[Himanshu Dubey and Payal Agarwal are with Vinod Kothari & Co.]
The seamless flow of information between a holding company and its subsidiaries is imperative for effective governance at the level of a corporate group. Since listed companies in India often function with complex structures with a number of subsidiaries, it is not feasible for the holding company to deliberate upon all the matters relating to their subsidiaries. Therefore, at least significant transactions, if not all, relating the subsidiaries shall be placed for consideration by the board of the holding company. Regulation 24 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘Listing Regulations’) provides for the same. Although this sounds commendable, it is also surrounded by various practical difficulties during its implementation. Sometimes, compliance with the aforesaid provision becomes merely perfunctory. If there is excessive reporting to the holding company, the relevance is lost; on the other hand, if too less information is reported, then the aspect of materiality is undermined.
Need for fostering corporate governance requirements with respect to subsidiaries
In the normal course of business, it is very common for companies to have subsidiaries. However, the significance of such subsidiaries on the overall performance of the holding company varies. In case of listed companies, since the interest of the public at large is at stake, it becomes imperative that such stakeholders shall not only be informed about the listed company but also its subsidiaries. Of course, the level and depth of information shall vary depending upon the significance of the subsidiaries as well as the significance of transactions being undertaken by such subsidiaries. Considering the aforesaid, Regulation 24 of the Listing Regulations requires the listed holding company to ensure corporate governance in its unlisted subsidiaries in certain ways. One of such ways is provided under sub-regulation (4) of Regulation 24 which states that the management of the unlisted subsidiary shall periodically bring to the notice of the board of directors of the listed entity a statement of all significant transactions and arrangements entered into by the unlisted subsidiary.
The above-mentioned requirement was earlier applicable only to material unlisted subsidiaries but, pursuant to an amendment applicable with effect from April 1, 2019, the requirement has now been made applicable to all the unlisted subsidiaries of the listed holding company. However, although the requirement seems unequivocal, it comes with certain anomalies and practical difficulties. The author seeks to present an analysis of regulation 24 so as to answer the anomalies coming in the way of its practical implementation.
Applicability to subsidiaries
It is very common for a large corporate group to have various subsidiaries which in turn have various subsidiaries under them, i.e., step down subsidiaries, from the angle of the ultimate holding company. The possibility of the holding company being listed and the subsidiaries including step down subsidiaries being unlisted is very high. This type of a structure is very common and can be seen in most of the major corporate groups in India. Since the regulation 24 speaks about subsidiaries, a question might arise whether it only includes the immediate subsidiaries or the step down subsidiaries as well.
Given the purpose of regulation 24 of enhancing corporate governance in the subsidiaries, the shareholders interested in the listed company shall be aware of the business being undertaken by the subsidiaries as well. The principle behind this is that, at a consolidated level, the performance of the holding company gets affected by the performance of its subsidiaries, including its step down subsidiaries. Therefore, it is pertinent to have some degree of supervision over them in terms of corporate governance although they are unlisted. Considering this rationale, there seems to be no purpose of excluding the step down subsidiaries from the purview of regulation 24. Hence, the regulation will be applicable to both immediate and step down unlisted subsidiaries. It would be useful to examine the applicability of regulation 24 under different scenarios enunciated below.
Scenario 1: Listed holding company and both subsidiary and step-down subsidiary are unlisted
Since both the immediate subsidiary and the step down subsidiary are unlisted, regulation 24 will apply to both of them and significant arrangements or transactions entered into by them will have be reported to the ultimate holding company.
Case 2: Listed holding company, listed subsidiary and unlisted step-down subsidiary
Since the subsidiary itself is a listed company, the regulation clearly states that it applies to unlisted subsidiary. Therefore, the regulation will not apply to the subsidiary. Going further, the step down subsidiary is unlisted, but the holding company just one level above is listed. Therefore, regulation 24 will apply to the unlisted step down subsidiary in relation to its immediate holding company. The ultimate holding company at the top will not be required to note nor review the significant transactions or arrangements of the step down subsidiary under the regulation.
Case 3: Listed holding company, unlisted subsidiary and listed step-down subsidiary
Since the subsidiary is unlisted, regulation 24 will have to be complied in relation to it. However, going forward to the listed step down subsidiary, since it is itself listed with the stock exchange, the regulation will not apply as it is applicable only to unlisted subsidiaries.
