[The following
post is contributed by Vinod Kothari
and Shampita Das of Vinod Kothari
& Company. They can be contacted respectively at [email protected] and [email protected]]
post is contributed by Vinod Kothari
and Shampita Das of Vinod Kothari
& Company. They can be contacted respectively at [email protected] and [email protected]]
The latest setback
from the MCA has come by way of the amendments to the Companies (Meetings of
Board and its Powers) Rules, 2014 (MBP Rules) vide its notification dated 14th August, 2014, which is
yet to be gazette.[1] The key
highlight of the amendment was the complete substitution of the Rule 15(3) of
the MBP Rules relating to conditions for obtaining approval from members for
entering into related party transactions (RPTs).
from the MCA has come by way of the amendments to the Companies (Meetings of
Board and its Powers) Rules, 2014 (MBP Rules) vide its notification dated 14th August, 2014, which is
yet to be gazette.[1] The key
highlight of the amendment was the complete substitution of the Rule 15(3) of
the MBP Rules relating to conditions for obtaining approval from members for
entering into related party transactions (RPTs).
Lets’ start over!
Section 188 of
the Companies Act, 2013 (Act) provides that approval of the Board would be
required for entering into certain related party transactions. The first proviso
to Section 188 provides that no contract or arrangement shall be entered into
by a company having paid-up share capital of not less than such amount, or
transactions not exceeding such sums, as may be prescribed, except with the
prior approval of the company by a special resolution.
the Companies Act, 2013 (Act) provides that approval of the Board would be
required for entering into certain related party transactions. The first proviso
to Section 188 provides that no contract or arrangement shall be entered into
by a company having paid-up share capital of not less than such amount, or
transactions not exceeding such sums, as may be prescribed, except with the
prior approval of the company by a special resolution.
To this effect, Rule
15 (3) of the MPB Rules (prior to the amendment) had laid down dual conditions
for passing of special resolution for entering into RPTs. The conditions were:
15 (3) of the MPB Rules (prior to the amendment) had laid down dual conditions
for passing of special resolution for entering into RPTs. The conditions were:
(a) Companies having paid up capital of Rs.
10 crores or more; or
10 crores or more; or
(b) Transaction value exceeds certain
prescribed limits.
prescribed limits.
This meant that
fulfillment of either of the conditions (i.e. paid up capital or transaction
limits) would have necessitated the approval of the RPT by way of a special
resolution. Thus even if my transaction value is Re. 1, if my paid up capital
exceeded Rs. 10 crores, I would have had to approach my members for passing the
related party contract.
fulfillment of either of the conditions (i.e. paid up capital or transaction
limits) would have necessitated the approval of the RPT by way of a special
resolution. Thus even if my transaction value is Re. 1, if my paid up capital
exceeded Rs. 10 crores, I would have had to approach my members for passing the
related party contract.
The Amendment
The amendment seeks
to substitute this sub-rule (3) to Rule 15 by completely removing the paid up
capital criteria of Rs. 10 crore.
to substitute this sub-rule (3) to Rule 15 by completely removing the paid up
capital criteria of Rs. 10 crore.
Further, the
transaction limits of the various related party contracts as listed under Section
188 (1) of the Act has also been reduced. The table below shows the limits of
the RPTs before and after the amendment:
transaction limits of the various related party contracts as listed under Section
188 (1) of the Act has also been reduced. The table below shows the limits of
the RPTs before and after the amendment:
|
|
Before
|
After
|
|
Sale, purchase or supply
of any goods or materials, directly or through appointment of agents, as mentioned in Clause (a) and Clause (e), respectively of Section 188 (1) |
Exceeding 25% of the
annual turnover |
Exceeding 10% of the turnover of the company or Rs. 100 crores, whichever is lower.
|
|
Selling or otherwise
disposing of, or buying, property of any kind directly or through appointment of agents as mentioned in Clause (b) and Clause (e), respectively of Section 188 (1) |
Exceeding 10% of the net
worth of the company |
Exceeding 10% of the net
worth of the company or Rs. 100 crores, whichever is lower |
|
Leasing of property of any
kind as mentioned in clause (c) of Section 188 (1) |
Exceeding 10% of the net
worth or 10% of turnover of the company |
Exceeding 10% of the net
worth or 10% of turnover or Rs. 100 crores, whichever is lower. |
|
Availing or rendering of
any services directly or through appointment of agents as mentioned in Clause (d) and Clause (e) of Section 188 (1) |
Exceeding 10% of the net
worth of the company |
Exceeding 10% of the turnover of the company or Rs. 50 crores, whichever is lower.
|
|
Further, an Explanation has been added after the
above sub clauses as follows:
‘It is hereby clarified that the limits specified in sub-clauses (i) to
(iv) shall apply for transaction or transactions to be entered into either individually or taken together with the previous transactions during a financial year.’ |
||
|
Appointment to any office
or place of profit in the company, its subsidiary company or associate company as mentioned in clause (f) of Section 188 (1) |
At monthly remuneration
exceeding Rs. 2.5 Lakh. |
At monthly remuneration
exceeding Rs. 2.5 Lakh.
