Context
The law on related party transactions (“RPTs”) has been evolving since its inclusion in the Companies Act, 2013 (“the Act”), and the introduction of stricter regulations for listed companies by the Securities and Exchange Board of India (“SEBI” or “Regulator”) in the Listing Obligations and Disclosure Requirements Regulations, 2015 (“LODR”). Yet, India Inc. continues to falter in its battle for good governance because of abusive RPTs, inadequate disclosures, and diversion of funds of listed companies to closely held promoter entities through innovative structures and shell entities – exacerbated because promoters own or control 75 per cent of listed entities in India.
SEBI has amended RPT-related provisions in the LODR multiple times since its introduction in 2015; however, two key amendments in April 2022 and April 2023 marked a paradigm shift – widening the ambit of “related party” and “related party transaction” to scrutinise subsidiary-level transactions and introducing the anti-abuse provision, “purpose and effect test”, for transactions with unrelated counterparties. Revising the materiality limit to an absolute monetary threshold of INR 1,000 crore for determining material RPTs and applying it to all companies, irrespective of size, also sparked intense debate. Currently, proxy advisory firms have been flagging many RPTs as abusive; many RPTs have even faced shareholder rejection.
SEBI’s Approach
SEBI has a four-pronged approach:
- Tightening regulations.
- Disenfranchising non-public shareholders.
- Allowing only independent directors on the Audit Committee to approve RPTs.
- Prescribing mandatory minimum disclosures for the Audit Committee and shareholders.
Current Developments
Following its dissatisfaction with the quantity and quality of listed entities’ disclosures to its Audit Committee – the first level of check on such transactions – SEBI issued a circular dated November 22, 2021, mandating certain minimum disclosures.
However, on realising that even those disclosures were inadequate due to the complexity of transactions, innovative structures, and the use of unrelated counterparties, SEBI mandated the Industry Standard Forum (“ISF”) – a forum of three leading chambers of commerce (ASSOCHAM, CII, FICCI) – to formulate minimum disclosure requirements. The ISF submitted its Guidance Note (prepared in consultation with SEBI) (“ISF Guidance Note”) which were notified by SEBI on 14th February 2025, stipulating the comprehensive list of minimum information a listed entity must provide to its Audit Committee and shareholders for the approval of RPTs. Effective April 1, 2025, onwards, this will mark yet another paradigm shift in Disclosure Standards.
Salient Features of RPT Disclosure Standard:
Sometime in December 2024, following SEBI’s directive, the three chambers of commerce constituted a Working Group under the ISF. SEBI also provided the new seven-category RPT disclosure format, including both balance sheets and P&L items, for listed entities to submit to its Audit Committee and its shareholders. Compared to SEBI’s original requirement in its circular dated November 22, 2021 (now consolidated in the Master Circular dated November 11, 2024), the new format requires special focus and more detailed disclosures. The Working Group then assigned seven sub-groups for each RPT category to make detailed assessments of the disclosures, eventually finalising the ISF Guidance Note. The updated requirements for the approval of RPTs are elaborate, prescriptive, and specific, especially for balance sheet items, which need comprehensive disclosures. Corporate India will have to reconfigure its MIS systems to provide the requisite information/data for submission to the Audit Committee and shareholders.
The key changes to the information disclosure format include the following:
- Details of the related party, including basic information, relationship and ownership, financial performance, previous transactions, and amount of the proposed transactions.
- Promoter entity to include any entity in which the promoter has only 2 per cent or more shareholding, directly or indirectly.
- Emphasis on valuation and requirement for a valuation report in specific circumstances.
- Invitation of bids for certain categories of transactions.
- Detailed Peer Comparison data in case of royalty payments.
- The Audit Committee’s statement of assessment that relevant disclosures for decision-making were placed before them and that they have confirmed that the promoter(s) will not benefit from the RPT at the expense of the public shareholder.
- Justification on the price and how the RPT is in the interest of the listed entity.
- Certification confirming that the RPTs to be entered into are not prejudicial to the interest of public shareholders and the terms and conditions of the RPT are not unfavourable to the listed entity, compared to the terms and conditions, had similar transaction be entered into with an unrelated party.
In a more nuanced approach to the disclosures of transactions impacting the balance sheet, the ISF has classified RPTs in the following categories:
- Sale, purchase, or supply of goods or services or any other similar business transactions.
- Loans, inter-corporate deposits, or advances given by a listed entity or its subsidiaries.
- Any investment made by the listed entity or its subsidiaries.
- Any guarantee (excluding performance guarantee), surety, indemnity or comfort letter by whatever name called, made, or given by the listed entity or its subsidiaries.
- Borrowings by the listed entity or its subsidiary.
- Sale, lease, or disposal of assets of subsidiaries or of a unit, division, or undertaking of the listed entity, or disposal of shares of the subsidiary or associate.
- Payment of royalty.