Issues to address
Regulation 24(4) of the Listing Regulations reads as below –
“The management of the unlisted subsidiary shall periodically bring to the notice of the board of directors of the listed entity, a statement of all significant transactions and arrangements entered into by the unlisted subsidiary.”
The following may be require to be identified –
- Who can be the management for the unlisted subsidiary?
- What should be the periodicity of reporting?
- How should one undertake the identification of significant transactions and arrangements?
While a plain reading of the regulation entails the aforesaid questions, a deeper analysis and a consideration of the practical implications give rise to further issues and questions, which have been dealt with at relevant parts in this post.
Meaning of ‘transactions’ or ‘arrangements’
The first question that arises while complying with the requirements of regulation 24(4) is the identification of what constitutes a ‘transaction’ or ‘arrangement’. While the term ‘transaction’ is not defined, the meaning of the same may be construed from regulation 2(1)(zc) of the Listing Regulations and Indian Accounting Standard (Ind-AS) 24, defining the term ‘related party transaction’ (RPT).
The term has been defined as follows:
A related party transaction is a transfer of resources, services or obligations between a reporting entity and a related party, regardless of whether a price is charged.
Accordingly, the term transaction may be understood to be “a transfer of resources, services or obligations between two parties”. Similarly, arrangements shall mean a plan or programme for undertaking or understanding to undertake such transactions in future.
Assessment of significance
The second step that emerges after identifying a transaction or arrangement is the assessment of its significance. For the purpose of regulation 24(4), a transaction or arrangement is significant if it individually exceeds or is likely to exceed ten percent of the total revenues or total expenses or total assets or total liabilities, as the case may be, of the unlisted subsidiary for the immediately preceding accounting year.
The criterion of significance as provided above requires that the threshold needs to be examined against different parameters “as the case may be”. The parameter to be considered will depend upon the nature of the transaction. Therefore, the significance shall be assessed against the threshold determined on the basis of figures under relevant head as explained below:
- If the transaction affects the revenue of the company, the significance shall be determined by calculating the threshold against the total revenue of the company.
- If the transaction affects the expenses of the company, the significance shall be determined by calculating the threshold against the total expenses of the company.
- If the transaction affects the assets of the company, the significance shall be determined by calculating the threshold against the total assets of the company.
- If the transaction affects the liabilities of the company, the significance shall be determined by calculating the threshold against the total liabilities of the company
There may be instances where the transaction does not affect any one parameter in isolation, but two or more of the parameters, i.e., revenue, expenses, assets or liabilities together. In such cases, an issue may arise as to which parameter has to be considered. In such cases, all the parameters applicable to such a transaction shall be considered. The 10% threshold for all such applicable parameters shall be determined and the lowest of such threshold shall be applied for assessment of significance of such transaction.
For example, S Ltd, the subsidiary of A Ltd, has entered into a transaction with Z Ltd, involving a sale of goods. Such a transaction involves revenue and, therefore, significance of such transaction has to be assessed as a percentage keeping the total revenue of the preceding accounting period as the base for deriving such percentage. Say for example, the revenue of S Ltd is Rs. 100 crore in the preceding financial year. Therefore, 10% of such revenue will be Rs. 10 crores. Hence, if the value of the transaction being entered into by S Ltd with Z Ltd exceeds Rs. 10 crores, the same will qualify as a significant transaction for the purpose of regulation 24(4).
However, consider another example in which S Ltd has entered into an arrangement which impacts both the assets and expenses of the company (e.g., the creation of a new capital asset involving a huge outflow of cash). In such a case, both the assets and expenses are involved, and the significance of the transaction has to be assessed for each of the bases individually and the one that triggers the requirement at the lower end shall be taken for assessment of significance. For example, say the assets and the expenses of S Ltd in the preceding financial year were Rs. 500 crores and Rs. 150 crores respectively. In such a case, the thresholds shall be calculated based on both the figures and the lower of the two shall be the one that will determine the significance of the transaction. In the instant case, the thresholds are Rs. 50 crores and Rs. 15 crores and, therefore, the lower of the two, i.e., Rs. 15 crores, will be considered. Hence, if the amount of transactions being undertaken exceeds Rs. 15 crores, it will qualify as a significant transaction.
[To be continued]
– Himanshu Dubey & Payal Agarwal