RELATED PARTY TRANSACTIONS UNDER THE NEW ERA BY CS DHANAPAL

RELATED PARTY TRANSACTIONS UNDER THE NEW ERA

Companies Act, 2013 has unveiled a new era in the Indian Corporate Sector which places more reliance on disclosure norms rather than on approvals. One such area is “related party transactions”. While the Companies Act, 1956 warranted approval of Central Government for related party transaction by large cap companies, Companies Act, 2013 calls for larger disclosures with members’ approval.

Section 188 of the Companies Act, 2013 combines the erstwhile Sections 314 and 297 of the Companies Act, 1956 which deal with holding of office or place of profit and related party transactions respectively. Section 188 awaits notification by the Ministry of Corporate Affairs (MCA) to become applicable.

ANALYSIS OF SECTION 188 OF COMPANIES ACT, 2013

Section 188 requires a company to obtain approval of the Board and of the members, in certain situations, prior to entering of any transaction or agreement with a related party. An analysis of Section 188 requires understanding the following:

•         Applicability of the Section
•         Definition/Meaning of Related Party
•         Transactions which are deemed as related party transactions
•         Nature of approvals required
•         Disclosure norms
•         Exemptions/Non-applicability
•         Consequences of non-compliance

We will proceed to understand the above dimensions.

Applicability of the Section

Section 188 is applicable to both private and public companies and will applicable from the date of its notification by the MCA. This Section has not been notified as yet.

Definition/Meaning of Related Party

Section 2(76), read with relevant rules made thereunder, defines a related party as under:

“related party”, with reference to a company, means—

1. a director or his relative;
2. a key managerial personnel or his relative;
3. a firm, in which a director, manager or his relative is a partner;
4. a private company in which a director or manager is a member or director;
5. a public company in which a director or manager is a director or holds along with his relatives, more than 2%  of its paid-up share capital;
6. any body corporate whose Board of Directors, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager;
7. any person on whose advice, directions or instructions a director or manager is accustomed to act:

            Provided that nothing in sub-clauses (vi) and (vii) shall apply to the advice, directions or instructions given in a professional capacity;

8. any company which is—

            (A) a holding, subsidiary or an associate company of such company; or

            (B) a subsidiary of a holding company to which it is also a subsidiary;

9. a director or key managerial personnel of the holding, subsidiary or associate company of such company or his relative;
10. any person appointed in senior management in the 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.

Transactions which are deemed as related party transactions

Any transaction between a company and its related party relating 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.

“office or place of profit” means any office or place—

(i) where such office or place is held by a director, if the director holding it receives from the company anything by way of remuneration over and above the remuneration to which he is entitled as director, by way of salary, fee, commission, perquisites, any rent-free accommodation, or otherwise;

(ii) where such office or place is held by an individual other than a director or by any firm, private company or other body corporate, if the individual, firm, private company or body corporate holding it receives from the company anything by way of remuneration, salary, fee, commission, perquisites, any rent-free accommodation, or otherwise;

Nature of approvals required

·         Approval of Board of Directors

•    Every company needs to seek the approval of its Board of Directors for entering into any related party transaction, as listed above, irrespective of the capital of the company or the value of the transaction.
•    Approval of the Board has to be sought at a duly convened meeting of the Board and same cannot be obtained by passing of a resolution by circulation.
•    Where any director is interested in any contract or arrangement with a related party, such director shall not be present at the meeting during discussions on the subject matter of the resolution relating to such contract or arrangement.

·         Prior approval of Members by means of special resolution

1.  In the following situations, in addition to approval of Board of Directors, prior approval of members by means of a special resolution must also be sought before entering into any related party transaction:

• paid-up share capital of the company is equal to or exceeds Rs. 1 Crore,
• the value of transaction individually or taken together with previous related party transactions during a financial year, exceeds 5% of the annual turnover or 20% of the net worth of the company as per the last audited financial statements of the company, whichever is higher,
• the transaction relates to appointment to any office or place of profit in the company, its subsidiary company or associate company at a monthly remuneration exceeding Rs. 1 Lakh.
• the transaction relates to remuneration for underwriting the subscription of any securities or derivatives thereof of the company exceeding Rs. 10 Lakhs.

