Managing Significant Transactions & Arrangements with Subsidiaries: Part 2

[Himanshu Dubey and Payal Agarwal are with Vinod Kothari & Co.

Part 1 is available here]

Basis for assessment – standalone or consolidated?

Having dealt with the parameter to be considered for various transactions, another question that may arise is whether the total revenues or expenses or assets or liabilities, as the case may be, have to be considered on a standalone basis or on a consolidated basis for the subsidiary. Here, one has to consider the fact that compliance with the provision has to be ascertained by the listed holding company. Any company, which is a subsidiary of the subsidiary company, ultimately becomes the step-down subsidiary of the listed holding company, thereby attracting regulation 24(4) of the Listing Regulations for reasons as discussed above, necessitating the reporting of its significant transactions or arrangements to the board of the listed company. In view of the same, an inference may be drawn that the aggregate figures for the preceding financial year shall be taken on a standalone basis, and not on a consolidated basis. This will also help in obtaining a clear picture and involving only those transactions that are actually significant for the subsidiary.

Determination of significance: transactions or arrangements based on contract

When companies enter into contracts with parties as part of their business, a common ambiguity that may arise relates to determining the amount of such transaction for the purpose of regulation 24(4). It is useful to analyse this scenario with some examples.

A Ltd., a subsidiary of B Ltd., enters into a rental agreement with X Ltd. The rental agreement extends to 5 years at a total value of Rs. 30 lakhs, i.e., at a monthly rent of Rs. 50,000 per month. In such a case, what is to be considered as the value of transaction for the purpose of regulation 24(4), i.e., Rs. 30 lakhs or Rs. 50 thousand? In our view, the total amount attributable to that particular financial year shall be considered for the purpose of the regulation. In the instant case, assuming that the contract is effective from October 1, 2021, the amount shall be Rs 3 lakhs (rent during the financial year 2020-21). Therefore, for assessing the significance of the transaction, the amount of Rs. 3 lakhs shall be compared against the threshold.

In the same case above, even if there has been no specific tenure of the contract and the contract only specifies a monthly payment of Rs. 50 thousand as rent, still the amount payable in total throughout that financial year shall be taken and not the monthly rent. The underlying principle is that the total amount of that transaction attributable to that financial year shall be considered as the amount of transaction for assessing significance under regulation 24(4).

Reporting: decoding the meaning of management and periodicity

Meaning of management

Regulation 24(4) states that “the management of the unlisted subsidiary shall periodically bring to the notice of the board of directors of the listed entity …”. This again gives rise to two questions: who constitutes management and what shall be the periodicity for bringing significant transactions or arrangements to the notice of the board of the listed holding company?

Going by the general meaning as well as the intent and purpose of this requirement, the board of directors of the subsidiary as well as the key managerial personnel or other senior executives just a level below the board should be taken to constitute ‘management’.

Periodicity of reporting

Coming to the question of periodicity, the same has not been specified in the Listing Regulations, but it is left to the discretion of the board. However, the intent of regulation 24 is to enhance corporate governance in the subsidiaries. Hence the periodicity should be reasonable enough to capture such a purpose.

Here, one may note that regulation 17(2) of the Listing Regulations requires the board of the listed company to meet at least four times a year. Further, under regulation 33, financial results are placed before the board on a quarterly basis, which also includes results of its subsidiaries (since the results have to be submitted on both standalone and consolidated basis). Therefore, in consonance with the same, the list of significant transactions or arrangements of the subsidiaries should also be placed before the board of the listed company, at least on a quarterly basis, if not more frequently.

De-minimis exemptions – can a leeway be created?

Regulation 24(4) of the Listing Regulations, though very significant in terms of enforcing corporate governance requirements and ensuring transparency in respect of the unlisted subsidiaries of the listed company, may sometimes prove extraneous to the spirit of the law. There may be cases where the subsidiary as a whole may be too small to have any significance on the accounts of the holding company.

A classic example of the same may be the case of a company, as a listed holding company, having a paid-up capital of Rs. 50 crores or above, having a subsidiary with total asset size of Rs. 1 crore. In this case, the total assets of the subsidiary amounts to mere 2% of the total asset size of the listed company. Here, a transaction involving purchase or sale of an asset of Rs. 10 lacs will fall within the meaning of a significant transaction for the subsidiary company. This will, however, have a minimal impact on the listed holding company. In such cases, going by the letter of the law, such transactions, even though having no significant impact on the listed entity as such, will have to be placed before the board thereby creating an unnecessary compliance burden producing no meaningful results.

A possible leeway may be created by providing certain de minimis exemptions on the basis of amounts or percentages. For example, a listed company may approve through its board and audit committee that any transaction undertaken by a subsidiary, which amounts to not greater than 2% of the turnover or the paid-up capital or the net worth of the listed company, will not be required to be reported to the board of the listed company.

However, while placing such de minimis exemptions, utmost care has to be taken to ensure that the self-approved exemptions do not turn out to completely erode the intentions of the law. Further, the requisite approvals have to be obtained and properly documented so as to avoid falling into a legal tangle at a later stage.

Conclusion

The requirement under regulation 24(4) enhances corporate governance standards in subsidiaries, which were otherwise unlisted and exempted from such scrutiny. It allows the listed holding company to exercise due diligence in relation to significant transactions entered by subsidiaries. However, in certain cases, the requirement becomes redundant due to absence of any material effect of subsidiary’s transactions on the overall performance of the holding company due to minimal asset size or revenue. Therefore, the idea of exempting subsidiaries below a certain threshold in terms of asset size or revenue of the listed company can be considered. The market regulator may also take a step to bring this as an amendment to the law, so as to ensure reduction of extra-compliance burden.

[Concluded]

Himanshu Dubey & Payal Agarwal

About the author

Add comment

Subscribe to Blog via Email

Enter your email address to subscribe to this blog and receive notifications of new posts by email.

Top Posts & Pages

Topics

Recent Comments

Archives

web analytics

Social Media