The ISF subdivided the categories of transactions into balance sheet items and profit & loss account items, specifically providing for comprehensive disclosures for balance sheet items, which could have a more profound impact on public shareholders. It has also provided detailed disclosure standards for the aforementioned items and prescribed an applicability matrix for “comprehensive disclosures” and “limited disclosures” for various categories of items, including the newly introduced threshold for determining materiality for RPTs which has been imported from Regulation 30 of LODR viz. 2% of turnover, as per the last audited consolidated financial statements of the listed entity; 2% of net worth, as per the last audited consolidated financial statements of the listed entity, except in case the arithmetic value of the net worth is negative; or 5% of the average of absolute value of profit or loss after tax, as per the last three audited consolidated financial statements of the listed entity.
Legal Effect of the Standard
The ISF Guidance Note, issued under Section 11(1) and 11A of the SEBI Act, 1992, read with Regulation 101 of the LODR, are mandatory. Any violation will amount to a breach of the SEBI Act, 1992, and incur a penalty.
On February 12, 2025, SEBI notified the Industry Standards Recognition Manual. Clause 10.5 empowers ISF to address genuine difficulties, provide clarifications, and amend the standards in consultation with SEBI. In case of amendments in relevant regulatory directions or if SEBI issues any clarifications, these standards would be modified/updated to reflect the revised position.
Implications of the New Standards on the Audit Committee
The new RPT disclosure standards entrust the Audit Committee with a significantly greater level of responsibility when approving the RPTs. It is important to note that while Regulation 23 allows only the independent directors on the Audit Committee to approve the RPTs, the ISF Guidance Note places all responsibility on the Audit Committee to provide the various confirmations required for placing the matter before the shareholders. The Audit Committee is expected to have all the information available to vote for or against the RPT and must scrutinise the RPT in granular detail and provide comments. However, some requirements, such as a statement confirming that “they have determined that the promoters will not benefit from the RPT at the expense of public shareholders”, exposes the Audit Committee to significantly higher risk should the assessment be proven misleading or inaccurate.
Proxy Advisory Firms and Public shareholders
Proxy advisory firms are expected to welcome the new disclosure standards, considering these would provide them with all the information for scrutinising the RPT rather than having to scour the internet and other sources for those details. This could lead to an increase in RPTs receiving negative voting recommendations from proxy firms.
Public shareholders will also applaud this move, as this will provide them with all the details, they need to make an informed decision on approving or rejecting an RPT.
The information to be disclosed to the shareholders is required to be included in the explanatory statement to the notice of the meeting called to approve such RPT.
As per Section 102(4) of the Companies Act, 2013, any non-disclosure or insufficient disclosure in the explanatory statement, being made by a promoter, director, manager or any KMP results in a benefit that accrues to such promoter, director, manager or KMP, either directly or indirectly, they shall hold such benefit in the trust for the company, and shall without any prejudice to any other action being taken against them under the Act or any other law in force, be liable to compensate the company to the extent of the benefit received by them. Further, it is settled law that where neither the notice nor the explanatory statement disclosed material facts pertaining to a resolution, the resolution would be invalid and ineffective.[1]
Practical Challenges
One practical challenge is that most listed companies have only four to six Audit Committee meetings in a year, with four focussed on approving quarterly financial results, as mandated for listed companies. Given that Indian company law mandates a uniform financial year – April to March – for all listed companies, most Audit Committees of various entities convene around SEBI’s stipulated time for calling meetings, which is usually after the close of each quarter. Considering many independent directors are on the Boards of multiple Audit Committees, this not only creates scheduling conflicts but also leaves them too time-crunched to comprehend company-provided voluminous information and evaluate RPTs in detail. As a result, the Audit Committee members rely on confirmations from CEOs and CFOs that the transactions are in an ordinary course and on arms-length basis. Moreover, SEBI has not provided any regulatory guidance to Audit Committee members on determining “arms-length price”.
The law made no clear distinction between routine profit & loss transactions (e.g., purchase of stationery, raw materials, and services) and high-value balance sheet transactions (e.g., sale of immovable property, corporate restructuring, and divestment of undertakings). As a result, Audit Committee members often allocated time to inconsequential matters and overlook transactions that could have a long-term negative impact on the interests of public shareholders. Before the ISF Guidance Note, focussing on balance sheet items was not required.
Concluding Thoughts
In their quest to find a balanced regulatory architecture for RPTs, the battle between the Regulator and the regulated appears relentless. Each time SEBI attempts to plug a loophole or curb a misconduct, regulated listed entities devise newer and more innovative structures to bypass the regulations and conduct transactions that benefit the controlling shareholder. In the process, however, well-managed companies find themselves saddled with higher compliance burden, which also defeats the Government of India’s stated objective of facilitating ease of doing business. The Regulator faces the challenge of achieving its twin objectives of safeguarding public shareholders’ interests from abusive RPTs and ensuring that there is no disproportionate burden of compliance on listed entities. SEBI’s quest to strike the perfect RPT regulatory balance continues.
[1] Firestone Tyre & Rubber Co. v. Synthetics and Chemicals Limited, (1971) 41 Com Cases 377 (Bom) and Shanti Prasad Jain v. Kalinga Tubes Limited (1965) 35 Com Cases 351 (SC)
