Related Party Transactions

Corporate Governance

Contents
Who is a Related party What is a Related party transaction Related Party Transaction policy in India Related party transaction in India The Satyam case and case of the CEO of listed company The unethical practices The good practices Related Party Transaction with Samsung Example Disclosure Consequences Implications

Who is a Related Party?

Director or his relative*

Key Managerial Personnel* or his relative Any person on whose advice, directions or instructions a director or manager is accustomed to act

A firm in which a director or 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 or holds along with his relatives, > 2% of its paidup share capital;

Any corporate whose BoD, MD or manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager;

Any company which is a holding, subsidiary or an associate company of such company; or a subsidiary of a holding company to which it is also a subsidiary

Parties considered Not Related

A single customer, suppliers, etc., simply because of economic reason

To companies simply because of common director

Franchiser, trade union, public utilities, and government department

having normal dealing with the enterprise

What is Related Party Transaction?

A business deal or arrangement between two parties who are joined by a special relationship prior to the deal.

Under the Companies Act, 2013, except with the consent of the Board of Directors, no company shall enter into any contract or arrangement with a related party with respect to(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.

RPT Under the New Company Law

New Companies Act, 2013 emphasis on the Related Party Transactions and the manner of approval & disclosure thereof. Under section 188
Consent of Board of Directors of company or in certain cases prior approval by special resolution required for every such contract or arrangement Details of every such contract or arrangement shall be referred to in the Boards Report along with the justifications.

Member who is related party to the any contract or arrangement shall not vote on the special resolution for approval of such contract or arrangement. Where any contract or arrangement is entered into by a director or any other employee, without complying with the provisions and if it is not ratified by the approving authority, such contract or arrangement shall be voidable at the option of the Board. The section also provides penalty for director or other employee of a company who had entered into or authorized the contract or agreement in violation of the provisions in case of listed company or unlisted company.

Indirect RPT
RPT have been routed through entities indirectly controlled by the promoter group/management in the form of businesses with group entities, reimbursement of expenses, etc. Example: RPT in the form of businesses with group entities MNCs sometimes: - source a significant portion of their raw material requirements from companies under the control of the same parent - sell their finished products to their parent or other group companies.

Companies involved in Indirect RPT

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In 2001-02, Gillette India sourced 44% (Rs 97 crore) of its input requirements (both
raw materials and traded products) from its US parent and its fellow subsidiaries. P&G Hygiene, Novartis also sourced a key portion of their input requirements either from their parents or sibling subsidiaries.

Nestle India, Gillette India and P&G, derive a significant portion of their revenues from sales of finished products to their parent or other group companies.

Dependence on group companies has both positive & negative implications Positive
If sourcing is through centralized procurement of inputs by a parent, it could result in input cost savings for its Indian co. Sales arrangement with a parent or other group companies could provide

Negative
Considerable influence over the revenues and profitability of a listed co. by the parent/group companies Difficult to judge whether the terms are unduly favorable to the group companies in the absence of

an assured market or a stable

source of revenues to the Indian co.

disclosures about price & other terms

at which sales/purchase transactions are executed

RPT Policy in India

The companies may have to adopt a 'policy on RPTs' and make the same public for benefit of all stakeholders Boards of listed companies should prepare a policy on dealing with RPTs and the same should be disclosed on its website as well as the annual report

Required to get RPTs approved by their shareholders through a special resolution but the
related parties should abstain from the voting

Listed entities should have a policy for determining "material RPTs Observing that mandatory real time disclosures of RPTs might be onerous and could pose practical difficulties for companies to comply with - It is proposed that the companies may be mandated to disclose details of all RPTs on a quarterly basis along with the compliance report on corporate governance

Related Party Transaction in India

Overview of the Satyam case, the unethical practices and the good practices in RPT

Asia Roundtable on Corporate Governance : Fighting Abusive Related Party Transactions in Asia and Workshop on Implementation

The Satyam Case

Plans to acquire controlling interest in Maytas

Ramalinga Raju family: Largest shareholders

Transfer of over Rs 60 billion cash : Satyams shareholders to the Raju family Outrage: Mutual funds and Institutional investors

Share prices continued to fall down

Acceptance of fraud and falsifying the books of accounts:
nonexistent cash balance of 3 billion

nonexistent accrued interest of 3.7 billion

understated liability of 12 billion on account of funds arranged by Raju an overstated debtor position of 4.9 billion as against 26 billion reflected in the books