 2. 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.

      3. In case of wholly owned subsidiary, the special resolution passed by the holding company shall be sufficient for the purpose of entering into the transactions between wholly owned subsidiary and holding company.

Disclosure norms

·         Disclosures to be made in notice calling Board Meeting:

(a) name of the related party and nature of relationship;

(b) nature, duration of the contract and particulars of the contract or arrangement;

(c) material terms of the contract or arrangement including the value, if any;

(d) any advance paid or received for the contract or arrangement, if any; and

(e) any other information relevant or important for the Board to take a decision on the proposed transaction.

·         Disclosures to be made in the explanatory statement to be annexed to notice of general meeting:

(a) name of the related party ;

(b) name of the director or key managerial personnel who is related, if any;

(c) nature of relationship;

(d) nature, material terms, monetary value and particulars of the contract or arrangement;

(e) any other information relevant or important for the members to take a decision on the proposed resolution.

·         Disclosures to be made in Board’s Report:

Every related party transaction or contract shall be disclosed in the Board’s report along with the justification for entering into such contract or arrangement.

Exemptions/Non-applicability

The above mentioned provisions will not be applicable in case of transactions entered into by the company in its ordinary course of business, which are on arm’s length basis.

“arm’s length transaction” means a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest.

Consequences of non-compliance

• If any related party transaction or contract is entered without seeking Board’s and/or Members’ approval and if the same is not ratified by the Board and/or Members as the case may be, within 3 months at a meeting, then the contract or transaction will be voidable at the option of the Board and if the transaction is with any related party to any director or is authorised by any other director, then the concerned directors are liable to indemnify any loss incurred by the company.

• Additionally, the company can also proceed against a director or employee who had entered into such contract or arrangement in contravention of the provisions of this section for recovery of any loss sustained by it as a result of such contract or arrangement.

• Any director or any other employee of a company, who had entered into or authorised the contract or arrangement in violation of the provisions of this section shall –

(i) in case of listed company, be punishable with imprisonment for a term which may extend to 1 year or with fine which shall not be less than Rs. 25,000/- but which may extend to Rs. 5,00,000/-, or with both; and

(ii) in case of any other company, be punishable with fine which shall not be less than Rs. 25,000/- but which may extend to Rs. 5,00,000/-.

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REGISTERED VALUERS UNDER COMPANIES ACT, 2013

Registered Valuer is one among the many new concepts introduced by the Companies Act, 2013 to provide for a proper mechanism for valuation of the various assets and liabilities related to a company and to standardize the procedure thereof. This will not only help in eliminating doubts relating to arbitrary valuation and window dressing but will also act as an assurance to the concerned stake holders and regulators regarding the authenticity of the valuation of the asset or liability under consideration. It also throws open a new area of professional opportunity.

Section 247 of the Companies Act, 2013 contains provisions exclusively regarding registered valuers.

Definition (Rule 17.1):

‘Registered Valuer’ means a person registered as a Valuer under Chapter XVII of the Act.

Who can act as a registered valuer?

A person who is registered as a Registered Valuer in pursuance of Section 247 of the Act with the Central Government and whose name appears in the register of Registered Valuers maintained by the Central Government or any authority, institution or agency, as may be notified by the Central Government only can act as a registered valuer. An application for registration as valuer shall be made in Form No. 17.1 by individuals and firms and Form No. 17.2 by others, along with the fee as provided.

The following persons shall be eligible to apply for being registered as a valuer:

·         A chartered accountant, company secretary or cost accountant who is in whole-time practice, or retired member of Indian Corporate Law Service or any Indian Citizen holding equivalent Indian or foreign qualification as the Ministry  of Corporate Affairs may by an order recognize.

 

·         A Merchant Banker registered with SEBI and having in his employment persons having qualifications as mentioned above to carry out valuation services by such qualified persons

 

·         A member of the Institute of Engineers and who is in whole-time practice

 

·         A member of the Institute of Architects and who is in whole-time practice

5 years of continuous post membership experience is mandatory in all the above cases.

In the case of merchant banker the valuation report shall be signed by the qualified person.

