The introduction of Companies Act, 2013 has brought out a new phase to the corporate sector. To make Corporate Law more effective much reliance is placed on the disclosure. There are number of sections which places reliance on disclosure norms, one of such section is section-188 relating to ‘Related Party transaction’ which combines the provisions of Sections -297& 314 along with some more provisions.
In order to mitigate the practical difficulties and to clarify the ambiguity of law, Ministry of Corporate Affairs have been providing on regular basis amendments, clarifications, notifications, circulars etc.
PROVISIONS RELATING THE RELATED PARTY
The recently notified section 188 of the Companies Act, 2013 talks about the approval required in order to enter into related party transactions. The section provides for the various transactions which cannot be entered into by the company without the consent of the Board of Directors. Meaning thereby unless the Board of Directors have given their consent by way of a resolution at a meeting of the Board, the company cannot enter into the prescribed transactions. Subsection 1 of Section 188 prescribes the following transactions:
a. Sale, Purchase or supply of any goods or materials;
b. Selling or otherwise disposing of, or buying, property of any kind;
c. Leasing of property of any kind;
d. Availing or rendering of any services;
e. Appointment of any agent for purchase or sale of goods, materials, services or property;
f. Such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company; and
g. Underwriting the subscription of any securities or derivatives thereof of the company.
It is to be noted that the proviso to the Section 188 provides that a company, whose paid-up capital is more than Rupees Ten crore or is proposed to enter into transactions exceeding such sums as prescribed under Rule 15 of the Companies (Meetings of Board and its Powers) Rules 20142, cannot enter into the transactions, except with the previous approval of shareholders by way of Special resolution.
The transactions, as prescribed under Rule 15 (3)3,which require prior approval of Shareholders by way of Special Resolution are:
a. With respect to the subsection 1 of Section 188, the following contracts or arrangements as per their respective limits:
1. Any Sale, purchase or supply of goods or materials directly or through any agents amount of which exceeds twenty five percent of the annual turnover of the Company;
2. Selling or otherwise disposing of, or buying, property of any kind directly or through the agent amount of which exceeds ten percent of net worth of the company;
3. Any leasing of property which amounts ten percent or more of the turnover of the company;
4. Availing or rendering of any services directly or through the agent amount of which exceeds ten percent of the net worth of the company;
b. Appointment to any office or place of profit in the company, its subsidiary company or associate company at a monthly remuneration exceeding Rupees Two Lakh Fifty Thousand;
c. The remuneration for underwriting the subscription of securities or derivatives thereof of the company exceeding one percent of the net worth of the company.
The Ministry of Corporate Affairs, Government of India, vide its notification dated 14th August 2014 has issued the Companies (Meetings of Board and its Powers) Second Amendment Rules, 2014 and modified the above mentioned Rule 15 (3) with respect to the provisions relating to Related Party Transactions.
The changes made by the Ministry under the above mentioned notification prescribes various thresholds limits with respect to the various transactions viz. the contracts or arrangements as mentioned under Sub Rule 3 of Rule 15 in reference to Sub section 1 of Section 188 of the Companies Act, 2013.
Earlier, the Companies having paid-up capital of Rs. 10 Crore or more were required shareholders approval by way of special resolution. This limit has been dispensed with and the new threshold limits have been introduced. The revised provision states that a company shall not enter into transaction(s) or transactions without the previous approval of shareholders, where the transaction(s) to be entered into involves the following:
a) Contracts or arrangements with respect to clauses (a) to (e) of Section 188(1) and involves:
1. Sale, purchase or supply of any goods or materials, whether directly or through any agent and wherein the amount involved exceeds ten per cent. of the turnover of the company or Rupees Hundred crore, whichever is lower;
2. Selling or otherwise disposing of or buying property of any kind, directly or through any agent and where the amount involved exceeds ten percent of the net worth of the company or Rupees Hundred crore, whichever is lower;
3. Leasing of property of any kind and the amount involved exceeds ten percent of net worth of the company or ten per cent. of turnover of the company or Rupees One Hundred crore;
4. Availing and rendering of any kind of services, directly or through appointment of agent and which involves amount exceeding ten per cent. Of the turnover of the company or Rupees Fifty Crore, whichever is lower;
The Notification issued by Ministry provides the explanation that the above mentioned limits that are specified for the transaction(s) shall apply to the transactions to be entered into either individually or taken together with the previous transactions during a financial year.
