Companies Act 2013

Related party transactions

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Both under the 2013 Act and RC49, requirements concerning related party transactions may be divided into four key parts, viz., identification of related parties, related party transactions, approval process and disclosure requirements. It is clear from discussion below that in most cases, RC49 contains stricter requirements vis-à-vis those under the 2013 Act. The definition of ‘related party’ under RC49 is likely to result in identificationof significantly higher number of related parties vis-à-vis those under the 2013 Act. RC49 contains a broader definition of‘related party transactions’ which is expected to cover all types of related party transactions. Unlike the 2013 Act, RC49 does not exempt related party transactions from special resolution of disinterested shareholders based on criteria, viz., (i) transaction is in the ordinary course of business and at arm’s length, or (ii) prescribed threshold regarding transaction value and share capital are not breached. The only exemption from special resolution of disinterested shareholders under RC49 is thatthe transaction does not breach materiality threshold. A listed company needs to consider the two requirements carefully and apply stricter of the two.

  • Identification of related parties

    What the Companies Act 2013 states:

    Definition under the 2013 Act

    The 2013 Act defines the term “related party” to mean:

    • A director or his relative
    • KMP or his relative
    • A firm, in which a director, manager or his relative is a partner
    • A private company in which a director or manager is a member or director
    • A public company in which a director or manager is a director and1 holds along with his relatives, more than 2% of its paid-up share capital
    • A body corporate whose board, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager, except if advice/ directions/ instructions are given in the professional capacity
    • Any person on whose advice, directions or instructions a director or manager is accustomed to act, except if advice/ directions/ instructions are given in theprofessional capacity
    • Any company which is:
      • A holding, subsidiary or an associate company of such company, or
      • A subsidiary of a holding company to which it isalso a subsidiary
    • Such other persons as may be prescribed.

    Related parties under “enabling clause” (clause (ix))

    In accordance with the draft rules, the following persons were to be covered under the enabling clause:

    • "A director or KMP of the holding, subsidiary or associate company of such company or his relative, or
    • Any person appointed in senior management inthe company or its holding, subsidiary or associate company, i.e., personnel of the company or its holding, subsidiary or associate company who are members of core management team excluding board of directors comprising all members of management one level below the executive directors, including the functional heads.”

    There was a concern that the definition, particularly, relations prescribed under the draft rules, will result in a long list of related parties for large conglomerates having multiple subsidiaries/operations. Many of these persons may not be in a position to influence the actions of a company, and may not even be known to the company. For example, a director or KMP of the subsidiary or associate, in most cases, may not be able to influence the parent/investor. Also, the persons at one level below executive directors and functional heads do not have authority and responsibility for planning, directing and controlling the activities of a company. Rather, they work under the supervision of the board of directors. Hence, the draft rules may have created significant administrative burden on companies to identify and track related party relations/ transactions on a continuous basis, which may not serve much useful purpose. Global practice is also not to include them in related parties.

    In the Definition Rules, this issue has been largely addressed. In the Definition Rules, the enabling clause includes only a director/ KMP of the holding company or his relative as the related party. We welcome the change made in the Definition Rules.

    Common directorship

    The definition of “related parties” in the 2013 Act provided that related party with reference to a company, among other matters, includes a public company in which a director or manager of the company is a director or holds along with his relatives, more than 2% of its paid up share capital (emphasis added).

    To explain, assume that ABC Limited and DEF Limited are two public companies. There is no relation between the companies, except relation below.

    • Mr. X is a reputed professional. He has recently been appointed as independent director on the board of ABC. Mr. X is also an independent director on the board of DEF. Based on common directorship, one will have concluded that ABC and DEF are related parties to each other. Consequently, all companies where Mr. X is a director would have become related parties to ABC and DEF.
    • Consider another scenario. Mr. X is a reputed professional.He has recently been appointed as independent directoron the board of ABC. One of the relatives of Mr. X holds 2% share capital in DEF. Based on the above clause, DEF would have been a related party to ABC. However, from DEF’s perspective, ABC will not have been a related party.

    It appears that the Government may not have intended that a company should identify a public company as its related party merely because there is a common director. To reflect its true intention and avoid undue hardship, the Central Government has proposed to issue the Companies 1st (Removal of Difficulties) Order, 2014. In accordance with the proposed order, the word ‘or’ highlighted above should be read as the word ‘and.’ For the purpose of this publication, it is assumedthat the proposed order is final and will become law soon. Hence, for a company, public company will be related party only if both the criteria are met:

    • Director or manager of the company is a director in the public company, and
    • Director or manager holds along with his relatives more than 2% of paid up share capital in the public company

    Definition under the RC49

    RC49 defines the term ‘related party’ in a broader manner. The definition under RC49 includes all related parties under the2013 Act. In addition, it includes related parties under Ind-AS24. RC49 states that a ‘related party’ is a person or entity that is related to the company. Parties are considered to be relatedif one party has the ability to control the other party or exercise significant influence over the other party, directly or indirectly, in making financial and/or operating decisions and includes the following:

    • A person or a close member of that person’s family is related to a company if that person:
      • Is a related party under section 2(76) of the 2013 Act
      • Has control or joint control or significant influenceover the company, or
      • Is KMP of the company or of a parent of the company
    • An entity is related to a company if any of the following conditions apply:
      • The entity is a related party under section 2(76) of the 2013 Act
      • The entity and the company are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others)
      • One entity is an associate or joint venture of the other entity (or an associate or joint venture of a member of a group of which the other entity is a member)
      • Both entities are joint ventures of the same third party e)    One entity is a joint venture of a third entity and the other entity is an associate of the third entity
      • The entity is a post-employment benefit plan for the benefit of employees of either the company or an entity related to the company. If the company is itself such a plan, the sponsoring employers are also related to the company, or
      • The entity is controlled or jointly controlled by a person identified in (1), or
      • A person identified in (1)(b) has significant influence over the entity (or of a parent of the entity).

    An explanation to the definition states that for this purpose, the term ‘control’ will have the same meaning as defined in the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011. These regulations define the term ‘control’ to include “right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner.”

    Definition of relative

    The 2013 Act defines the term ‘relative’ as ‘with reference to any person means anyone who is related to another, if:

    • They are members of a Hindu Undivided Family
    • They are husband and wife, or
    • One person is related to the other in such manner as may be prescribed’

    The draft rules prescribed a list of 15 relations to be covered under (iii) above. In the Definition Rules, this list has been rationalized to exclude grandparents and grandchildren. Now, it covers only 8 relations (see Table 3).