–
No Change |
|
Remuneration for
underwriting the subscription of any securities or derivatives thereof of the company as mentioned in clause (g) of Section 188 (1) |
Exceeding 1% of the net
worth of the company |
Exceeding 1% of the net
worth of the company.
–
No Change |
Understanding its Impact
The amendment
has changed the entire essence of the earlier Rule. Now, any company – big or
small, public or private, irrespective of
its paid up capital will be required to pass a special resolution in case
the transactions being entered into with related parties come within the
amended limits of Rule 15(3) of the MBP Rules.
has changed the entire essence of the earlier Rule. Now, any company – big or
small, public or private, irrespective of
its paid up capital will be required to pass a special resolution in case
the transactions being entered into with related parties come within the
amended limits of Rule 15(3) of the MBP Rules.
Also, most of
the contract limits have been reduced to bring more RPTs within the scanner of
the members and the government. This includes putting an upper cap for
transactions worth Rs. 100 crores or Rs. 50 crores to necessarily require
special resolution, notwithstanding its percentage value to the networth or
turnover of the company.
the contract limits have been reduced to bring more RPTs within the scanner of
the members and the government. This includes putting an upper cap for
transactions worth Rs. 100 crores or Rs. 50 crores to necessarily require
special resolution, notwithstanding its percentage value to the networth or
turnover of the company.
Further, the Explanation
that has been added to the amended Rule provides that the contract limits shall
apply to both individual transactions, and transactions taken together in a
financial year with a related party. The question here arises is whether the
same needs to be assessed for ‘all contracts with one related party’ or ‘all
contracts with each related party’.
that has been added to the amended Rule provides that the contract limits shall
apply to both individual transactions, and transactions taken together in a
financial year with a related party. The question here arises is whether the
same needs to be assessed for ‘all contracts with one related party’ or ‘all
contracts with each related party’.
That is, suppose
a company has A, B and C as related parties and it enters into sale of goods
agreement with each of them. The aggregate value of the contract with A comes
to Rs. 70 crore, with B to Rs. 102 crores and with C to Rs. 25 crores, in a
financial year. The aggregate value of such contracts with each related party comes
to Rs. 197 crores. However the threshold (i.e. Rs. 100 crores) of all contracts
with one related party is breached only for B.
a company has A, B and C as related parties and it enters into sale of goods
agreement with each of them. The aggregate value of the contract with A comes
to Rs. 70 crore, with B to Rs. 102 crores and with C to Rs. 25 crores, in a
financial year. The aggregate value of such contracts with each related party comes
to Rs. 197 crores. However the threshold (i.e. Rs. 100 crores) of all contracts
with one related party is breached only for B.
Here, the
special resolution will be required for entering into transactions with only B,
i.e. all contracts with one related party needs to be seen. This is because the
Section 188 (1) uses the phrase ‘….no company shall enter into any contract or
arrangement with a related party with respect to -’. Hence the merit of
transactions with individual related parties needs to be seen and not the
aggregate of the all such transactions.
special resolution will be required for entering into transactions with only B,
i.e. all contracts with one related party needs to be seen. This is because the
Section 188 (1) uses the phrase ‘….no company shall enter into any contract or
arrangement with a related party with respect to -’. Hence the merit of
transactions with individual related parties needs to be seen and not the
aggregate of the all such transactions.
Further, the
MCA has clarified in its Circular No. 30/2014 dated 17 July 2014[2] that only the related
party to such contract or arrangement will refrain from voting on the special
resolution.
MCA has clarified in its Circular No. 30/2014 dated 17 July 2014[2] that only the related
party to such contract or arrangement will refrain from voting on the special
resolution.
A Critical Take on the Amendment
With the
amendment in Rules, Section 188 has become completely futile. There was
absolutely no case for dropping the “large company” criteria – in
fact, there was a very strong case to make the “large company” and
“large contract” criteria cumulative, rather than alternative.