For the purposes of this rule, a person shall be deemed “to be in whole-time practice”, when individually or in partnership or in limited liability partnership or in merchant banker with other persons in practice who are members of other professional bodies, he, in consideration of remuneration received or to be received:

(i) engages himself in the practice of valuation; or

(ii) offers to perform or performs services involving valuation of any assets with the object of arriving at financial value of the asset being valued; or

(iii) renders professional services or assistance in or about matters of principle or detail relating to valuation.

 

·         A person or entity possessing necessary competence and qualification as may be notified by the Central Government from time to time.

 

What requires valuation by a registered valuer under the Act?

Any property, stocks, shares, debentures, securities or goodwill or any other assets or net worth of a company or its liabilities which requires valuation under the provision of the Companies Act, 2013 shall be valued by a registered valuer.

In the Act, specific mention about valuation by registered valuer has been made in the following Sections:

Section 62(1)(c) – Further issue of share capital, other than Rights Issue and Issue under a Scheme of Employee Stock Option.

Section 192(2) – Non cash transaction involving directors

Section 230(2) – Valuation report in case of a scheme of compromise or arrangement with creditors or members

Section 236(2) – Purchase of minority shareholding

Section 281(1)(a) proviso – Submission of report by company liquidator

Section 305(2)(d) – Declaration of solvency in case of proposal to wind up voluntarily

Section 319(3)(b) - Power of Company Liquidator to accept shares, etc., as consideration for sale of property of company.

 

Methods of valuation

Ø  Before adoption of the methods of valuation, the registered valuer shall decide the approach to valuation based upon the purpose of valuation:

(a) Asset approach;

(b) Income approach;

(c) Market approach

Ø  The valuer shall consider the following points while undertaking valuation

(a)Nature of the business and the History of the Enterprise from its inception;

(b) Economic outlook in general and outlook of the specific industry in particular;

(c) Book value of the stock and the financial condition of the business;

(d) Earning capacity of the company;

(e) Dividend –paying capacity of the company;

(f) Goodwill or other intangible value;

(g) Sales of the stock and the size of the block of stock to be valued

(h) Market prices of stock of corporations engaged in the same or a similar line of business;

(i) Contingent liabilities or substantial legal issues, within India or abroad, impacting the business;

(j) Nature of instrument proposed to be issued, and nature of transaction contemplated by the parties.

Ø  A registered valuer shall make a valuation of any asset as on valuation date, in accordance with any one or more of the following methods:

(a) Net asset value method - represents the value of an entity’s assets less the value of its liabilities

(b) Market Price method: Under this method the current price at which the subject of valuation is bought or sold in the market between unrelated third parties is taken into account;

(c) Yield method / Profit Earning Capacity Value (PECV): Under this method the value is calculated by capitalizing the average of the after tax profits for the preceding three years (or such other period. Provided adequate justification is available for choosing another period) at capitalisation rates specified in the report

(d) Discounted Cash Flow Method (DCF): This method expresses the present value of the business as a function of its future cash earnings capacity.

(e) Comparable Companies Multiples Methodology (CCM): This Method uses the valuation ratios of a publicly traded company and applies that ratio to the company being valued (after applying appropriate discount or premium, as the context may require).

(f) Comparable Transaction Multiples Method (CTM) - entails valuation on the basis of similar transactions among unrelated parties in the peer group companies.

(g) Price of Recent Investment method (PORI) - entails valuation on the basis of recent investment received in the company from an independent investor.

(h) Sum of the parts valuation (SOTP) – where each part of the business is valued according to method(s) appropriate to that business, and the results are summed up to obtain total value of the business

(i) Liquidation value - if the value is being calculated in a liquidation scenario

(j) Weighted Average Method – Under this method the weights are assigned to the values calculated under different valuation approaches.

(k) Any other method accepted or notified by the Reserve Bank of India, Securities and Exchange Board or Income Tax Authorities.

(l) Any other method(s) that the valuer may deem fit to adopt in the given circumstances of the case, provided that adequate justification for use of such method(s) (and not any of the methods above) must be included in the report.

Ø  A registered valuer shall make a valuation of any asset as on valuation date, in accordance with the applicable standards, if any, as may be stipulated for this purpose.