    Table 3: List of relatives

    Father (including step-father)

    Daughter

    Mother (including step-mother)

    Daughter’s husband

    Son (including step-son)

    Brother (including step-brother)

    Son’s wife

    Sister (including step-sister)

    In the context on independent directors, RC49 states that the term ‘relative’ will have the same meaning as defined under the2013 Act and rules prescribed thereunder.

    EY insights

    • Among other matters, the definition of ‘relative’ is likelyto have significant impact on aspects such as coverage of related party transactions or appointment, qualification and disqualification of auditor and independent directors. We believe that rationalization of the list of relatives is an improvement from the definition contained in the draft rules and it may somewhat reduce challenges in ensuring continuing independence of the auditor/independent directors. However, the fact remains that a person may not be able to control/influence actions of other person if the other person is not financially dependent on him/her. Similarly, a person may be able to influence other persons who are financially dependent on him or her, even if they are not covered in specific list or relations. Going forward this aspect may be revisited by the MCA.
    • Refer discussion under the head ‘common directorship’, including change made through the proposed Companies 1st (Removal of Difficulties) Order, 2014. Interestingly, the concerned clause for identifying related party is not based on the principle of reciprocity. Hence, it is possible that one company identifies other company as its related party. However, it does not necessarily mean that the second company will also identify the first one as its related party. Rather, it will perform its own independent evaluation. See example below.

      ABC Limited and DEF Limited are two public companies. Mr. X, a reputed professional, is an independent director on the board of ABC. Mr. X is also a director on the board of DEF. Wife of Mr. X holds 2% share capital in DEF. Besides this, there is no relationship between two companies. In this case, ABC will treat DEF as its related party as both the criteria for identifying a public company as related party are met. For DEF, ABC is not a related party since criterion (ii) explained under the head ‘common directorship’ is not met.

      Also, it may be noted that the proposed order is relevant only for the identification of public company as related party. There is no change in the criterion to determine whether a private company is related party to the company. Also, it is pertinent to note that the above differentiation between private and public companies is from the perspective of the company who is being identified as related party and not the company who is identifying its related party. Table 4 explains this aspect from ABC Limited’s perspective:

      Table 4: Related party identification

      ABC Limited

      Public/ Private

      Public/ Private

      Public/ Private

      Public/ Private

      DEF Limited

      Public

      Public

      Private

      Private

      Common director

      Yes

      Yes

      Yes

      Yes

      Director’s shareholding in DEF

      2%

      Nil

      2%

      Nil

      Director’s shareholding in ABC

      Nil

      2%

      Nil

      2%

      Whether DEF is related party to ABC

      Yes

      No

      Yes

      Yes

      Whether ABC is related party to DEF (DEF’s perspective)

      Yes, if ABC is a private company.

      No, if ABC is a public company.

      Yes in both the cases.

      Yes, if ABC is a private company.

      No, if ABC is a public company.

      Yes in both the cases.

    • Whilst the RC49 uses the terms such as ‘close member of family’, ‘joint venture’ and ‘group,’ it does not define those terms.It may be argued that since definition of related parties is based on Ind-AS 24, a listed company should refer Ind-AS for appropriate definition of these terms.
    • The definition of ‘related party’ under the RC49 is much more exhaustive. Related parties under section 2(76) of the 2013 Act are just one element of related party relationships covered under the RC49. RC49 is likely to result in identification of much higher number of related parties and identification on a more consistent basis. Consider the example in diagram 1 below:

      EY - Definition of related party

    In this example, analysis under the 2013 Act is likely to be as below:

    • For company H, company A is an associate company and its related party.
    • The definition of related party in the 2013 Act doesnot refer to joint venture as related party. However, the definition of “associate company” includes “joint venture company.” Thus, for company H, company S is also a related party
    • On the same basis as (b) above, for company Z, company Sis a related party.

    It is assumed that there is no other relationship between parties. Basis this, for company A, company H is not a related party. Similarly, for company S, neither H nor Z is related party. Company S and A are not related parties to each other. Company Z and H are also not related to each other.

    All three related party relationships identified under the 2013Act continue under RC49. In addition, the following new relationships get identified:

    • For company A, company H is a related party under clause2(c) of ‘related party’ defination under RC49.
    • On similar lines, both H and Z are related parties to company S.
    • Company S and A are related parties to each other under clause 2(e) of ‘related party’ defination under RC49.

    Even under RC49, company Z and H are not related to each other.

  • Identification of relevant transactions

    What the Companies Act 2013 states:

    Section 188 of the 2013 Act deals with the related party transactions with respect to:

    • Sale, purchase or supply of any goods or materials
    • Selling or otherwise disposing of, or buying, property of any kind
    • Leasing of property of any kind
    • Availing or rendering of any services
    • Appointment of any agent for purchase or sale of goods, materials, services or property
    • Related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company, and
    • Underwriting the subscription of any securities or derivatives thereof, of the company.

    In contrast, RC49 defines the related party transactions as a transaction involving “transfer of resources, services or obligations between a company and a related party, regardless of whether a price is charged.”

    EY insights

    In the definition under RC49, specific attention is drawn to the use of the word ‘resource’ which may include even items that do not meet criteria for recognition as an asset. To illustrate, a listed company is transferring to its fellow subsidiary ‘research work’ carried out in the past which does not meet AS 26 criteria for recognition as an intangible asset. Under RC49, the proposed transaction will be covered as transfer of resource.Hence, RC 49 contains a broader definition which is expected to cover all types of related party transactions.

    The two issues discussed below regarding identification of related party transactions are not relevant under RC49.

    Section 188(1)(b) of the 2013 Act covers contract with related parties with respect to “selling or otherwise disposing of, or buying, property of any kind.” Does the term ‘property’ cover only ‘immovable property’? Or will it include even movable property and intangible assets?

    Whilst section 188(1)(b) of the 2013 Act covers “selling or otherwise disposing of, or buying, property of any kind,” section 188(1)(a) deals with “sale, purchase or supply of any goods or materials.” This indicates that ‘goods or materials’ are not covered under section 188(1)(b) and discussions below are relevant only for other items.

    Section 188 of the 2013 Act does not define the term ‘property.’ However, it may be noted that explanation (iv) to Section 232, which deals with merger and amalgamation of companies, states that “for the purpose of this section, the term property includes assets, rights and interests of every description.”

    The above guidance, along-with the term used, viz., ‘property of any kind’ seems to indicate that all forms of property, including intangible assets such as intellectual property rights, may be covered under Section 188(1)(b).

