Material Related Party Transactions – Proxy Advisory Perspective of Disclosure and Legal Concerns - MMJC

Introduction

Related Party Transactions is a common phenomenon among all the companies. Related party transactions are subject to higher scrutiny as they inherently involve conflict of interest. Related party transactions subject to various approvals within the company depending on the legal framework applicable to the company.

Transactions brought before the members of the company are subject to clearance from audit committee and board of directors of the company first.

Related party transactions crossing specified threshold as per 1^st proviso to section 188(1) read with rule 15(3) of Companies (Meeting of its Board and its Powers), rules 2014 of companies act, 2013 or as per regulation 23 (1) of Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements), Regulations, 2015 are brought before the members of the company for approval. Members voting on relating party transactions consider the information provided for in the explanatory statement to the resolution for approval of related party transactions while taking a decision to vote on resolutions. In addition to this they also refer to the views expressed by proxy advisors. In this article we shall understand the relevance of having a detailed explanatory statement and a views of proxy advisors in various scenarios.

Importance of Explanatory statement in the approval of material related party transactions

Related parties, whether they are part of the transaction or not, are not allowed to vote to approve the related party transactions brought before members for approval[1]. Further no member of the company shall vote on resolution to approve any contract or arrangement which may be entered into by the company if such member is a related party to the transaction[2]. So, related party transactions brought before the members of the company are subject to approval by public shareholders only. Public shareholders would vote on the resolution by referring to the disclosures provided by the company in the explanatory statement provided along with resolutions.

Explanatory statement shall provide for material facts concerning each item of business to be transacted viz. nature of concern or interest, financial or otherwise or any other information and facts that may enable members to understand the meaning, scope, and implication of the items of business and to take decision thereon[3].

Further as per SEBI circular dt: November 22, 2021[4] listed companies are required to provide disclosures relating to proposed related party transactions:

a. A summary of the information provided by the management of the listed entity to the audit committee;

b. Justification for why the proposed transaction is in the interest of the listed entity;

c. Where the transaction relates to any loans, inter-corporate deposits, advances, or investments made or given by the listed entity or its subsidiary,

d. A statement that the valuation or other external report, if any, relied upon by the listed entity in relation to the proposed transaction will be made available through the registered email address of the shareholders;

e. Percentage of the counter-party’s annual consolidated turnover that is represented by the value of the proposed RPT, on a voluntary basis;

f. Any other information that may be relevant.

But is this data sufficient for a member to vote on the resolution relating to related party transactions?

As related party transactions involve conflict of interest, they are assessed on various parameters to ensure their sanctity. Hence it is necessary that explanatory statements shall be drafted stating not only the facts that are required by law but also all the all-relevant facts that a member should know to take decision on voting on related party transactions.

Failure to provide necessary details would make it difficult for members to appreciate the need and justification for proposed related party transaction(s). Members may also be misled due to lack of information.  Hence it is very much necessary to draft the explanatory statement pertaining to related party transaction with due care. This would lead to all relevant information being made available to members thereby leading to approval of proposals relating to related party transaction. This would also enhance confidence of shareholders in the company.

Legal provisions relating to explanatory statements are clear enough but as mentioned above members also refer the view of proxy advisors in this article a list of concerns is given which proxy advisors raise while assessing relating party transactions. This needs to be referred to while drafting of resolutions while proposing related party transactions. The concerns raised by proxy advisors are categorized as governance concerns, legal concerns, and disclosure concerns.

In this article we would see the varied nature of legal and disclosure concerns raised by proxy advisors when they assess the material related party transactions. Below is the compilation of these concerns raised by proxy advisors in various scenarios:

