Monday, August 18, 2014

Guest Post - MCA amends RPT rules: Makes provisions stricter

[The following post is contributed by Vinod Kothari and Shampita Das of Vinod Kothari & Company. They can be contacted respectively at and]

The latest setback from the MCA has come by way of the amendments to the Companies (Meetings of Board and its Powers) Rules, 2014 (MBP Rules) vide its notification dated 14th August, 2014, which is yet to be gazette.[1] The key highlight of the amendment was the complete substitution of the Rule 15(3) of the MBP Rules relating to conditions for obtaining approval from members for entering into related party transactions (RPTs).

Lets’ start over!

Section 188 of the Companies Act, 2013 (Act) provides that approval of the Board would be required for entering into certain related party transactions. The first proviso to Section 188 provides that no contract or arrangement shall be entered into by a company having paid-up share capital of not less than such amount, or transactions not exceeding such sums, as may be prescribed, except with the prior approval of the company by a special resolution.

To this effect, Rule 15 (3) of the MPB Rules (prior to the amendment) had laid down dual conditions for passing of special resolution for entering into RPTs. The conditions were:

(a)        Companies having paid up capital of Rs. 10 crores or more; or

(b)       Transaction value exceeds certain prescribed limits.

This meant that fulfillment of either of the conditions (i.e. paid up capital or transaction limits) would have necessitated the approval of the RPT by way of a special resolution. Thus even if my transaction value is Re. 1, if my paid up capital exceeded Rs. 10 crores, I would have had to approach my members for passing the related party contract.

The Amendment

The amendment seeks to substitute this sub-rule (3) to Rule 15 by completely removing the paid up capital criteria of Rs. 10 crore.

Further, the transaction limits of the various related party contracts as listed under Section 188 (1) of the Act has also been reduced. The table below shows the limits of the RPTs before and after the amendment:

Sale, purchase or supply of any goods or materials, directly or through appointment of agents, as mentioned in Clause (a) and Clause (e), respectively of Section 188 (1)

Exceeding 25% of the annual turnover
Exceeding 10% of the turnover of the company or Rs. 100 crores, whichever is lower.
Selling or otherwise disposing of, or buying, property of any kind directly or through appointment of agents as mentioned in Clause (b) and Clause (e), respectively of Section 188 (1)

Exceeding 10% of the net worth of the company
Exceeding 10% of the net worth of the company or Rs. 100 crores, whichever is lower
Leasing of property of any kind as mentioned in clause (c) of Section 188 (1)
Exceeding 10% of the net worth or 10% of turnover of the company
Exceeding 10% of the net worth or 10% of turnover or Rs. 100 crores, whichever is lower.

Availing or rendering of any services directly or through appointment of agents as mentioned in Clause (d) and Clause (e) of Section 188 (1)

Exceeding 10% of the net worth of the company
Exceeding 10% of the turnover of the company or Rs. 50 crores, whichever is lower.

Further, an Explanation has been added after the above sub clauses as follows:
‘It is hereby clarified that the limits specified in sub-clauses (i) to (iv) shall apply for transaction or transactions to be entered into either individually or taken together with the previous transactions during a financial year.’

Appointment to any office or place of profit in the company, its subsidiary company or associate company as mentioned in clause (f) of Section 188 (1)

At monthly remuneration exceeding Rs. 2.5 Lakh.
At monthly remuneration exceeding Rs. 2.5 Lakh.
-       No Change
Remuneration for underwriting the subscription of any securities or derivatives thereof of the company as mentioned in clause (g) of Section 188 (1)
Exceeding 1% of the net worth of the company
Exceeding 1% of the net worth of the company.
-       No Change

Understanding its Impact

The amendment has changed the entire essence of the earlier Rule. Now, any company – big or small, public or private, irrespective of its paid up capital will be required to pass a special resolution in case the transactions being entered into with related parties come within the amended limits of Rule 15(3) of the MBP Rules.

Also, most of the contract limits have been reduced to bring more RPTs within the scanner of the members and the government. This includes putting an upper cap for transactions worth Rs. 100 crores or Rs. 50 crores to necessarily require special resolution, notwithstanding its percentage value to the networth or turnover of the company.

Further, the Explanation that has been added to the amended Rule provides that the contract limits shall apply to both individual transactions, and transactions taken together in a financial year with a related party. The question here arises is whether the same needs to be assessed for ‘all contracts with one related party’ or ‘all contracts with each related party’.

That is, suppose a company has A, B and C as related parties and it enters into sale of goods agreement with each of them. The aggregate value of the contract with A comes to Rs. 70 crore, with B to Rs. 102 crores and with C to Rs. 25 crores, in a financial year. The aggregate value of such contracts with each related party comes to Rs. 197 crores. However the threshold (i.e. Rs. 100 crores) of all contracts with one related party is breached only for B.

Here, the special resolution will be required for entering into transactions with only B, i.e. all contracts with one related party needs to be seen. This is because the Section 188 (1) uses the phrase ‘….no company shall enter into any contract or arrangement with a related party with respect to -’. Hence the merit of transactions with individual related parties needs to be seen and not the aggregate of the all such transactions.

Further, the MCA has clarified in its Circular No. 30/2014 dated 17 July 2014[2] that only the related party to such contract or arrangement will refrain from voting on the special resolution.

A Critical Take on the Amendment

With the amendment in Rules, Section 188 has become completely futile. There was absolutely no case for dropping the "large company" criteria - in fact, there was a very strong case to make the "large company" and "large contract" criteria cumulative, rather than alternative. However, the section as it now stands is counterproductive - as it will be tougher for small companies to comply with, than for large companies.

We are surprised as to how the amendment is a case of dilution of the provisions of law. The change in the Rules has exactly gone opposite to the essential philosophy of control over RPTs. It has made section 188 lighter for larger companies and harder for small companies. If you see the discussions before the Parliamentary Committee, MCA has represented there that section 188 is meant for larger companies. Now, as the situation prevails, small contracts by large companies do not need sanction; however for small companies, smaller contracts need sanction (as the limit reduced from 25% to 10%). Dichotomy between listing norms and the Act continues - as SEBI's rules still continue to define "material RPTs" differently. The implication of Section 188 as it now stands defies all logic - smaller companies, for whom every small contract will be relatively large, as they themselves have small aggregate turnover and networth, will have to run to get general meeting resolutions every now and then. Proposed exemption notification for private companies was also diluted before going to Parliament to deny complete exemption to private companies. Hence, private companies will also need to run to their general bodies to approve contracts with related parties. Worst hit will be smaller public companies, which do not have any exemption from the Rule that requires a related party to refrain from voting.

Also, as the change of Rules happened mid way during the financial year, what about those contracts which have already been signed/approved during the financial year, before the Gazette notification?

How could larger companies and smaller companies, particularly those with no public stakes at all, be painted with the same brush? Is there clarity as to the direction in which the Companies Act is moving?

This is the biggest concern that had been mentioned in Mr. Vinod Kothari’s article titled "Ten monsters of the Companies Act, 2013[3]". He had mentioned that as lawmaking moves from the domain of the Parliament to the domain of the MCA, the executive arm of the government starts doing what the Parliament of the country is supposed to do. How could such massive changes take place, completely without any deliberation or public discussion? Had it been the time-tested, globally followed Parliamentary process, this change would have required a Bill, debate in Parliament, and so on. Now, since rule making is absolutely in the clutches of the MCA, all that it needed was one simple notification, and there is such a substantive swing in substantive rights and liberties of businesses.

- Vinod Kothari & Shampita Das

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