    Further, section 44 of the 2013 Act states that shares, debentures or other interest of any member in a company will be movable property transferable in the manner provided by the articles of the company. This indicates that even shares/ securities are included in definition of “property.”

    Since this is a legal matter, we suggest that a company consults its legal professionals before taking any final view on the matter.

    Since the term ‘property’ includes ‘securities’ also, does Section 188(1)(b) cover only sale/or transfer of securities in the secondary market or would allotment of securities, i.e., primary issue of securities, also be covered?

    As discussed in the response to previous issue, the existing shares constitute property. Hence, a related party transaction involving sale/purchase, etc., of the existing shares/securities allotted in the past is likely to trigger compliance under section 188. This requires a company to assess whether it meets any of the exemption criteria and approvals required.

    Fresh allotment of shares/securities may not constitute property since the company did not own those shares before the allotment. Also, the word ‘buy’ may not include fresh allotment of shares. Basis this, one may argue that fresh allotment/subscription of securities to related parties does not trigger section 188.

    We believe that this is a matter of legal interpretation and a company needs to consult legal professionals before taking any final view.

  • Approval process

    What the Companies Act 2013 states:

    Though related party transactions both under the 2013Act and RC49 require approval of similar bodies, there are differences in the conditions which trigger such approvals. Particularly, RC49 does not exempt material relatedparty transactions from special resolution of disinterested shareholders based on the criteria, viz., (i) transaction is in the ordinary course of business and at arm’s length, or (ii) prescribed thresholds regarding transaction value and share capital are not breached. Listed companies need to consider the requirements carefully and apply the same in a manner that compliance with both requirements can be ensured. In other words, they need to comply with stricter of the two requirements.

    The 2013 Act

    Section 188(1) of the 2013 Act provides below for approval of related party transactions:

    • “(1) Except with the consent of the Board of Directors given by a resolution at a meeting of the Board and subject to such conditions as may be prescribed, no company shall enter into any contract or arrangement with a related party with respect to:
      • Sale, purchase or supply of any goods or materials
      • Selling or otherwise disposing of, or buying, property of any kind
      • Leasing of property of any kind
      • Availing or rendering of any services
      • Appointment of any agent for purchase or sale of goods, materials, services or property
      • Such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company, and
      • Underwriting the subscription of any securities or derivatives thereof, of the company
      Provided that no contract or arrangement, in the case of a company having a paid-up share capital of not less than such amount, or transactions not exceeding such sums, as may be prescribed, shall be entered into except with the prior approval of the company by a special resolution.

      Provided further that no member of the company shall vote on such special resolution, to approve any contract or arrangement which may be entered into by the company, if such member is a related party.

      Provided also that nothing in this sub-section shall apply to any transactions entered into by the company in its ordinary course of business other than transactions which are not on an arm’s length basis.”

    In accordance with section 177(4)(iv) of the 2013 Act, one of the functions of the Audit Committee is “approval or any subsequent modification of transactions of the company with related parties.”

    Under the 2013 Act, a company needs approval of the Audit Committee, if applicable, 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 or they do not breach the share capital/transaction value thresholds prescribed in the Board Rules.

    For a transactions meeting both the criteria (i) transaction is entered into the ordinary course of business, and (ii) transaction is at arms’ length price, neither the board approval nor the special resolution of disinterested shareholders is required. For transactions, which are either not in the ordinary course of business or not at arm’s length, the company will need atleast approval of the board, irrespective of the share capital/transaction value.

    Regarding the special resolution of disinterested shareholders, there is an additional exemption which needs to be considered, viz., the company satisfies both the criteria (i) paid-up share capital of the company is below the prescribed threshold, and (ii) transaction value does not exceed the prescribed limit. Thus, a company requires approval through shareholder’s special resolution at general meeting, if criteria at (i) and (ii) below are met. Members of the company, who are related parties, are not permitted to vote on the special resolution.

    • Related party transactions are either not in the ordinary course of business or not at arm’s length, and
    • Company’s paid-up share capital is not less than prescribed limit, or transaction(s) amount exceeds specified threshold.

    There is no change in approval process under the Board Rules. However, monetary thresholds for passing special resolution have increased vis-à-vis the draft rules. See Table 5.

    Table 5: Monetary thresholds for passing special resolution

    Criteria

    Final rules

    Draft rules

    Paid-up share capital threshold

    `10 crores or more

    `1 crores or more

    Transaction value threshold

     

     

    Sale, purchase or supply of any goods or materials (Directly or through agent)

    More than 25% of annual turnover

    Total transaction value during the year exceeds 5% of annual turnover or 25% of net worth of the company as per its last audited financial statements

    Selling or otherwise disposing of, or buying, property of any kind (Directly or through agent)

    More than 10% of net worth

    Leasing of property of any kind

    More than 10% of net worth or 10% of turnover

    Availing or rendering of any services (Directly or through agent)

    More than 10% of net worth

    Appointment to any office or place of profit in the company, its subsidiary company or associate company

    Remuneration exceeds `250,000 per month

    Remuneration exceeds `100,000 per month

    Underwriting the subscription of any securities of the company or derivatives thereof

    Remuneration exceeds 1% of net worth

    Remuneration exceeds `1,000,000

    To claim exemption from special resolution of disinterested shareholders either the transaction has to be in the ordinary course of business and at arm’s length or below the prescribed threshold. Based on the criteria above, it needs to be ensured that paid-up share capital of the company is below the threshold given in table 5 as well as that the transaction value does not exceed threshold given in table 5. If either of the two criteriais breached, a company will not be eligible to avail exemption unless the transaction entered into by the company is in its ordinary course of business and it has been entered into on an arm’s length basis.

    Revised Clause 49

    Under RC49, all related party transactions require prior approval of the Audit Committee, irrespective of whether they are material or not. RC49 also requires all materialrelated party transactions to be approved by the shareholders through special resolution. Related parties should abstain from voting on such resolutions. Unlike the 2013 Act, RC49 does not exempt material related party transactions from special resolution of disinterested shareholders based on the criteria, viz., (i) transaction is in the ordinary course of business and atarm’s length, or (ii) prescribed thresholds regarding transaction value and share capital are not breached.

    RC49 does not make any reference to the board approval for related party transactions. However, one may argue that under the principles of corporate governance, any matter to be referred to the shareholders is routed through the board. Also, under RC49, one of the functions of the board is to “monitor and manage potential conflicts of interest of management, board members and shareholders, including misuse of corporate assets and abuse in related party transactions.” This suggests that the board also need to approve all material related party transactions entered into by a listed company.

