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January 17, 2025
Material Related Party Transactions – Proxy Advisory Perspective of Governance Concerns - MMJC
Introduction
In the first article on subject matter, we saw the relevance of giving legal disclosures and disclosures that are necessary. In this article we would be focusing on recommendations made on ‘Governance Concern’ by proxy advisors resolutions pertaining to approval of material related party transactions. Governance concerns are pertaining to ‘why’ this transaction is being entered.
Listed companies proposing to enter into these transactions provide for the reasons for entering into these transactions. Proxy advisors raise governance concerns if related party transactions proposed to be entered into does not prima facie seem commercially viable. Also, concerns are raised if the justification provided by the listed company is not adequate for shareholders to understand implication of the transaction.
Below is the list of governance concerns raised by proxy advisors with respect to related party transactions:
| Sr.no | Concerns relating to | Reason by proxy advisors for recommending against. |
| 1 | Concentrated transactions with related parties | If related party transactions with a single party are substantially high as compared to the turnover of the related party then questions are asked with respect to the necessity of such huge volumes for such related party transactions. |
| 2 | Sudden surge in related party transactions | If listed company starts entering into related party transaction with a related party with whom there were no transactions entered till now or if related party transactions have seen a sudden surge as compared to previous financial year, then concerns are raised with respect to such sudden surge if there is no adequate justification for such sudden surge [e.g. If transactions with A ltd [promoter controlled company] for availing of services was Rs 10 and from next financial year if the value of transaction has gone beyond Rs 80 (without any growth in business) then concerns are raised. For justifying such related party transaction companies generally mention that purchase of raw material from promoter-controlled company would give company a sustainable supply of raw material as compared to other suppliers looking at geo political situations then questions would be raised regarding at what price this transaction would be done, will this arrangement end once geo political situation normalizes etc. |
| 3 | Non-disclosure of limits of related party transactions | Listed entity had provided limits for each transaction that it would be entering into with a related in party in financial year. Now while continuing the related party transaction in the next financial year the listed company choose to mention a cumulative limit of related party transactions with related party instead of specifying individual limit for each related party transactions earlier. e.g. A ltd proposed to enter into transactions for buying raw materials worth Rs 100, provide services worth Rs 200, avail services worth Rs 300 with related party in a financial year. In next financial year A ltd proposed to enter into related party transactions with same related party for Rs 1000 but there is no bifurcation for which services what value is attached. |
| 4 | Is transaction commercially viable? | If related party transaction is relating to inter corporate loans and guarantee then it is checked if the loan being provided to the related party or for whom the guarantee is given is commensurate with the operations of the company. E.g. suppose a company is having losses of Rs 450 crore and loan is provided to the company or guarantee is being given for loan being availed by the company then concerns are raised why such guarantee or loan is being given? What is the valid justification for such transaction? Is the company already defaulting on other loans provided by market and they are not ready to further extend the transaction? Further questions are also asked whether listed company is the only company who is providing guarantee or loan or any other group company has also extended loan or guarantee? If no one else if extending the loan or guarantee then why is listed company giving the same? This raises questions as to how the transaction is in the best interest of the listed company. |
| 5 | In case a listed company is proposing a material related party transaction to convert a loan into equity then questions are raised with respect to following: Why is this transaction of converting loan into equity being proposed?If the entire loan is not being converted to equity, then why a small portion is being converted only. E.g. If loan is of Rs 400 crore but only Rs 25 crore is being converted? Why is this being proposed when company has a healthy cash flow? | |
| 6 | In case a company is proposing to give loans, provide guarantees to its subsidiary and for doing this company is using cash by withdrawing money from liquid investments before maturity or idle cash lying with the company then following questions are raised: How is this decision commercially viable and in the best interest of the company? Is the subsidiary company generating healthy cash flow enough to service the debt? What was the return company was getting through its liquid investments and what is the return company going to get in the form of interest through this loan? Would this loan be given on same terms as the liquid investments were? | |
| If related party transaction is entered with the subsidiary company for supply of raw materials while there is not much business in subsidiary company for utilizing this material provided and manpower is also not employed then questions are raised for this transaction. | ||
| 7 | Time period for entering into related party transactions | Listed entity proposing to enter into related party transactions with related parties but no time period is prescribed for continuation of the transaction then concerns are raised as to why such transactions are being proposed in perpetuity. |
| 8 | Resolutions with confusing timelines | Listed entity had proposed and got it approved transaction with a related party for providing loan and guarantee for a period of five years in the previous financial year. Now in the current financial year the same resolution is again proposed for approval with same set of transactions but with one new related party being added. As already the resolution was approved for loan and guarantee for a period of five years then why is the same resolution being again amended with new related party and why not a separate resolution is being proposed with it. |
| 9 | Clubbing of resolution | Clubbing of resolutions of different nature would lead to shareholders not getting a chance to vote on important resolutions. E.g. related party transaction resolution for issuance of non-convertible redeemable preference shares was clubbed with other resolutions for supply of goods or rendering of services or availing of services proposed. |
| 10 | Transactions involving pecuniary relationship. | Transaction is being entered with a firm for availing of consultancy services. Non-executive director of the company is a partner of the firm. Non-executive director is not going to draw any remuneration from company but he is drawing remuneration from the firm. Questions were raised as to why director is not taking remuneration in listed company but having a pecuniary relationship through firm. Why this transaction is being proposed in this year only and was listed company taking this consultancy earlier also? If listed company was not taking the consultancy earlier then why this year has it started and from this firm only? |
| 11 | Ordinary course of business | If listed company is taking an omnibus approval for sale of land, building, plant etc. then questions are raised as to how is this transaction being considered as ‘ordinary course of business’? Why omnibus approval is being taken for such transactions and why not specific approval is being taken? |
| 12 | Questionable business arrangements | In case a listed company’s promoter has started a news business and wants the listed company to transfer the resources and purchase its finished products then questions are raised as to why this new business is being done by a promoter-controlled entity and not the listed company itself? Was this transaction evaluated by the board of directors? What was the reasoning behind not doing the business under the listed company? How is this transaction in the best interest of listed entity? |
| 13 | Statutory auditors raising concern relating to transactions | Listed companies continuing to enter into related party transactions even when statutory auditors have qualified the audit report stating that there is non-repayment of loan already given to related party or the guarantee given by listed company for and on behalf of related party got invoked due to which there is mounting debt obligations on the listed entity. Inspite of this if related party transactions are being entered without justification or any concrete steps to recover the money then questions are raised on the validity of related party transactions. |
Conclusion
Assessment of related party transactions on governance aspect would differ according to the business and transactions proposed. Governance concerns provide a different perspective to the related party transactions. Addressing these governance concerns proactively would help listed companies get better support from members for the related party transactions.
This article is published in Taxmann. The link to the same is as follows: –
This article was written by Vallabh Joshi – Senior Manager – vallabhjoshi@mmjc.in