IndiaCorpLaw

Identification of Related Parties of Subsidiaries

[Aisha Begum Ansari is a Manager at Vinod Kothari and Company]

The provisions pertaining to related party transactions (RPT) under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (the ‘LODR Regulations’) were substantially amended by the Securities and Exchange Board of India (SEBI) on November 9, 2021. Pursuant to the amendments, the definitions of a related party, material RPT, requirements of obtaining audit committee and shareholders’ approval were altered.

The definition of ‘RPT’ was amended to include cross-RPTs. Earlier, only transactions between the listed entity and its related parties were covered, but now the following transactions are also covered:

  1. Transactions between a listed entity and its related parties;
  2. Transaction between the subsidiaries of the listed entity and its related parties;
  3. Transaction between the listed entity and related parties of subsidiaries;
  4. Transaction between subsidiaries and related parties of listed entity;
  5. Transaction between subsidiaries and related parties of other subsidiaries.

In order to identify the RPTs and to obtain requisite approvals, the listed entity is first required to identify its related parties and share their details with its subsidiaries. Similarly, the subsidiaries are required to identify their related parties and share them with the listed entity and other subsidiaries. The subsidiaries are also required to track the RPTs at their level on an ongoing basis, to check if the value of their RPTs exceeds the threshold limits requiring audit committee or shareholders’ approval of the listed entity. Therefore, to carry out the implementation of the RPT framework at the holding company level, the subsidiaries are also required to identify their related parties.

Now, a question arises as to which definition of related party should be followed by the subsidiaries. The subsidiary can be a listed subsidiary or an unlisted subsidiary. An unlisted subsidiary prepares its list of related parties according to section 2(76) of the Companies Act, 2013 as the LODR Regulations do not apply to them. However, for the purpose of compliance of regulation 23 by the listed parent, should the unlisted subsidiary continue providing the list of related parties only in accordance with the Companies Act, or should it prepare another more holistic list of related parties as per each of the clauses of reg. 2(1)(zb) of the LODR Regulations? Further, if the subsidiary is in a foreign jurisdiction, should it follow the law of the Indian holding company or the law of the country in which the subsidiary is incorporated?

The law, as of now, is not clear on this. Hence, there is a possibility of varied interpretations. One interpretation is to identify related parties in accordance with the law applicable to the LODR Regulations. However, on the other side, it might be possible to say that related parties of subsidiaries should be identified as per the law applicable to them.

This post seeks to analyse the highlights and challenges of each of the above options.

Option 1: Identifying related parties as per the LODR Regulations

Option 1 applies an entity-agnostic definition across the parent as well as all its subsidiaries. The subsidiaries may be Indian unlisted companies, or overseas entities. The definition of related party under reg. 2(1)(zb) of the LODR Regulations is quite comprehensive and means:

  1. related parties defined under section 2(76) of the Companies Act, 2013;
  2. related parties defined under the applicable accounting standards;
  3. any person or entity forming a part of the promoter or promoter group of the listed entity;
  4. any person or any entity holding equity shares of 20% or more (10% or more, with effect from April 1, 2023) in the listed entity either directly or on a beneficial interest basis as provided under section 89 of the Companies Act, 2013, at any time, during the immediately preceding financial year.

Merits

If the subsidiary follows the laws as applicable to the listed parent entity i.e., the LODR Regulations, it will be required to identify the related parties applying the definition given in regulation 2(1)(zb) thereof. The advantage of following the definition in the LODR Regulations by the subsidiary is that there is a consistency of definition used by both entities. There is a common template, consisting of items (1), (2), (3) and (4) above which is circulated to all the subsidiaries. The subsidiaries fill the common templates, and that is how the RPTs at the level of the subsidiaries are identified. In essence, for the identification of related parties as well as RPTs, there is a common group-wide definition. As such, there will be consistency in the law followed by the entire group, making the implementation of the RPT framework, right from the identification of related parties to approval and disclosure requirements, easier at the parent level.

Demerits

If we closely examine the definition of related parties under regulation 2(1)(zb), we obtain a different view. The parties covered under the proviso (i.e., promoter and promoter group or entities holding shares on a beneficial interest basis) specifically refer to listed entities – therefore, these are not relevant for unlisted subsidiaries, or subsidiaries outside India.

As for applicable accounting standards, it very clearly seems to be referring to standards applicable to the entity in question and, therefore, an entity-agnostic approach does not seem implied there. In case of overseas entities, ‘applicable accounting standards’ will obviously mean accounting standards as may be applicable to the entity and, therefore, entity-specific accounting standards.

The only clause which is, therefore, left to be applied is the definition under the Companies Act, 2013. That definition applies to both listed and unlisted companies in India. However, such an extension by exported jurisdictions may create complexity for the subsidiaries incorporated outside India. At times, the terminology used in foreign jurisdictions are not the same as that used in India. For example, terms such “relative” (a part of the definition of related party) may have a completely different meaning in various jurisdictions. Further, the definition of “subsidiary” or “associate’ may also be different. As a result, there is a strong possibility of inaccuracy or irreconcilability in the list of related parties provided by such foreign subsidiaries.

Option 2: Identifying related parties as per the applicable laws

Option 2 lets each company define related parties based on the definition applicable to it. There may or may not be analogous controls on RPTs, but clearly, accounting standards are almost the same all over the countries that matter. Since a part of the definition of related party even under the LODR Regulations refers to ‘applicable accounting standards’, if we are using the definition as per accounting standards of the jurisdiction, we are serving the requirement of the law. Besides, going by the respective laws as applicable to the subsidiaries would be more convenient for the subsidiaries, as they would anyways maintain the list of related parties to comply with its applicable law.

Closing remarks

Based on the analysis above, it can be said that there can be two possible approaches. One, the listed entity requires the subsidiaries to maintain and provide the list of related parties as per the LODR Regulations. Alternatively, subsidiaries may be allowed to share the list of related parties maintained according to their respective local laws. The LODR Regulations, at present, do not provide ample clarity on the approach to be followed. Nor is there any guidance issued by the regulator so far. Therefore, neither of the said approaches can be said to be non-compliant. Hence, the listed entities may take a considered call to go by any of the options. In our view, allowing subsidiaries to prepare the list by their local laws may be more convenient.

Aisha Begum Ansari