    A transaction with a related party is considered to be material if the transaction/transactions to be entered into individually or taken together with previous transactions during a financial year, exceeds 5% of the annual turnover or 20% of the net worth of the company as per its last audited financial statements, whichever is higher.

    Interaction between the 2013 Act and RC49

    A listed company needs to apply stricter of the 2013 Act and RC49 requirements. Considering the impact of the 2013 Act andRC49, the approval requirements will operate as below:

    • To comply with RC49, a listed company needs to get all related party transactions approved by the Audit Committee.It also needs to get all material related party transactions approved by the Board and Special Resolution of DisinterestedShareholders. The exemptions given under the 2013 Act will not apply.
    • For immaterial transactions of listed companies and all related party transactions of non-listed entities, approval requirements of the 2013 Act apply. It is noted that due to differences in criteria, even an immaterial related party transaction (as per RC49) may need board/disinterested shareholder approval under the 2013 Act. For example, this may arise because transaction isnot in the ordinary course of business and/or not on arms’ length basis, and the share capital or transaction vale thresholds are breached.

    Diagram 2 below explains practical applicability of the approval process. The diagram illustrates approval requirements of both the2013 Act and RC49.

    Diagram 2

    EY - Related Party Transactions Approval Process

    1Under the 2013 Act, non-listed companies, which do not meet the prescribed criteria, are not required to constitute Audit Committee. In such case, Audit Committee approval requirement does not apply.

    ×

    Diagram 2

    EY - Related Party Transactions Approval Process

    1Under the 2013 Act, non-listed companies, which do not meet the prescribed criteria, are not required to constitute Audit Committee. In such case, Audit Committee approval requirement does not apply.

    EY insights

    The discussion regarding practical issues focuses on the 2013 Act. Nonetheless, most of it would also be relevant for purposes of complying with the listing requirements. At appropriate places, we have made references to RC49.

    Section 177(4)(iv) of the 2013 Act requires the Audit Committee approval on any transaction entered into by a company with its related parties, including subsequent modification thereto. Is the Audit Committee approval required prior to execution of the contract with a related party? Or will it be acceptable to obtain the approval after the contract has been executed?

    One view is that section 177(4)(iv) does not specifically use the word ‘prior approval.’ Hence, one view is that it may be acceptable to obtain approval even after the execution of the contract. The second view is that the term used is ‘approval’ and not ‘ratification.’ This seems to indicate that the approval should be obtained prior to execution of the contract. The proponents of second view also state that it will be more prudent for a company to obtain the approval before entering into any transaction with a related party. If the Audit Committee does not approve any previously executed contract, it may have the effect of de-railing the entire transaction and causing financial loss to the company as well as the counterparty.

    In case of listed companies, RC49 specifically requires all related party transactions to be pre-approved by the Audit Committee.

    With regard to the board approval/special resolution of disinterested shareholders section 188(3) of the 2013 Act provides as below:

    • “Where any contract or arrangement is entered into by a director or any other employee, without obtaining the consent of the Board or approval by a special resolution in the general meeting under sub-section (1) and if it is not ratified by the Board or, as the case may be, by the shareholders at a meeting within three months from thedate on which such contract or arrangement was entered into, such contract or arrangement shall be voidable at the option of the Board and if the contract or arrangement is with a related party to any director, or is authorised by any other director, the directors concerned shall indemnify thecompany against any loss incurred by it.”

    Apparently, section 188(3) does not intend to allow companies to take post-facto approval for related party transactions. Rather, it prescribes the corrective measures to be taken and impact, if a company does not comply with the requirements of section 188(1) on a timely basis.

    Let us assume that a company is entering into related party transaction requiring the Audit Committee and the Board approval. From the process perspective, is there any requirement to obtain the board approval first or the Audit Committee approval first?

    Neither the 2013 Act and nor the Board Rules prescribe any particular process flow/order for obtaining required approvals. For example, there is no specific requirement whether a company should obtain the Audit Committee approval first or the Board approval first, if both the approvals are needed. Typically, one expects that the approval of shareholder, i.e., special resolution of disinterested shareholders, will be obtained only after other approvals have taken place. In other cases, more than one view seems possible.

    • One view is that section 188 generally requires the board approval to be obtained before entering into a contractor arrangement with the related party. However, there is no clear requirement for the Audit Committee pre- approval. This seems to indicate that a company can sign the agreement with a related party by having the Audit Committee approval as condition precedent. Hence, in one scenario, the company can take the board approval first and the Audit Committee approval later.
    • The second view is that the Audit Committee is required to act in accordance with the terms of reference made by the board. It would not be appropriate if the Audit Committee rejects a transaction, which has already been approvedby the board. Hence, in practice, the board may first refer proposed related party transaction to the audit committee. Upon receiving the audit committee approval/rejection,the board will make its decision. To support this view, one may also draw reference to JJ Irani Committee Report2. The report, among other matters, stated that all matters relating to related party transactions and other matters involving conflicts of interest should be referred to the board only through the Audit Committee.

    In case of listed companies, RC49 requires all related party transactions to be pre-approved by the Audit Committee. This indicates that in case of listed companies, only the second view should be applied. For non-listed companies also, the second view is preferred approach. In other words, it is preferable approach to get the Audit Committee approval first before referring a related party transaction to the board.

    Related parties not entitled to vote

    For transactions requiring approval through special resolution at the general meeting, second proviso to the section 188(1) states that no member of the company will vote on such special resolution, if such members are related parties. RC49 also contains similar requirement for approval of material related party transactions. Is the prohibition from voting applicable to all shareholders who are related parties? Ordoes it apply to only those related parties who are conflicted with respect to the specified transaction?

    Consider the example in diagram 3. Subsidiary S intends to make royalty payment to Parent P, which is concluded to be not at arm’s length or not in the ordinary course of business. Also, the prescribed threshold criteria are breached, requiring special resolution at the general meeting. Members of the company, who are related parties, are not permitted to voteon the special resolution. It is clear that P is not entitledto vote on the special resolution. However, it is not clear if other related parties also are not entitled to vote. In simple words, what is not clear is from whose perspective the related parties should be considered. In this case whether it is related parties of S, or related parties of P who are shareholders inS or both or all related parties that may have a conflict of interest in that transaction. Particularly, in this fact pattern, the question is whether Investor A can vote on the special resolution.

