Wednesday, January 6, 2016

Omnibus Approval of Related Party Transactions and Threshold for Fraud Reporting by Auditors

[The following guest post is contributed by Amitabh Robin Singh, who is an Associate at DSK Legal]

With the notification bringing Sections 13 and 14 of the Companies (Amendment) Act, 2015 (“Amendment Act”) into force being published in the official gazette on December 15, 2015, we now have new provisions on the omnibus approval of related party transactions by companies. On a separate note, a threshold has been set for frauds discovered by the auditors of a company which are required to be reported to the Central Government.

The Amendment Act was originally brought into force with effect from May 29, 2015 but Sections 13 and 14 were held back so rules could be framed for the matters contemplated by them (as mentioned above).

Section 14 of the Amendment Act amends Section 177 of the Companies Act, 2013 (“Act”) to provide for prescribing rules to specify the manner of omnibus approval of related party transactions by the audit committee of a company. For the same purpose, the Companies (Meeting of Board and its Powers) Second Amendment Rules, 2015 (“MBP Amendment Rules”) were notified on December 15, 2015. The provisions inserted by this amendment effectively bring the Act in line with Regulation 23 of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015.

The MBP Amendment Rules added a new Rule 6A to the Companies (Meeting of Board and its Powers) Rules, 2014 (“MBP Rules”).

The MBP Amendment Rules state that all related party transactions are to be approved by the audit committee of the company (an audit committee is required to be constituted by all public companies with a paid-up share capital of Rs. 10 crores or more, all public companies with turnover of Rs. 100 crores or more and all public companies with aggregate outstanding loans or borrowings or debentures or deposits of more than Rs. 50 crores).

The new rule 6A sanctions omnibus approval by the audit committee subject to certain conditions such as specification of the criteria for the omnibus approval which will include the maximum value of transactions which can be made under the omnibus approval in a year. Also, the maximum value of a single transaction under the umbrella omnibus approval is to be laid down. The transactions which are entered into under such omnibus approval will be required to be reviewed by the audit committee at certain intervals as decided at the discretion of the audit committee.

The audit committee is also required to specify which kind of transactions cannot be subject to the omnibus approval granted by it. For example, it can be specified that transactions with a particular entity will not be covered under the omnibus approval despite it being below the annual limits and the sub-set of the per transaction threshold. Further the audit committee is mandated to satisfy itself that omnibus approval for repetitive transactions (for example periodical purchase of goods or raw material from a related party) is in the interest of the company.

It is also required that the omnibus approval should specify the name of the parties, the nature and duration of the transactions, the maximum amount of the transactions which can be entered into and an indicative base price or the current contract price and the variation formula if the price is required to be altered.

However, there is a proviso to this providing for an exception in the case where a related party transaction is unforeseen and the details mentioned in the preceding paragraph above are not available, then the audit committee may still make omnibus approval for such transactions, but subject to a limit of Rs. 1 crore per transaction.

The MBP Amendment Rules provide that omnibus approval will only be valid until the end of the financial year in which it is granted and fresh approval will be required in the new financial year.

The MBP Amendment Rules go on to further state that no omnibus approval will be allowed in the case of selling or disposing of the undertaking of the company. There is already a similar provision requiring the passing of a special resolution at a meeting of the shareholders of the company for any such transaction (related party or otherwise) under Section 180(1)(a) of the Act. “Undertaking” is clarified to mean an undertaking in which the company has invested 20% or more of its net worth (as per the last audited balance sheet) or an undertaking which generates 20% of the total income of the company in the immediately preceding financial year. However, it must be noted that Section 180 only applies to public companies post the notification exempting private companies from certain provisions of the Act dated June 5, 2015.

The MBP Amendment Rules also change the requirement of a special resolution in the MBP Rules for certain related party transactions into an ordinary resolution which brings the rules in line with the Amendment Act which made a similar replacement in Section 188 of the Act

These amendments to the MBP Rules and notification of Section 14 of the Amendment Act appear to serve the purpose of making it simpler to do business, while there are also what seem to be sufficient safeguards to prevent abuse of this provision in manners that are detrimental to the interests of the company.

Section 13 of the Amendment Act was also brought into force by the same notification. As mentioned above this provision modifies Section 143 of the Act to prescribe a threshold for the reporting of frauds committed against the company. For this purpose the Companies (Audit and Auditors) Amendment Rules, 2015 (“Audit Amendment Rules”), were notified on December 15, 2015.

Under the earlier provisions, any fraud being committed against the company by its officers or employees was required to be reported to the Central Government. Now a threshold of Rs. 1 crore has been inserted.

If the auditor does discover a fraud of Rs. 1 crore or above, then the auditor must report the fraud to the board of directors or the audit committee of the company (as the case may be) not later than 2 days of discovery of the fraud. Then the board of directors or audit committee is required to give its reply or observations to the auditor within 45 days, which is to be forwarded to the Central Government, failing which, the auditor shall forward his own report to the central government with a note mentioning that no reply or observations were received from the board of directors or the audit committee of the company within the prescribed 45 days.

For a fraud below Rs. 1 crore, the auditor is required to report the fraud to the board of directors or the audit committee not later than 2 days of its discovery specifying the name of the fraud committed with a description of the same, the approximate involved and the parties involved in the fraud. Then, in the report of the board of directors for that financial year, the abovementioned details shall be provided along with the remedial action which was taken resultant to the fraud which was committed.

This Audit Amendment Rules will help in reducing the reporting to the Central Government for comparatively minor frauds but will keep the provisions for fraud robust as the members of the company will get to know of such relatively minor transgressions in detail in the report of the board of directors along with remedial action taken so the members can hold the board accountable for response to the fraud.

The bringing into force of these two provisions of the Amendment Act are a step forward in increasing the ease of doing business for companies while still managing to protect the shareholders and showing that the two concepts are in no way mutually exclusive.


- Amitabh Robin Singh

2 comments:

Kosha said...

very informative!!

Girish Kumar said...

Thanks for the explanation. Useful.