[Sikha Bansal and Avinash Shetty are with Vinod Kothari & Co]
The regime surrounding related party transactions (‘RPT’) under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (as significantly amended in 2021) (the ‘LODR Regulations’), is very wide and includes cross RPTs across the group. That is, transactions of a listed entity with related parties of its subsidiaries as well as transactions of a subsidiary (listed or unlisted) with related parties of the parent listed entity would come under the purview of RPTs and, therefore, would be subject to enhanced controls at the parent level.
Therefore, the prerequisite for effective implementation of the RPT controls is the correct identification of the related party at both levels – by the parent and by the subsidiary. While in the case of a listed entity it is clear that the definition of a related party under the LODR Regulations has to be followed, there was a lack of clarity as to whether an unlisted subsidiary should also follow the same definition or it can simply adhere to the law as applicable to it.
In this regard, in an Informal Guidance issued in October this year, the Securities and Exchange Board of India (‘SEBI’) has opined that unlisted subsidiaries of the listed entities are required to identify the related parties and RPTs in accordance with the provisions of the LODR Regulations.
Possible Alternatives for Identifying Related Parties of Subsidiaries
Regulation 2(1)(zb) of the LODR Regulations defines a related party to mean the following:
- as defined under section 2(76) of the Companies Act, 2013 (the ‘CA, 2013’);
- as per applicable accounting standards;
- person or entity forming part of the promoter or promoter group of the listed entity;
- person or any entity holding 10% or more of equity shares, directly or on a beneficial interest basis, at any time during the immediately preceding financial year.
While the listed entities identified related parties based on the above definition, there was a lack of clarity on the manner of identification of related parties for unlisted subsidiaries in India and overseas. The LODR Regulations do not specify the approach to be followed for identifying related parties of unlisted subsidiaries.
Consequently, there could be two possible approaches. First, the subsidiaries maintain a list of their related parties according to the LODR Regulations. Alternatively, subsidiaries may be allowed to maintain a list of related parties as per their respective applicable/local laws. SEBI’s informal guidance, however, states that the first approach needs to be followed for assessing the RPTs undertaken by the subsidiary with its own related parties.
While the approach of applying an entity-agnostic definition of the LODR Regulations may seem to bring consistency and ease of collation of information across the group, there may be several arguments against this approach, as we discuss below.
Issues Related to SEBI’s Approach
Context
Words and expressions in any law have to be read in the context in which they are used. When the term ‘related party’ is used in the context of a listed entity, one will have to refer to the definition provided in regulation 2(1)(zb) of the LODR Regulations, as those regulations are applicable to a listed entity (per regulation 3 thereof). However, when the term ‘related party’ is used in the context of an unlisted entity, it cannot be said that the LODR Regulations are applicable to unlisted entities. In case of RPTs, the LODR Regulations have sought to impose controls on RPTs undertaken by unlisted entities, albeit only through their listed parents – and not directly. Applying the definition of ‘related party’ to unlisted entities would mean expanding the direct applicability of the LODR Regulations to unlisted entities, which cannot be the case. Therefore, when it comes to a related party of unlisted entities in India, one will have to look at the residual definition provided in regulation 2(2) of the LODR Regulations, which in turn refers to the CA 2013. In case of overseas subsidiaries, as the CA 2013 is inapplicable, one will have to refer to the laws applicable to such entity.
Superimposing laws relating to listed entities on unlisted entities
RPTs at the subsidiary’s level that cross the specified threshold under regulation 23(2) of the LODR Regulations are required to be placed before the audit committee of the listed parent. If an unlisted entity is required to prepare its list of related parties in accordance with the LODR Regulations, then, it will have to take all those transactions, which otherwise are not RPTs for it under the companies’ legislation or local laws, to its board of directors or audit committee (before it is taken to the audit committee of the parent). This would mean that the unlisted entity will have to comply with the LODR Regulations, which are otherwise not applicable to the unlisted entity. Although the SEBI amendments were to have a holistic and group-wide approach towards RPTs, this intent of superimposing listing laws on unlisted entities, if at all, is neither reflected in the present language of the LODR Regulations nor is there any discussion in the Report of the Working Group on Related Party Transactions.