    Diagram 3

    EY - Approval process

    ×

    Approval process

    EY - Approval process

    Neither the 2013 Act nor the Board Rules nor RC49 are clear which related parties are not entitled to vote. This is likely to result in multiple views on the matter.

    The first view is that a perusal of the second proviso to Section 188(1) indicates that all members of a company, who are related parties, are barred from voting on special resolution to approve a related party contract/arrangement. However, such a strict interpretation of the proviso creates an ambiguity. Also, it is likely to result in undue hardship to the parties who may not be conflicted in the transaction. These parties may argue that without any reason, they are being deprived of legal rights available under the 2013 Act.

    The supporters of first view argue that if certain provisions of law are not clear, one needs to look at overall context for interpreting/understanding those requirements. In this case, the requirements have been introduced to avoid conflict of interest. Hence, one should apply requirements keeping this context in the mind.

    Considering the above, supporters of the first view argue that only such members who are related to a company and have an interest in the subject matter of special resolution should not be allowed to vote. Hence, in the above example, investor A should not be barred from voting unless A is also interested party in the transaction and/or related to parent P.

    The second view is that subsidiary S is interested in making payment to its parent P. Hence, it may attempt to influence decision of its related parties. Consequently, no related party of subsidiary S should be entitled to vote. Under this view, investor A, who is related party to S, will also not be entitled to vote. One major drawback with this view is that investor A may be an unrelated party to P and may want to stop such royalty payment because it is unreasonable. However, Investor A will not be entitled to vote.

    The third view is that all related parties of Parent P, who are also shareholders in subsidiary S, are not entitled to vote. The acceptance of this view may pose additional practical challenges since subsidiary S may not be aware about related parties of P. The fourth view is that related parties of both S and P (who are shareholders in S) are not entitled to vote.

    We believe that the first view is logically correct and probably reflects the intention of the legislator. It may be appropriate for the MCA and the SEBI to clarify. Until such guidance or clarification is provided, it may be appropriate for a company to consult legal professionals before taking any final view.

    Special resolution in case of wholly owned subsidiaries

    In certain cases, it may so happen that all shareholders in a company are related parties and therefore not entitled to vote. For example, consider a scenario where a wholly owned subsidiary proposes to enter into a transaction with its holding company. It is concluded that the transaction requires special resolution at the general meeting. Members of the company, who are related parties, are not permitted to vote on the special resolution. In this case, how does the subsidiary comply with the special resolution requirement?

    The Board Rules state that in case of wholly owned subsidiary, the special resolution passed by the holding company will be sufficient for the purpose of entering into the transactions between wholly owned subsidiary and holding company.

    In many cases, Indian companies are wholly owned subsidiaries of overseas companies. A reading suggests that in such cases, the overseas company need to pass special resolution. However, since the 2013 Act/RC49 do not have any jurisdiction over the overseas entities, one may argue that this may not apply in such cases.

    Consider another example. Assume that XYZ Private Limited is a joint venture between three companies, viz., X Limited, Y Limited and Z Limited. XYZ is entering into a common related party transaction with all three shareholders. In this case, it is unclear as to how XYZ will comply with the requirement concerning special resolution of disinterested shareholders, if such resolution is needed. Using an analogy of wholly owned subsidiaries, one may argue that special resolution passed by X Limited, Y Limited and Z Limited may be sufficient compliance. Alternatively, it may also be argued that since there are no disinterested shareholders, the requirement concerning special resolution is infructuous for XYZ Limited.

    We suggest that MCA and SEBI provide an appropriate guidance on such issues.

    Master agreements

    With regard to the Audit Committee/Board/disinterested shareholders’ approval required on related party transactions, can a company take a view that it will be sufficient compliance if it obtains the required approval on the master agreements (“MA”) with broad terms agreed therein? Or is it mandatory to obtain separate approval on each transaction?

    Neither the 2013 Act nor the Board Rules nor RC49 provide any guidance on whether a company needs to obtain separate approval of the Audit Committee/Board/disinterested shareholders, as applicable, on each contract/transaction or it is sufficient compliance if the company obtains the required approval on the MA with the broad terms agreed therein. Under the second view, the company does not require separate approval for any sub-agreement/purchase order executed between parties.

    One view is that section 188 refers to ‘any contract or arrangement.’ Therefore, separate approval for each contract, including sub-agreement, is required. However, the second view is that the term arrangement has wider meaning than the term ‘contract/agreement.’ Hence, one may argue that for standard contracts involving sale/rendering of goods/services, it is possible to obtain the requisite approval only on the MA, which lays down all critical terms and conditions such as type of good/ service, pricing arrangement, credit period and payment terms. Based on the terms agreed in the MA, subsequent transactions are consummated and these transactions are closely aligned with the terms agreed in the MA. In this case, one may argue that subsequent purchase orders/sub-agreements are merely an execution of what has already been agreed and approved. They do not result into any new contract/arrangement. Hence, there is no need for obtaining any separate approval on the same. However, if the sub-agreement contains terms, which are different from the MA, or there is any modification in terms or the underlying circumstances have changed, separate approval is needed. Also, for the contracts, which are highly complex and specialized in nature, it may not be possible to define all critical terms under the MA. Rather, a company needs to obtain separate approval for each such contract.

    Since the 2013 Act or Board Rules or RC49 do not deal with this aspect, a company may need to evaluate its specific facts and circumstances and consult professionals, including legal professionals, before taking any final view.

    Non-reciprocal relationship

    As mentioned earlier, identification of related parties under the 2013 Act is not based on the principle of reciprocity. It is possible that one company identifies other company as its related party. However, it does not necessarily mean that the second company will also identify the first one as its related party. Let us assume that ABC Limited and DEF Limited are two public companies. Based on its evaluation and criteria prescribed, ABC determines that DEF is its related party. However, for DEF, ABC is not a related party. ABC is proposing to sell a big piece of land to DEF. It is determined that the transaction is not in the ordinary course of business. Also, the prescribed threshold criteria are breached.

    In the above case, how the approval process will work? Do both ABC and DEF need to obtain approvals required for related party transaction?

    It appears that the identification of related parties and related party transactions is an independent exercise for each company. Such identification is likely to determine, among other matters, approvals required. In the example above, ABC has identified DEF as its related party and, therefore, proposed land deal is related party transaction from ABC’s perspective. This requires ABC to obtain the requisite approvals, viz., the Audit Committee and Board approval and special resolution of disinterested shareholders, as appropriate.

    From DEF’s perspective, ABC is not a related party. Hence, one may argue that proposed land deal is not a related party transaction for DEF. Basis this, it may be argued that DEF need not obtain approvals required for related party transactions.

