Omnibus Approval of Related Party Transactions and Threshold for Fraud Reporting by Auditors

[The
following guest post is contributed by Amitabh
Robin Singh
, who is an Associate at DSK Legal]
With the notification
bringing Sections 13 and 14 of the Companies (Amendment) Act, 2015 (“Amendment Act”) into force being
published in the official gazette on December 15, 2015, we now have new
provisions on the omnibus approval of related party transactions by companies. On
a separate note, a threshold has been set for frauds discovered by the auditors
of a company which are required to be reported to the Central Government.
The Amendment Act was
originally brought
into force
with effect from May 29, 2015 but Sections 13 and 14 were held
back so rules could be framed for the matters contemplated by them (as
mentioned above).
Section 14 of the Amendment Act
amends Section 177 of the Companies Act, 2013 (“Act”) to provide for prescribing rules to specify the manner of
omnibus approval of related party transactions by the audit committee of a
company. For the same purpose, the Companies (Meeting of Board and its Powers)
Second Amendment Rules, 2015 (“MBP Amendment
Rules
”) were notified
on December 15, 2015. The provisions inserted by this amendment effectively
bring the Act in line with Regulation 23 of the Securities and Exchange Board
of India (Listing Obligations and Disclosure Requirements) Regulations, 2015.
The MBP Amendment Rules added a
new Rule 6A to the Companies (Meeting of Board and its Powers) Rules, 2014 (“MBP Rules”).
The MBP Amendment Rules state
that all related party transactions are to be approved by the audit committee
of the company (an audit committee is required to be constituted by all public
companies with a paid-up share capital of Rs. 10 crores or more, all public
companies with turnover of Rs. 100 crores or more and all public companies with
aggregate outstanding loans or borrowings or debentures or deposits of more
than Rs. 50 crores).
The new rule 6A sanctions
omnibus approval by the audit committee subject to certain conditions such as
specification of the criteria for the omnibus approval which will include the
maximum value of transactions which can be made under the omnibus approval in a
year. Also, the maximum value of a single transaction under the umbrella
omnibus approval is to be laid down. The transactions which are entered into
under such omnibus approval will be required to be reviewed by the audit committee
at certain intervals as decided at the discretion of the audit committee.
The audit committee is also
required to specify which kind of transactions cannot be subject to the omnibus
approval granted by it. For example, it can be specified that transactions with
a particular entity will not be covered under the omnibus approval despite it
being below the annual limits and the sub-set of the per transaction threshold.
Further the audit committee is mandated to satisfy itself that omnibus approval
for repetitive transactions (for example periodical purchase of goods or raw
material from a related party) is in the interest of the company.
It is also required that the
omnibus approval should specify the name of the parties, the nature and
duration of the transactions, the maximum amount of the transactions which can
be entered into and an indicative base price or the current contract price and
the variation formula if the price is required to be altered.
However, there is a proviso to
this providing for an exception in the case where a related party transaction
is unforeseen and the details mentioned in the preceding paragraph above are
not available, then the audit committee may still make omnibus approval for
such transactions, but subject to a limit of Rs. 1 crore per transaction.
The MBP Amendment Rules provide
that omnibus approval will only be valid until the end of the financial year in
which it is granted and fresh approval will be required in the new financial
year.
The MBP Amendment Rules go on
to further state that no omnibus approval will be allowed in the case of
selling or disposing of the undertaking of the company. There is already a
similar provision requiring the passing of a special resolution at a meeting of
the shareholders of the company for any such transaction (related party or otherwise)
under Section 180(1)(a) of the Act. “Undertaking” is clarified to mean an
undertaking in which the company has invested 20% or more of its net worth (as
per the last audited balance sheet) or an undertaking which generates 20% of
the total income of the company in the immediately preceding financial year. However,
it must be noted that Section 180 only applies to public companies post the
notification exempting private companies from certain provisions of the Act
dated June 5, 2015.
The MBP Amendment Rules also
change the requirement of a special resolution in the MBP Rules for certain
related party transactions into an ordinary resolution which brings the rules
in line with the Amendment Act which made a similar replacement in Section 188
of the Act
These amendments to the MBP
Rules and notification of Section 14 of the Amendment Act appear to serve the
purpose of making it simpler to do business, while there are also what seem to
be sufficient safeguards to prevent abuse of this provision in manners that are
detrimental to the interests of the company.
Section 13 of the Amendment Act
was also brought into force by the same notification. As mentioned above this provision
modifies Section 143 of the Act to prescribe a threshold for the reporting of
frauds committed against the company. For this purpose the Companies (Audit and
Auditors) Amendment Rules, 2015 (“Audit
Amendment Rules
”), were notified
on December 15, 2015.
Under the earlier provisions,
any fraud being committed against the company by its officers or employees was
required to be reported to the Central Government. Now a threshold of Rs. 1 crore
has been inserted.
If the auditor does discover a
fraud of Rs. 1 crore or above, then the auditor must report the fraud to the
board of directors or the audit committee of the company (as the case may be) not
later than 2 days of discovery of the fraud. Then the board of directors or
audit committee is required to give its reply or observations to the auditor
within 45 days, which is to be forwarded to the Central Government, failing
which, the auditor shall forward his own report to the central government with
a note mentioning that no reply or observations were received from the board of
directors or the audit committee of the company within the prescribed 45 days.
For a fraud below Rs. 1 crore,
the auditor is required to report the fraud to the board of directors or the
audit committee not later than 2 days of its discovery specifying the name of
the fraud committed with a description of the same, the approximate involved
and the parties involved in the fraud. Then, in the report of the board of
directors for that financial year, the abovementioned details shall be provided
along with the remedial action which was taken resultant to the fraud which was
committed.
This Audit Amendment Rules will
help in reducing the reporting to the Central Government for comparatively
minor frauds but will keep the provisions for fraud robust as the members of
the company will get to know of such relatively minor transgressions in detail
in the report of the board of directors along with remedial action taken so the
members can hold the board accountable for response to the fraud.
The bringing into force of
these two provisions of the Amendment Act are a step forward in increasing the
ease of doing business for companies while still managing to protect the
shareholders and showing that the two concepts are in no way mutually
exclusive.

– Amitabh Robin Singh

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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