The Companies Bill, 2012, proposes a number of significant changes to corporate governance norms. Among the most debated is Clause 188, on related party transactions (RPTs). Under the current Companies Act, 1956, compulsory sanction of the board of directors is required for the company to enter into certain proposed transactions, where a director may have a personal interest which conflicts, or may possibly conflict with the interests of those to whom he owes a fiduciary duty.
The Bill broadens the scope of transactions covered with related parties and views RPTs as potential conflict of interest situations. It conveys the legislative intent that RPTs must not be detrimental to the company’s minority shareholders, and it seeks to strengthen the approval mechanism by requiring shareholder approval for the transaction, via special resolution, instead of just a sanction by the board. In addition, Clause 188 prohibits a member of the company, being a related party, from voting in the special resolution (though applicable to probably only larger companies). The lessons from the Satyam Computers scandal, where the acquisition of related entities—Maytas Properties and Maytas Infra—was opposed by the shareholders and approved by the board, seem to have been at the back of the Bill draftsman’s mind. The Bill further mandates that the requirement for a special resolution shall not operate for any RPTs that are entered into by the company in its ordinary course of business on an arm’s length basis, that is, a transaction conducted as if the entities are unrelated and is devoid of conflict of interest.
Sebi too has raised concerns regarding the abuse of RPTs by controlling shareholders in its Consultative Paper on Review of Corporate Governance Norms and has recommended the use of voting by non-interested shareholders and has implemented it in court-driven M&As with prior dis-interested shareholder vote by two-thirds majority. It has done so in several other instances as well.
The regulatory posturing on RPTs may have been motivated by the peculiarity of Indian corporate structures, where nearly half of shareholding on average is held by promoters and the ‘group structure’ with many related party transactions. It is not uncommon in Indian listed companies for the promoter to lease office space to the company or own the brand for which he charges an annual royalty to the company. By bringing in the requirement that the RPTs that are not undertaken in the course of ordinary business and not conducted at arm’s length must require approval of the ‘majority of the minority or disinterested shareholders’, the move is aimed towards introducing a higher standard of corporate governance.
There may be a counter-argument on the grounds of loss of competitive advantage for the company due to the passage of time in seeking shareholder approval. The Bill has adequately provided that where an RPT, not being at an arm’s length or in the ordinary course of business, is entered into without seeking the board’s approval or winning the shareholders’ mandate under a special resolution within 3 months from the date the contract was entered into, the contract may be declared voidable at the option of the board.
A negative fallout of this could be felt in situations where the company is locked in a takeover battle, where apart from the interested shareholder, shares are held by a hostile entity. This requirement would essentially pre-empt the possibility of any successful takeover defence being made by the controlling shareholder via an RPT. Additionally, even in cases where the balance shares are held by a competing entity, as opposed to the minority shareholders, some benign RPTs could be stalled and thus be an impediment to business. Finally, there may be rare cases of a large shareholder holding the majority shareholder to ransom. This situation would be rare because most RPTs are not desirable in any case. However, on the whole, the move would be good both for minority shareholders and hostile acquirers and thereby the corporate governance standards of India.
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