    Ordinary course of business

    Since RC49 does not contain any exemption from approval process based on the ‘ordinary course of business’ criterion, this discussion is not directly relevant under RC49. However, demonstrating that a transaction has been entered into by a company in its ordinary course of business is likely to help in the approval process and demonstrating good corporate governance. Hence, the following discussion may be useful even under RC49 from this perspective.

    What is meant by the phrase ‘ordinary course of business’? What are the key factors to be considered in determining whether a transaction is in the ordinary course of business?

    The phrase ‘ordinary course of business’ is not defined under the 2013 Act or the Board Rules. It seems that the ordinary course of business will cover the usual transactions, customs and practices of a business and of a company.

    In many cases, it may be apparent that a transaction has been entered into by a company in its ‘ordinary course of business.’ For example, a car manufacturing company sells cars to its sister concern. The price charged for the sale is the same as what it charges to other corporate customers who are unrelated parties. In this case, it seems clear that the company has entered into the transaction in its ordinary course of business.

    Similarly, in certain extreme cases, it may be clear that the transaction is highly unusual and/or extraordinary from the company as well as its business line perspective. Hence, it is not in the ordinary course of business. SA 550 Related Parties contains the following examples of transactions outside an entity’s normal 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, or
    • Transactions under contracts whose terms are changed before expiry.

    The above examples are just illustrative and not conclusive. In cases where related party transaction is not falling under either of the two extremes, the assessment of whether a transactionis in the ordinary course of business is likely to be highly subjective, judgemental and will vary on case-to-case basis. No authoritative guidance is available on making this assessment. The experience indicates that companies may like to consider the following aspects:

    • Whether the transaction is covered in the main objects or objects incidental to the main objects as envisaged in the Memorandum of Association
    • Whether a transaction is usual or unusual, both from the company and its line of business perspective. To illustrate, a particular telecom company may not have outsourced its IT process in the past. However, most of other telecom companies have already outsourced their IT process to save cost. In this case, one may argue that the transaction may be unusual for the company; however, it is not unusual for the telecom industry.
    • Frequency: If a transaction is happening quite frequently over a period of time, it is more likely to be treated as an ordinary course of business. However, the inverse does not necessarily hold true.
    • Whether transaction is taking place at arm’s length: SA 550 contains “sale with unusually large discounts or returns” as an example of transaction which is not in the normal course of business. Hence, arms’ length price is also one factor for this evaluation. However, it may not be sole determining factor. In certain cases, a company may be able to demonstrate that even transactions at below cost price are in the ordinary course of business. For example, if a company is selling cars at below cost to increase its market share. The same price is applicable to all customers, including related parties.
    • Business purpose of the transaction: For example, a company has 20 floor building for its office. Out of this, two floors are vacant and the company leases the same to its sister concern at market rent. In this case, one may argue that lease has been entered into by the company in its ordinary course of business. Consider another example. A software company purchased land and constructed building thereon just to lease the entire building to its group company. In this case, it may be difficult to justify that transaction represents ordinary course of business.
    • Whether transaction is done on similar basis with otherthird parties
    • Size and volume of transaction

    Finally, the assessment of whether a transaction is in the ordinary course of business is likely to be very subjective, judgemental and will vary on case-to-case basis. The factors mentioned above may help companies in making this assessment. However, they cannot take into account the unique circumstances of each business and transaction or replace the exercise of judgment by the management.

    Arms’ length

    Since RC49 does not contain any exemption from the approval process based on the “arms’ length” criterion, this discussion is not directly relevant under RC49. However, demonstrating that a transaction has been entered into by a company on an arms’ length basis is likely to help in the approval process and demonstrating good corporate governance. Hence, the following discussion may be useful even under RC49 from this perspective

    Are there any specific methodologies/approaches to be used for identifying whether a related party transaction has been entered into on an arms’ length basis? If no such methodologies/approaches are prescribed under the 2013 Act, can a company use the methodologies/approaches prescribed under other statutes, e.g., the Income-tax Act? What are other key factors to be considered?

    The 2013 Act or the Board Rules do not prescribe methodologies and approaches, which may be used to determine whether a transaction has been entered into on an arm’s length basis. One may consider the following aspects in this regard:

    • TP guidelines under the Income-tax Act, 1961, prescribe methodologies/approaches to be used for determining arms’ length price. In absence of specific guidanceunder the 2013 Act, one may find methodologies/ approaches under the TP guidelines to be useful. However, it may be noted that the objective of the TP guidelines is different from that of the 2013 Act. The purpose of the TP guidelines is to ensure that there is no tax leakage. The 2013 Act requirements aim to protect minority shareholders’ interest. Hence, one may need to factor these differences in objective and make suitable adjustments to the methodologies/approaches under the TP guidelines.
    • Section 188 does not require the ‘registered valuer’ certification to determine ‘arm’s length’ price. However, one may evaluate the same on case by case basis. In manycases, whether the transaction is at arms’ length price may be clear from the face of the transaction itself, withoutany further analysis. For example, refer earlier example where a car manufacturing company sells cars to its sister concern at the same price which is charged to unrelated corporate customers. In this case, one may argue that price is at arms’ length without involving registered valuer.In other cases, complex analysis/valuation may be needed. In such cases, the involvement of registered valuer may help companies in demonstrating that transaction hasbeen entered into on arms’ length basis.
    • Under the 2013 Act, an explanation states that the expression ‘arm’s length transaction’ means a transaction between two related parties that is conducted as if they are unrelated, so that there is no conflict of interest. Neither the 2013 Act nor the Board Rules clarify howa company can demonstrate the absence of ‘conflict of interest.’ From common parlance perspective, it appears that to demonstrate this, a company will need to show that the existence of special relationship between thecontracting parties has not affected the transaction and its critical terms, including the price, quantity and other terms and conditions governing the transaction. Hence, terms of the transaction are comparable to those which unrelated parties would have agreed for a similar transaction.
  • Disclosure in the board report

    What the Companies Act 2013 states:

    Section 188 (2) of the 2013 Act requires that every contract/ arrangement entered into under section 188 (1) will be referred to in the board report along with justification.

    RC49 prescribes the following additional disclosures for listed companies:

    • Policy on dealing with related parties on its website and in the annual report
    • Details of material related party transactions on a quarterly basis along with the compliance report on corporate governance
    • Disclosure by senior management to the Board of all material financial and commercial transactions where they have a personal interest that may have a potential conflict with the interest of the company

    EY insights

    The 2013 Act requires that every contract/ arrangements entered into under section 188(1) is referred in the board’s report, along with justification for entering into such transaction. Does it require a company to disclose even the transactions, which are entered into by the company in its ordinary course of business and at arms’ length price and therefore, require neither board approval nor special resolution of disinterested shareholders, in the board report?