However, the section as it now stands is counterproductive – as it will be
tougher for small companies to comply with, than for large companies.
amendment in Rules, Section 188 has become completely futile. There was
absolutely no case for dropping the “large company” criteria – in
fact, there was a very strong case to make the “large company” and
“large contract” criteria cumulative, rather than alternative.
However, the section as it now stands is counterproductive – as it will be
tougher for small companies to comply with, than for large companies.
We are surprised
as to how the amendment is a case of dilution of the provisions of law. The
change in the Rules has exactly gone opposite to the essential philosophy of control
over RPTs. It has made section 188 lighter for larger companies and harder for
small companies. If you see the discussions before the Parliamentary Committee,
MCA has represented there that section 188 is meant for larger companies. Now,
as the situation prevails, small contracts by large companies do not need
sanction; however for small companies, smaller contracts need sanction (as the
limit reduced from 25% to 10%). Dichotomy between listing norms and the Act
continues – as SEBI’s rules still continue to define “material RPTs”
differently. The implication of Section 188 as it now stands defies all logic –
smaller companies, for whom every small contract will be relatively large, as
they themselves have small aggregate turnover and networth, will have to run to
get general meeting resolutions every now and then. Proposed exemption
notification for private companies was also diluted before going to Parliament
to deny complete exemption to private companies. Hence, private companies will
also need to run to their general bodies to approve contracts with related
parties. Worst hit will be smaller public companies, which do not have any
exemption from the Rule that requires a related party to refrain from voting.
as to how the amendment is a case of dilution of the provisions of law. The
change in the Rules has exactly gone opposite to the essential philosophy of control
over RPTs. It has made section 188 lighter for larger companies and harder for
small companies. If you see the discussions before the Parliamentary Committee,
MCA has represented there that section 188 is meant for larger companies. Now,
as the situation prevails, small contracts by large companies do not need
sanction; however for small companies, smaller contracts need sanction (as the
limit reduced from 25% to 10%). Dichotomy between listing norms and the Act
continues – as SEBI’s rules still continue to define “material RPTs”
differently. The implication of Section 188 as it now stands defies all logic –
smaller companies, for whom every small contract will be relatively large, as
they themselves have small aggregate turnover and networth, will have to run to
get general meeting resolutions every now and then. Proposed exemption
notification for private companies was also diluted before going to Parliament
to deny complete exemption to private companies. Hence, private companies will
also need to run to their general bodies to approve contracts with related
parties. Worst hit will be smaller public companies, which do not have any
exemption from the Rule that requires a related party to refrain from voting.
Also, as the
change of Rules happened mid way during the financial year, what about those
contracts which have already been signed/approved during the financial year,
before the Gazette notification?
change of Rules happened mid way during the financial year, what about those
contracts which have already been signed/approved during the financial year,
before the Gazette notification?
How could larger
companies and smaller companies, particularly those with no public stakes at
all, be painted with the same brush? Is there clarity as to the direction in
which the Companies Act is moving?
companies and smaller companies, particularly those with no public stakes at
all, be painted with the same brush? Is there clarity as to the direction in
which the Companies Act is moving?
This is the
biggest concern that had been mentioned in Mr. Vinod Kothari’s article titled
“Ten monsters of the Companies Act, 2013[3]“.
He had mentioned that as lawmaking moves from the domain of the Parliament to
the domain of the MCA, the executive arm of the government starts doing what
the Parliament of the country is supposed to do. How could such massive changes
take place, completely without any deliberation or public discussion? Had it
been the time-tested, globally followed Parliamentary process, this change
would have required a Bill, debate in Parliament, and so on. Now, since rule
making is absolutely in the clutches of the MCA, all that it needed was one
simple notification, and there is such a substantive swing in substantive rights
and liberties of businesses.
biggest concern that had been mentioned in Mr. Vinod Kothari’s article titled
“Ten monsters of the Companies Act, 2013[3]“.
He had mentioned that as lawmaking moves from the domain of the Parliament to
the domain of the MCA, the executive arm of the government starts doing what
the Parliament of the country is supposed to do. How could such massive changes
take place, completely without any deliberation or public discussion? Had it
been the time-tested, globally followed Parliamentary process, this change
would have required a Bill, debate in Parliament, and so on. Now, since rule
making is absolutely in the clutches of the MCA, all that it needed was one
simple notification, and there is such a substantive swing in substantive rights
and liberties of businesses.
– Vinod Kothari & Shampita Das
