Related Party Transactions and Audit Committee


The Companies Amendment Act, 2017 read with Notification S.O. 1833(E) dated 7th May 2018 amended law related to the audit committee. Certain transactions related to related parties shall be voidable unless ratified by the audit committee. In this post, we will discuss updated law related to approval of related parties in the audit committee.

Detail discussion in the law governing audit committee and its terms of references was posted on this post earlier here.

The term of reference suggested under clause (iv) of Section 177(4) – approval or any subsequent modification of transactions of the company with related parties -is one of most important and sensitive for corporate governance.

First Proviso

The Companies Amendment Act, 2015 with effect from 14th December 2015 inserted the first proviso to Section 177(4)(iv) as under:

“Provided that the Audit Committee may make omnibus approval for related party transactions proposed to be entered into by the company subject to such conditions as may be prescribed;”

Rule 6A of the Companies (Meeting of the Board and its Powers) Rules, 2014 prescribes the procedure for omnibus approval as mentioned in the First Proviso to clause (iv) of Section 177(4). Rule 6A was earlier discussed here but reproduced here for consolidation of information at one place.

CONDITIONS

These conditions mentioned in Rule 6A are:

  • The Audit Committee shall, after obtaining approval of the Board of Directors, specify the criteria for making the omnibus approval which shall include criteria mentioned in Clause 6A(1);
  • The Audit Committee shall consider the certain factors while specifying the criteria for making omnibus approval;
  • The Audit Committee shall satisfy itself on the need for omnibus approval for transactions of repetitive nature and that such approval is in the interest of the company;
  • The omnibus approval shall contain or indicate certain details related to a transaction;
  • Omnibus approval shall be valid for a period not exceeding one financial year and shall require fresh approval after the expiry of such financial year;
  • Omnibus approval shall not be made for transactions in respect of selling or disposing of the undertaking of the company; and
  • Any other conditions as the Audit Committee may deem fit.”

Criteria

According to Clause (1) of Rule 6A, the Audit Committee shall, after obtaining approval of the Board of Directors, specify the criteria for making the omnibus approval which shall include the following, namely:-

(a) the maximum value of the transactions, in aggregate, which can be allowed under the omnibus route in a year;

(b) the maximum value per transaction which can be allowed;

(c) extent and manner of disclosures to be made to the Audit Committee at the time of seeking omnibus approval;

(d) review, at such intervals as the Audit Committee may deem fit, related party transaction entered into by the company pursuant to each of the omnibus approval made;

 (e) transactions which cannot be subject to the omnibus approval by the Audit Committee.

 The Audit committee may fix these criteria as a policy for omnibus approvals of related party transactions on annual basis. This policy shall have the approval of the Board of Directors. Related Party Transactions which fulfil these criteria may get omnibus approval otherwise case to case approval shall be required. Policy among other criteria shall have the maximum aggregate value of transactions for a financial year (contest here is the financial year), maximum value per transaction, and disclosure requirement. The policy shall also have provision for timely review of these omnibus approvals. The policy may exclude certain transaction from omnibus approval in addition to the other exclusions given in the law.

Factors

According to Clause (2) of Rule 6A, the Audit Committee shall consider the following factors while specifying the criteria for making omnibus approval, namely: –

(a) the repetitiveness of the transactions (in past or in future);

(b) the justification for the need of omnibus approval.

A related party transaction which is not of repetitive nature may not get omnibus approval, even if such transaction may take place more than one time. This is the duty of audit committee to consider justification for the need of omnibus approval.

Repetitive Nature

According to Clause (3) of Rule 6A, the Audit Committee shall satisfy itself on the need for omnibus approval for transactions of repetitive nature and that such approval is in the interest of the company.

Repetitive nature is one prominent condition under this Rule for omnibus approval of related party transaction by the audit committee. Not only clause (3) put it as a condition but clause (2) put it a factor to be considered by audit committee while granting omnibus approval to a related party transaction. The audit committee has to satisfy that related party transaction under consideration for omnibus approval has repetitive nature to satisfy a condition under clause (3) and the factor of repetitiveness shall be considered to satisfy the condition under clause (2).

Such omnibus approval of related party transaction by the audit committee should be in the interest of the company. Any related party transaction disparaging the interest of company bound to be rejected by the audit committee and may subject to judicial or regulatory review.