    From a reading of 188(2), it seems clear that only transactions covered under the section 188(1) require disclosure in the board report. Transactions meeting the exemption criteria in third proviso, viz., transactions entered into by a company in its ordinary course of business and at arms’ length price, are completely outside the scope of section 188(1). Hence, the 2013 Act does not require disclosure of such transactions in the board report.

    Whilst the above view seems clear from the 2013 Act, the MCA has prescribed Form AOC-2 in the Accounts Rules for disclosure of related party transactions in the board report. The form includes disclosure for (i) all (both material and immaterial) related party transactions which are not on arms’ length basis, and (ii) material related party transactions which are on an arms’ length basis. It seems that in prescribing disclosures at (ii) above, the Form AOC-2 has gone beyond disclosures required under the 2013 Act.

    Since the Form notified by the MCA has prescribed specific disclosures, we believe that a company may, out of abundant caution, disclose material related party transactions even if they are entered into on an arms’ length basis. We believe that the MCA should resolve this inconsistency and amend Form AOC-2 to omit disclosures not required by the 2013 Act.

    This disclosure regarding related party transactions in the boardreport is applicable to both listed and non-listed companies. In addition, listed companies need to make disclosuresrequired under RC49. To avoid/ minimize duplication of similar disclosures and give meaningful information to users, a listed company may need to structure its board report, annual corporate governance report and annual report carefully.

  • Transitional requirements

    What the Companies Act 2013 states:

    The 2013 Act or the Board Rules do not contain any specific transitional provisions. The SEBI Circular regarding amendment to the RC49 states as below:

    • “The provisions of Clause 49(VII) as given in Part-B shall be applicable to all prospective transactions. All existing material related party contracts or arrangements ason the date of this circular which are likely to continue beyond 31 March 2015 shall be placed for approval of the shareholders in the first General Meeting subsequent to 1 October 2014. However, a company may choose to get such contracts approved by the shareholders even before 1 October 2014.”

    How does the applicability of the 2013 Act impact related party contracts that have been previously entered into by a company and are alive on the commencement of Section 188? Can a company take a view that these contracts are grandfathered and hence no fresh approval is required? What will be the implication of any subsequent amendment to these contracts?

    The 2013 Act or the Board Rules do not provide any specific guidance on this issue. One view is that the 2013 Act is applicable to all contracts, including contracts previously entered into by a company. Hence, if a company enters into any new transaction/sub-agreement/purchase order under the previously signed contract, it will need to obtain approvals, if any, required under the 2013 Act. However, the second view is that section 188 does not prescribe any retrospective application. Rather, it is applicable only to new contracts/ arrangement entered into by a company. Hence, one may argue that ‘grandfathering’ may be permitted. However, any modification in the nature and type of transaction with related parties will trigger approval requirements under the 2013 Act.

    For listed companies, RC49 requires that all existing material related party contracts or arrangements, which are likely to continue beyond 31 March 2015, should be placed for approval of the shareholders in the first General Meeting subsequent to 1 October 2014. However, a company may choose to get such contracts approved by the shareholders even before 1 October 2014.

    Hence, a listed company, for material contracts/arrangements likely to continue beyond 31 March 2015, needs to comply with the approval requirements of RC49. In other cases, it seems likely that grandfathering may be permitted. However, any modification in the nature and type of transaction with related parties will trigger approval requirements under the 2013 Act.

    We recommend that before taking any final view on the matter, a non-listed company should consult with the legal professionals.

  • Loans to directors and subsidiariese

    What the Companies Act 2013 states:

    In accordance with section 185 of the 2013 Act, a company cannot, directly or indirectly, give any loan, including loan represented by a book debt, to any of its directors or to any other person in whom the director is interested or give any guarantee or provide any security in connection with any loan taken by him or such other person.

    The 2013 Act explains the expression ‘any other person in whom director is interested’ to include “a body corporate, the board of directors, managing director or manager, whereof is accustomed to act in accordance with the directions or instructions of the board, or of any director or directors, of the lending company.” Apparently, this explanation may cover subsidiary companies. Hence, one interpretation was that a holding company cannot give any loan to/guarantee/ security on behalf of its subsidiary. This view, along with the fact that section 185 is applicable from 12 September 2013, has created significant hardship for many companies. This was particularly for the reason that in many cases, a subsidiary may not be able to raise finance without support of its holding company.

    Since the notification of section 185, the MCA has tried addressing this hardship through various circulars; however, these circulars were not very clear.

    To address this issue, the Board Rules provide the following exemptions. These exemptions are subject to a condition that loans should be utilized by the subsidiary company for its principle business activities.

    • Any loan made by a holding company to its wholly owned subsidiary company or any guarantee given or security provided by a holding company in respect of any loan made to its wholly owned subsidiary company is exempted from the requirements under 185.
    • Any guarantee given or security provided by a holding company in respect of loan made by any bank or financial institution to its subsidiary company (includes subsidiaries that are not wholly owned) is exempted from the requirements under this section.

    In other words, there seems to be prohibition only with respect to giving of loans to a subsidiary that is not a wholly owned subsidiary. It is understandable that most companies will take the position stated in the Board Rules, though the concern whether the rules can override the 2013 Act remains.

  • Loans and investments by companies

    What the Companies Act 2013 states:

    Section 186 of the 2013 Act requires that a company will not (i) give loan to any person/other body corporate, (ii) give guarantee or provide security in connection with a loan to any person/other body corporate, and (iii) acquire securities of any other body corporate, exceeding the higher of:

    • 60% of its paid-up share capital, free reserves and securities premium, or
    • 100% of its free reserves and securities premium.

    The 2013 Act states that for providing loan/giving guarantee/ security or acquiring security exceeding the above limit, a company will need to take prior approval by means of a special resolution passed at the general meeting.

    Unlike the 1956 Act, the 2013 Act did not contain any exemption for loan made/guarantee given/security provided by a holding company to its wholly owned subsidiary companies. Consequently, it was required that a company will includethe amount of loan/guarantee/security to its wholly owned subsidiary as well in the 60%/100% limit. This was likely to create hardship for many subsidiary companies, which are significantly dependent on their parent for financing. Also, in many cases, loans given, guarantee and security provided by the parent may have immediately breached the 60% or 100% limit.