b) Appointment of any person in the office or any place of profit in the company, its subsidiary or associate company at a monthly remuneration exceeding Rupees Two lakh Fifty Thousand;
c) Remuneration for underwriting of subscription of any securities or derivatives of the Company exceeding one percent of net worth of the company.
The Notification issued by Ministry provides the explanation in regard to above provisions that the turnover or the net worth referred in the above Subrules shall be computed on the basis of the Audited Financial Statements of the preceding financial year.
Further, the Explanation (2) of Rule -15 of the Companies (Meetings of Board and its Powers) Rules, 2014 provides that, in case of wholly owned subsidiary, the special resolution passed by the holding company for entering into the transactions between the wholly owned subsidiary and the holding company shall suffice.
Explaining further, the Ministry provides that the explanatory statement which is required to be annexed to the notice of General Meeting shall contain the following viz. name of the related party, name of the director or key managerial personnel interested in such transaction, nature of relationship, material value or monetary terms attached to such transaction or any other information which is necessary or important for the members for taking the decision on proposed resolution respectively4.
The Ministry has provided major changes only in the limits of Contracts or arrangements with respect to clause (a) to (e) of Section 188(1), whereas the companies are also waiting for amendment related to transaction between two wholly-owned subsidiaries. But this major change in the limits of contracts or arrangements is also appreciated.
PROS AND CONS OF THE AMENDMENT:
The Amendment introduced by Ministry on August, 14, 2014, is a welcome step, as this amendment has somehow reduced the problems that are being faced by the companies. Earlier the companies whose paidup capital is rupees Ten crore or more, they need approval from the shareholders. But now the criteria are changed as threshold limits has been introduced. These amended provisions are more beneficial for those enterprises having smaller net worth as they can avail the benefits easily by these amended provisions and given them a broad smiles on their faces but companies having higher net worth will face difficulty in getting the approval of shareholders for entering into any transaction.
The above mentioned monetary limits are definitely a good step but larger companies may face problem because this threshold limit is a very low amount as it is computed for a group of transactions. For example – a company having a turnover of say Rs. 5000 crore, the transaction limits as provided by Ministry is 10% of the turnover which is 10% of 5000 crore i.e. Rs. 500 crore or Rs. 100 crore whichever is lower5. This implies that the companies with high turnover would require taking sale or purchase or any transaction beyond Rs. 100 crore for obtaining shareholders approval.
Earlier focus was more on paid-up capital, now the focus shifts from paid-up capital to threshold limits. These limits may create some havoc for the large corporate enterprises as well.
Further, the ministry talks about transaction between holding and its wholly owned subsidiary and only special resolution is required for the contracts between them. On the other hand, there remains a grey area which does not talk about the transcation which takes place between two wholly owned subsidiaries.
These amended provisions issued by the Ministry in the name of Companies (Meeting of Board and its Powers) Second Amendment rule, 2014 is a good effort by the Ministry which needs to be praised. They have somehow reduces the difficulties of the companies but along with that increased the practical difficulties to larger companies. These provisions are a treat to small and medium enterprises and a black dot for larger companies. But as we all know Ministry from time to time has reduces the difficulties faced by the Companies, it will definitely bring a provisions for removing the further difficulties. We believe that Ministry of Corporate affairs very soon will introduce a the provisions related to transaction between two wholly owned subsidiaries and would also consider about making executive director instead of Audit committee for approving the related party transactions with only transactions that are not at arm’s length or in the ordinary course of business or material, to be brought to the Audit Committee for their additional approval.
Source – Mondaq, ICSI, MCA