Certain Details

According to Clause (4) of Rule 6A, the omnibus approval shall contain or indicate following details related to related party transaction

  • name of the related parties;
  • nature and duration of the transaction;
  • the maximum amount of transaction that can be entered into;
  • the indicative base price or current contracted price and the formula for variation in the price, if any; and
  • any other information relevant or important for the Audit Committee to take a decision on the proposed transaction.
Non – availability of certain details

According to the proviso to clause (4) of Rule 6A, where the need for related party transaction cannot be foreseen and aforesaid details are not available, audit committee may make omnibus approval for such transactions subject to their value not exceeding rupees one crore per transaction.

In other words, the audit committee may grant omnibus approval to a foreseen transaction for which these details required under clause (4) of Rule 6A are not available at the time of granting omnibus approval. Such approval, as per clause (5) of Rule 6A, shall have validity for one financial year. The value of such omnibus approval for such foreseen related party transaction shall not exceed rupees one crore per transaction. This limit shall not be calculated for a standalone transaction but for a related party transaction with repetitive nature which satisfy the condition of clause (3) of Rule 6A.

Period for approval

According to Clause (5) of Rule 6A, omnibus approval shall be valid for a period not exceeding one financial year and shall require fresh approval after the expiry of such financial year.

All omnibus approval granted by audit committee during a financial year shall expire at the end of financial year of the company. The financial year shall end according to the definition under Section 2(41) of the Companies Act, 2013. At the start of new financial year a company may not enter into such related party transaction without approval or omnibus approval by the audit committee. Such fresh approval shall be granted only after the expiry of earlier financial year not before that period. This is advisable to have meeting of audit committee to grant fresh omnibus approval in earliest possible time of the financial year for smooth transactions.

“Financial Year”, in relation to any company or body corporate, means the period ending on the 31st day of March every year, and where it has been incorporated on or after the 1st day of January of a year, the period ending on the 31st day of March of the following year, in respect whereof financial statement of the company or body corporate is made up. [Section 2(41)]

Selling or disposing of Undertaking

According to Clause (6) of rule 6A, omnibus approval shall not be made for transactions in respect of selling or disposing of the undertaking of the company.

All transaction in respect of selling or disposing of the undertaking of the company shall not be granted omnibus approval.

Other Conditions

According to Clause (7) of Rule 6A, the audit committee may impose any other conditions as the Audit Committee may deem fit to grant the omnibus approval.

Three New Proviso

Now, the Companies Amendment Act, 2017 with effect from 7th May 2015 inserted second, third and fourth proviso as under:

“Provided further that in case of the transaction, other than transactions referred to in section 188, and where Audit Committee does not approve the transaction, it shall make its recommendations to the Board:

Provided also that in case any transaction involving an amount not exceeding one crore rupees is entered into by a director or officer of the company without obtaining the approval of the Audit Committee and it is not ratified by the Audit Committee within three months from the date of the transaction, such transaction shall be voidable at the option of the Audit Committee and if the transaction is with the related party to any director or is authorised by any other director, the director concerned shall indemnify the company against any loss incurred by it:

Provided also that the provisions of this clause shall not apply to a transaction, other than a transaction referred to in section 188, between a holding company and its wholly owned subsidiary company.”

Recommendation

As per newly inserted second proviso, the audit committee shall make its recommendation to the Board:

  • where it does not approve a transaction, or
  • in case of the transaction other than a related party transaction under Section 188.

Voidable Transaction

As per newly inserted third proviso (first part), a transaction shall be voidable at the option of an audit committee, if:

  • any amount not exceeding one crore rupees is entered into by a director or officer of the company without obtaining the approval of the Audit Committee; and
  • it is not ratified by the Audit Committee within three months from the date of the transaction.

Indemnify a loss

As per newly inserted third proviso (second part), the director concerned shall indemnify the company against any loss incurred by it, if –

  • the voidable transaction (as mentioned in the first part) is with the related party to any director; or
  • the voidable transaction (as mentioned in the first part) is authorised by any other director (other than audit committee).

Exemption in case of a wholly owned subsidiary

The provisions of clause (iv) of Section 177(4) shall not apply to a transaction, other than a transaction referred to in section 188, between a holding company and its wholly owned subsidiary company.

Transaction governed by Section 188 are –

(a) sale, purchase or supply of any goods or materials;
(b) selling or otherwise disposing of, or buying, the property of any kind;
(c) leasing of the property of any kind;
(d) availing or rendering of any services;
(e) appointment of any agent for purchase or sale of goods, materials, services or property;
(f) such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company; and
(g) underwriting the subscription of any securities or derivatives thereof, of the company.

 

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