    To address the above challenge, the Board Rules provide that where a loan or guarantee is given or where a security has been provided by a company to its wholly owned subsidiary company or a joint venture company, or acquisition is made by a holding company of the securities of its wholly owned subsidiary company, the requirement concerning special resolution atthe general meeting will not apply. However, the company will disclose the details of such loans or guarantee or security or acquisition in the financial statements.

    EY insights

    From a reading of the Board Rules concerning section 185 and186, the following position emerges:

    • A parent company can give loan to/ provide security or guarantee on behalf of its wholly owned subsidiary company or acquire securities of wholly owned subsidiaries. These loans/guarantees/security will not be included to determine whether the company has breached the 60%/100% limit. This effectively brings the position at par with what was prevalent under the 1956 Act.
    • A parent company can provide security or guarantee on behalf of its subsidiary company which is not wholly owned subsidiary company. However, it cannot give any loan to such subsidiary company. These guarantees/security willbe included in determining whether the company has breached the 60% or 100% limit.
    • Loan given to, security/guarantee provided on behalf of the joint venture company will not be included in determining whether the company has breached the 60% or 100% limit.
    • In the Board Rules, there is no relaxation/exemption on the requirement concerning charging of interest on loans. Hence, it appears that a company may need to charge interest at the specified rate on all its loans, including loans given to wholly owned subsidiaries and joint ventures. In accordance with the 2013 Act, rate of interest cannot be less than prevailing yield on one year, three year, five year or ten year Government Security closest to the tenor of the loan.

    These changes in the rules help resolving many practical challenges that were likely to arise. However, an unresolved issue is that a company can no longer give interest free loan to its wholly owned subsidiary. This is likely to create significant hardship for many groups. Also, the concern regarding rules overriding the law remains.

    Omnibus resolution

    One of the paragraphs in the Board Rules states that special resolution passed at a general meeting to give any loan or guarantee or investment or provide any security will specify the total amount up to which the board of directors is authorizedto give such loan or guarantee, to provide security or acquire investments. This suggests that omnibus resolution will be permitted. The draft rules had permitted omnibus resolution only for guarantees.

    Investment in mutual funds

    Section 186 of the 2013 Act deals with all loans and investments made by a company, including loans etc. to a person. Hence, there is a concern whether investments in mutual funds will also be included in the 60%/100% limit. Under the 1956 Act, section 372A dealt only with inter-corporate loans and investments. Hence, such investments were not included in the 60%/100% limit.

    It may be noted that in section 186, sub-paragraph dealing with loans, guarantee and security refer to person as well as body corporate. However, the sub-paragraph dealing with investment covers only acquisition of securities of a body corporate. Inan earlier decision, the Supreme Court has held that mutual funds constituted as trust are not body corporate. This seems to suggest that section 186 does not apply to investments in mutual funds and they will not be included in the 60%/100% limit.

    Foreign currency loans

    Under the 2013 Act, the rate of interest cannot be less than prevailing yield on one year, three year, five year or ten year Government Security closest to the tenor of the loan. This is likely to result in an apparent issue in case of foreign currency loans. For example, an Indian company is making loan to a body corporate in Japan where interest rates are negligible. In such a case, it may not be appropriate to require companies to charge interest based on the rates applicable to government securities in India. To address this issue, the MCA should clarify that currency of the government securities should be consistentwith the currency of loan.

    Loan between fellow subsidiaries

    As mentioned earlier, there appears to be a prohibition on the parent company giving loans to its subsidiary that is not a wholly owned subsidiary. This raises an interesting issue whether a company can give loan to its fellow subsidiary.Assume that parent P has two subsidiaries, viz., S1 and S2. The parent owns 75% equity capital of S1 and 100% equity capitalof S2. It seems clear that P cannot give loan to S1. The issue is whether S2 can give loan to S1.

    One view is that S2 will not have any business/commercial reason to give loan to S1, except their relationship with the Parent P. Hence, it may be argued that S2 is giving loan toS1 on behalf of its parent. Since section 185 of the 2013 Act prohibits provision of both direct and indirect loans, some believe that loan proposed to be given by S2, in substance, contravenes the 2013 Act.

    According to the supporters of the second view, one should not generalize the situation to state that a subsidiary will alwaysact on behalf of its parent and apply all the restrictions of the parent to its subsidiary. In their view, if one can establish that P has not provided any back-to-back funding to S2 and S2 hasmade its independent decision to provide loan to S1, S2 will not be acting on behalf of its parent P. The supporters of this view believe that in such cases, S2 can provide loan to S1, without getting impacted by the prohibition on its parent company.

    Companies should consider fact pattern specific to their situation and seek legal consultation before proceeding on these matters.

    Loan from foreign parent

    It appears that the restrictions under sections 185 and 186 of the 2013 Act apply to a company which is providing the loan. These sections do not prohibit the borrower company from accepting loan from its parent. Let us assume that an overseas company intends to provide interest free loan to itspartly owned Indian subsidiary. In this case, one may argue that since sections 185/186 do not apply to the foreign company, there is no restriction on the company giving loan to its Indian subsidiary. Similarly, these sections do not prohibit Indian subsidiary from accepting loan from its foreign parent. Hence, it may be argued that such loan is not in contravention of sections185 and 186 of the 2013 Act. It may be appropriate for theMCA to clarify this.

    Transitional requirements

    One paragraph in the Board Rules state that where the aggregate of the loans and investment so far made, guarantee and security so far provided, along-with the investment,loan, guarantee or security proposed to be made, exceed the limits prescribed, then no investment or loan will be madeor guarantee will be given or security will be provided unless previously authorized by special resolution passed at the general meeting.

    An explanation to the above paragraph of Board Rules clarifies that it would be sufficient compliance if such special resolution is passed within one year from the date of notification of this section.

    The main paragraph in the Board Rules and explanation thereto are drafted in a confusing manner. A collective reading of the two indicates that for loans existing at the enactment date, i.e.,1 April 2014, and new loans granted during the first year, a company can pass special resolution by 31 March 2015 if the60%/100% limit is breached. In other words, a company is not required to take prior-approval by special resolution for making loans or investment or providing security/guarantee during the first year in excess of the limit. In such cases, resolution may be passed by 31 March 2015.

    It is understandable that many companies may prefer taking this view. However, like many other instances, there is aconcern that Board Rules may be overriding the 2013 Act since the 2013 Act requires prior approval by special resolution. We suggest that before taking final view, a company may like to consults its legal professionals.