Regulatory actions followed

The Satyam Case and Abusive RPT

The role of the board and the management
The role of the auditor :PwC The role of the Chairman, CEO and CFO and the senior officials The effectiveness of the regulatory requirements

Case of a CEO of a Listed Company

CEO asked to resign:
he favored his friends corporate friends at the expense of the company by spending for parties
for his and showed the expenses were on account of sales promotion; he fudged the events to claim compensation for fictitious conferences like distributors conferences he claimed reimbursement on expenses of his daughter and wife he sponsored programmes on TV channels and art shows in different studios and hotels which his friends and relations were the main beneficiaries

Commonly used artifices to avoid easy detection of related party transactions

Sections 297, 299 and 314 (1A) of the Companies Act Resignation of the common director and then reinstigated

Unethical practices in RPT: Reasons

Negative connotation
Accounting reasons

Avoidance of restriction imposed by the Companies Act

for inter company loans Use of SPVs Off shore units

Good Practices in RPT

Clear direction and culture on all PRT

Reviews of RPT exceeding 1% of revenue.

Audit committee reviews Systems, processes, procedures are in place to avoid RPT becoming abusive. Strong ethics policy communicated to employees Directors/Commissioners/Controlling shareholders are made liable The financials of all subsidiaries and related entities are published on the web so that the shareholders can get a clear picture Insiders required to make statement Develop and make public the policy of approving a RPT

Samsung RPT Policy

Committees have been formed which are represented by expertise Directors
Management Committee Audit Committee Independent Director Recommendation Committee Related Party Transactions Committee Compensation Committee CSR Committee

 Each agenda approved by board committees is instantly notified to all Directors. The Board of Directors may put the resolutions approved by the committees for voting at the Board meeting. Purpose The RPT Committee is a committee under the BoD to enhance corporate transparency and promote fair transactions. Composition The Related Party Transactions Committee shall comprise of three Independent Directors.

Operation The Related Party Transactions Committee shall hold regular meetings at least once a quarter. Authority and Duties Authority a) Authority to Receive Reports on Related Party Transactions b) Authority to Order Investigations on Related Party Transactions c) Authority to Recommend Corrective Measures for Unfair Related Party Transactions

Duties a) Duty of good faith b) Duty to investigate and report to the Board c) If the committee finds any related party transaction that is in violation of laws or regulations, it shall promptly report to the Board. d) Duty to prepare minutes

Infosys RPT Policy

Ideally avoid RPTs Inform the CFO Review of Transaction by CFO,CEO and Audit committee Most Significant RPT to be reviewed thoroughly and documented Inform the governing bodies HR policy implication

Disclosure
Relationships between parents and subsidiaries [IAS 24.16] Entity must disclose the name of its parent/ ultimate controlling party/ the name of the next most senior parent Management compensation [IAS 24.17] Disclose key management personnel compensation in total Short-term/long term employee benefits Termination/post-employment benefits Related party transactions [IAS 24.18-19] The amount of the transactions, outstanding balances Provisions for doubtful debts Expense in respect of bad or doubtful debts due from related parties

Consequences
In case, where any contract or arrangement is entered in to by a director or any other employee, without obtaining the consent of the board or approval in the general meeting under sub section (1) and, 1) 2) if it is not ratified by the board or by the shareholders at a meeting within three months from the date 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 contractor arrangement is with are related party to any director, or is authorised by any other director, the directors concerned shall indemnify the company against any loss incurred by it.

 Recovery of loss Company can proceed against a director or any other employee for recovery of any loss sustained by it. Penal provisions In case of a listed company any director or other employee of the listed company be punishable with - Imprisonment for a term extending upto 1 year or - Fine of not less than Rs. 25,000 but may extend to Rs. 5,00,000. - With both In case of other than listed company either of the two penalties listed above

Implications for Companies

Shift from control based thinking to self-regulatory practices Wider scope Clearly defined related parties Enhanced scope of transactions Effect on transactions between group companies i.e. holding, subsidiary, associate Greater scrutiny Great emphasis on approval process and deliberations for entering into RPTs Now comes under the scrutiny of the audit committee Companies must now clearly define RPTs, and lay down guidelines. Preventive internal processes will have to be developed.