Interpretational issues
The approach of applying the definition used in the LODR Regulations on unlisted entities might lead to certain interpretational issues. For instance, while assessing a related party under ‘applicable accounting standards’, the question would be whether the subsidiary would follow the accounting standards applicable to the listed entity or that applicable to the subsidiary itself. If it is contended that the unlisted subsidiary will refer to accounting standards as applicable to the listed entity, it would again be considered as a superimposition of inapplicable laws. Besides, there would be multiple interpretational issues given that the respective accounting standards are vastly different. On the other hand, if it is opined that the subsidiary can follow accounting standards as applicable to it, then by juxtaposition, the same analogy (that terms are to be read in the context of which they are used) would apply to the definition of a related party as well. There might be similar interpretational issues involved in this approach and the concern becomes more pertinent in the case of overseas subsidiaries (see below).
Overseas subsidiaries
Applying the definitions of Indian law to overseas entities may raise concerns as to the extra-territorial jurisdiction of the regulator. It would be interesting to note that in the context of regulation 46 of the LODR Regulations, which requires a listed entity to disseminate audited financials of its subsidiaries on its website, SEBI in its informal guidance to HCL Technologies Limited, referred to the exemption granted by Ministry of Corporate Affairs in this regard under section 136(1) of the CA, 2013 and opined that where a foreign subsidiary is not required to get its financial statements audited under any law of the country of its incorporation, and which does not get such financial statement audited, the listed entity may place such unaudited financial statements on its website in accordance with the provisions of the said section. Hence, the Ministry as well as the regulator had, in the past, acknowledged that the compliance domain of overseas entities is limited to the laws of the country in which they are incorporated and, therefore, domestic laws were not imposed on them.
Although, there have been no direct precedents on the issue, courts have, at different points of time and in different contexts, have rendered varying pronouncements. For instance, in Vodafone International Holdings B.V v. Union of India, the Supreme Court observed: “It is generally accepted that the group parent company is involved in giving principal guidance to group companies by providing general policy guidelines to group subsidiaries. However, the fact that a parent company exercises shareholder’s influence on its subsidiaries does not generally imply that the subsidiaries are to be deemed residents of the State in which the parent company resides.” However, the Supreme Court in GVK Inds. Ltd. v. the Income Tax Officer recognised the powers of the Parliament to make laws with respect to extra-territorial aspects or causes that have an impact on or nexus with India. In Securities and Exchange Board of India v. Pan Asia Advisors Ltd., the Court applied the ‘effects test’ and upheld the power of SEBI to deal with lead managers based overseas for global depository receipts issued in India, as “it will have a far reaching consequence on the Indian investors on securities as well as the stock market”. However, it may be observed that the judgment specifically noted various sections of the SEBI Act, 1992, including sections 11B, 11C, 12 and 12A to arrive at its conclusion.
Further, applying domestic definitions to overseas subsidiaries may create complexity for the overseas subsidiaries. For example, the terminologies used in foreign jurisdictions are not the same as those used in India; terms such as ‘relative’ (a part of the definition of related party) may have completely different meanings in different jurisdictions. Further, the definition of ‘subsidiary’ or ‘associate’ may also be different. As a result, there is a strong possibility of inaccuracy, incompleteness, or irreconcilability in the list of related parties provided by such foreign subsidiaries.
Operational issues
Imposing the definition of the LODR Regulations on unlisted entities might increase the compliance burden on the unlisted entities, requiring them to assess related parties under multiple laws. Alternatively, if the subsidiaries identify the related parties based on the definition applicable to it, the same would be more convenient for the subsidiaries as it would anyways maintain the list of related parties to comply with its applicable law.
Concluding Remarks
The framework of RPTs requires accurate identification of a related party to ensure compliance and effective group governance. SEBI’s informal guidance on identifying related parties for unlisted subsidiaries provides a view on the approach to identification of related parties by subsidiaries for the purpose of enabling compliances by the listed parent. However, in our view, the approach may pose its own set of difficulties as discussed above. On the other hand, a group-wide approach to RPTs which simultaneously respects entity-specific boundaries might be more feasible in terms of ease of interpretation as well as ease of implementation of the law. It is to be noted that the views expressed in the informal guidance are those of the department and do not constitute SEBI’s final decision, as explicitly stated in the guidance. Therefore, the views expressed therein should not be seen as the regulator’s final stand on the issue. In any case, a clear explanation in the LODR Regulations themselves might be desired to ensure uniformity in the implementation of RPT controls by listed entities and their unlisted subsidiaries
– Sikha Bansal & Avinash Shetty