 

For the purposes of this rule, ‘valuation date’ means the date on which the estimate of value is applicable. It may be different from the date of the valuation report or the date on which the investigations were undertaken or completed.

Appointment of registered valuer [Section 247(1)]:

The registered valuer needs to be appointed by the audit committee or in its absence, by the Board of Directors.

 

Duties of Registered Valuer [Section 247(2)]:

(a) make an impartial, true and fair valuation of any assets which may be required to be valued;

(b) exercise due diligence while performing the functions as valuer;

(c) make the valuation in accordance with such rules as may be prescribed; and

(d) not undertake valuation of any assets in which he has a direct or indirect interest or becomes so interested at any time during or after the valuation of assets.

 

Contents of Valuation Report

The report of valuation by a registered valuer shall be as near to and shall contain such information as set out in Form No. 17.3.

Furnishing of Particulars in certain cases by registered valuers

Where any person who is registered as a valuer under section 247 or who has made an application for registration as a valuer under that section is, at any time thereafter,—

(a) sentenced to a term of imprisonment for any offence; or

(b) found guilty of misconduct in his professional capacity by any association or institute or other body of which he is a member or with which he is registered;

he shall immediately after such conviction or finding, intimate the particulars thereof to the Central Government, institution or agency with which he is registered as a valuer and cease to act as valuer unless

Ø  permitted by the Central Government, institute or agency with which he is registered as a valuer, or

Ø  the order imposing penalty/sentence has been stayed by competent authority.

In case valuer is found guilty of professional misconduct or otherwise by the Institute of which he is a member or by NFRA or where the SEBI removed the registration of the merchant banker, such valuer shall cease to be the valuer automatically and their name shall be removed from the register of valuer unless such order has been stayed by the Competent Authority.

Any ongoing assignment of such valuer, who has ceased to be a valuer, shall be assigned to other valuer from the panel maintained by Central Government or any authority or institution to complete the assignment, if no stay is granted on such appeal, if any.

Removal and restoration of names of valuers from register

Removal:

The name of a registered valuer can be removed from the register by the Central Government if the government is satisfied –

Ø  that his name has been entered in the register by error or on account of misrepresentation or suppression of a material fact

Ø  that he has been convicted of any offence and sentenced to a term of imprisonment or has been guilty of misconduct in his professional capacity which, in the opinion of the Central Government or any authority, institution or agency, renders his name unfit to be kept in the register.

Ø  that his performance is such that his name should not remain on the register of valuers, satisfied, after giving that person a reasonable opportunity of being heard and after such further inquiry, if any, as it thinks fit to make.

The Central Government or any authority, institution or agency may appoint one or more competent persons as enquiry officer(s) for conducting an enquiry as referred above. The officer(s) conducting an enquiry shall have the same powers as are vested in a Civil Court under the Code of Civil Procedure, 1908 while make an enquiry and he may also call upon such experts from the field of law, economics, business, finance, accountancy, international trade, management, technology or such other discipline as he deems necessary to assist him in conducting the enquiry.

Appeal:

A registered valuer aggrieved by an order passed for removal of name may prefer an appeal in accordance with the procedure laid down in the respective Acts, regulations or bye-laws governing the respective professional. An appeal against the order of the Central Government shall be preferred to the Tribunal.

Restoration:

The name can be restored on sufficient cause being shown to the satisfaction of the Central Government.

 

Penal Provisions [Section 247(3) & (4)]:

·         If a valuer contravenes the provisions of this section or the rules made thereunder, the valuer shall be punishable with fine which shall not be less than Rs. 25,000/- but which may extend to Rs. 1,00,000/-.

·         If the valuer has contravened such provisions with the intention to defraud the company or its members, he shall be punishable with imprisonment for a term which may extend to 1 year and with fine which shall not be less than Rs. 1,00,000/- but which may extend to Rs. 5,00,000/-.

·         Where a valuer has been convicted as above, he shall be liable to—

(i) refund the remuneration received by him to the company; and

        (ii) pay for damages to the company or to any other person for loss arising out of incorrect or misleading statements of particulars made in his report.

Author : CS Dhanapal

E-mail:csdhanapal@gmail.com

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