Sl.no	Concerns relating to	Reason by proxy advisors for recommending against.
Disclosure concerns
1	Non-disclosure of manner of determining project cost and methodology of awarding of contract	In case of approval of material related party transactions wherein the project is being assigned to a related party, but the project cost report is not disclosed and the methodology as to how was related party determined as the contender for execution of project is also not disclosed.   E.g. A transaction is proposed by the listed company with the holding company for construction of a plant for manufacturing products of listed company. Listed company states that the contract for manufacturing would cost Rs 300 crores and the contract was awarded through bidding process. Then in this case if the listed company does not disclose the project report through which this cost of Rs 300 crore was taken and also does not disclose the details as to how bidding process was done (viz. how many submitted bids, what was price etc.) then concerns are raised with respect to disclose for related party transactions.
	Clubbing of multiple transactions into one resolution for approval of members	Clubbing of multiple transactions with multiple related parties into one resolution may lead to inadequate disclosures in the resolution.   E.g. A ltd is proposing to enter transactions for supply of goods, availing of services, sharing of human resources, sharing of premises and other allied services with B Ltd (subsidiary company), C Ltd (associate company), D Ltd (fellow subsidiary) and E Ltd (subsidiary company). In this scenario it is not clear with whom what kind of transaction is proposed to be entered it is to be entered at what price, terms, and conditions. Also, shareholders if they want to approve one transaction but want to reject the other transaction it is not possible.
	Non-disclosure of arm’s length pricing and arm’s length basis	Sometimes resolutions proposing related party transactions don’t provide for at what price the transaction would be entered or on what terms the transactions would be entered. Neither any formula or guidance is provided as to how the price will be determined or whether the terms of transactions would be same as that of related party. In this case even if the resolution says that transactions would be at arm’s length price and on arm’s length basis this statement remains invalidated.
	Differing practices in proposing resolutions for approval of material related party transactions	Listed entity has a practice of proposing separate resolutions for approval of material related party transactions with each related party with limit specified for each related party transactions. From a particular period, company decides to change this practice. Listed company now starts proposing material related party transactions for approval with clubbed resolutions and without separate limits for each related party (viz. resolution for approval of related party transactions with multiple related parties for multiple transactions and consolidated limits) then concerns are raised due to this sudden change in practice without adequate justification.
	Non-disclosure of details pertaining to the transactions	Inadequate disclosure pertaining to details of transactions. E.g. If A ltd engaged into real estate business is proposing to enter into transactions with related parties for sale of flats, commercial places, shops and establishments being constructed by the listed company then questions are raised as to within how many units will be sold, within what time it will be sold, what will be end purpose of these transactions for the related party buying those units, for what time this arrangement is proposed, at what price these transactions would be entered and how will the price be determined etc.
	Nature of relationship with related parties not disclosed	Related party transactions proposed with related parties but nature of relationship with related parties was not mentioned. Due to this it becomes difficult to understand what impact these related party transactions would have on the listed entity. E.g. A Ltd proposing related party transaction with B ltd and C Ltd but what is the relation between A Ltd, B Ltd and C Ltd is not explained due to which it becomes difficult to understand what impact this transaction would have on listed company.
	Value of transactions with related parties not disclosed	If related party transactions are being proposed with a related party for 3 years but it is not mentioned what value of transaction will be entered with the related party every year during this period then questions are raised for non-disclosure. Concerns are also raised as to why company is not able to ascertain the value of these transactions.
Legal concerns
3	Minimum data as per SEBI Circular dt: November 22, 2021	While entering into related party transactions if the minimum details as are required by SEBI circular dt: November 22, 2021 are not provided in the notice for approval of related party transactions then legal concerns would be raised.
	Omnibus approval for more than one year	As per SEBI Circular dt: April 8, 2022 omnibus approval of material related party transactions shall be proposed for a period of one year only. These transactions shall be proposed to be brought before the members every year. In case a listed company proposes omnibus approval of material related party transactions with related parties or related party for a period exceeding one year or one financial year then legal compliance concerns are raised.

Conclusion

Disclosures in detail about various aspects of proposed related party transactions helps stakeholders understand the relevance of related party transactions. It makes easy for members of the company to decide whether to consent or dissent the proposed related party transactions. Related party transactions inherently involve conflict of interest. Hence it is necessary to ensure that all the requisite details of proposed related party transactions leaving no room confusion amongst stakeholders. It would act as a first step towards stakeholder’s engagement.

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[1] Reg 23(4) of SEBI LODR

[2] 2^nd proviso to section 188(1) of Companies act, 2013

[3] Section 102 of companies act, 2013

[4] https://www.sebi.gov.in/legal/circulars/nov-2021/disclosure-obligations-of-listed-entities-in-relation-to-related-party-transactions_54113.html