loan earns an interest of 3.5
per cent a year while even an investment in the dullest fixed deposit
scheme in India could return more than double the interest.
Related partiesSection
188 of the Act says any contract or arrangement with a related party
would need the approval of the board of directors. For certain companies
or transactions, it takes a special resolution.
‘Related
party’ has been defined in Section 2(76) and is wide enough to cover
anyone even remotely related to the company or any of its key management
personnel. The board of directors are supposed to justify the
transaction in their report and provide details of it.
If
the board’s approval or the special resolution has not been obtained,
the board can call the contract null and void. And if any directors are
involved, they must pay for the loss.
Penalty and
imprisonment clauses are an integral part of Section 188. The section
was a bit generally worded and clarifications were sought on when and
how the special resolution would be needed. Later, the Ministry of
Corporate Affairs (MCA) came out with a general circular, which is even
more liberally worded.
It clarified that related
party referred to in the second proviso had to be construed with
reference only to the contract or arrangement for which the said special
resolution was being passed.
Alibaba and MCXIt
is stated that when the International Accounting Standards Board (IASB)
sold the concept of International Financial Reporting Standards (IFRS)
to China, they fell for it hook, line and sinker but were very uneasy
about the extensive related party disclosures that were needed.
The recent IPO document filed by Chinese e-tail giant Alibaba proves that China thrives on related party transactions.
In
India, the post-mortem audit of the MCX revealed that the exchange
entered into agreements with related trading parties, paid about ₹709
crore to erstwhile promoter Financial Technologies India and group firms
without following a proper documentation process and that there were
gaps in the way MCX processed related party transactions.
The
audit firm expressed doubts whether these agreements were conducted on
an arm’s length basis. MCX also entered into related-party transactions
with other FT group companies for various ancillary services.
In
an economy such as India, there are bound to be a number of related
party transactions due to the fact that many businesses are family-owned
and trust forms an integral part of other businesses.
The
Indian corporate sector has to get its act right on entering into
properly documented related party transactions and justifying them. If
not, the Companies Act is waiting with Section 188 and the Income Tax
Department with its Section 92BA on domestic transfer pricing. The
mantra is clear “When in doubt, just disclose it”.