Related party transactions (RPTs) often lead to conflicts between listed companies and their related parties. Since many Indian listed companies are promoter-driven or closely held, SEBI has consistently updated the regulatory framework governing RPTs to mitigate the risk of its misuse. The framework for related party transactions in listed entities is primarily laid out in the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR Regulations). These regulations focus on ensuring transparency, disclosure, and compliance. SEBI has taken significant steps to reinforce the regulatory framework for RPTs. one such step is SEBI Working Group Report on RPTs, published on January 27, 2020. This report noted that while companies were adhering to the letter of the law, they often violated its spirit. As a result, SEBI expanded the scope of RPT regulations to include transactions with unrelated parties if such transactions have the "purpose and effect" of benefiting a related party. In addition to that, recent enforcement actions involving Linde India Limited (LIL) and Reliance Home Finance Limited (RHFL) prove that SEBI is moving towards stricter enforcement of the related party transactions framework. The regulator now focuses on examining the purpose and effect of transactions carried out by listed companies and their subsidiaries to determine compliance with related party transactions regulations.
In the case of RHFL, SEBI issued a detailed order on August 22, 2024, penalizing 27 companies. RHFL, a non-banking financial company (NBFC), had transferred significant funds to borrowers with weak financials and little or no cash flow, bypassing standard due diligence procedures. SEBI alleged that these actions were part of a deliberate scheme created by RHFL's promoters and key management personnel to provide funds to entities connected to the promoters. RHFL argued that these loans were given in the ordinary course of business, at arm's length, and therefore did not constitute related party transactions. However, SEBI found that these transactions were part of a coordinated effort to benefit related entities at the expense of public shareholders. SEBI's investigation revealed connections between RHFL and the borrowing entities through common directorships, addresses, and cross-holdings. RHFL also claimed that SEBI lacked jurisdiction to act, as the company was regulated by the National Housing Bank and the Reserve Bank of India. SEBI refuted this, asserting its authority over RHFL as a listed company. SEBI concluded that RHFL had violated the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Markets) Regulations, 2003, by misleading investors about the diversion of funds, which also breached the LODR Regulations due to inadequate disclosures.
SEBI passed an order on Linde India Limited on July 24, 2024, relating to agreements between LIL, a listed company, and Praxair India Private Limited (PIPL), an unlisted company, following the global merger of Linde AG and Praxair Inc. These agreements involved commercial transactions and a joint venture/shareholder agreement detailing business allocation. Investors raised concerns that these agreements constituted related party transactions that were not in the best interest of public shareholders. LIL contended that shareholder approval was unnecessary because the transactions did not meet the materiality threshold of 10% of turnover, as required under Regulation 23 of the LODR Regulations. LIL further argued that only transactions executed under a "common contract" should be aggregated when calculating the materiality threshold. SEBI disagreed, ruling that all RPTs with a related party must be aggregated for assessing materiality, regardless of whether they were under different contracts. SEBI also rejected LIL’s argument that allocating business opportunities did not constitute an related party transactions, noting that future business allocation is effectively a transfer of assets and should be subject to the same scrutiny. Furthermore, SEBI found that the board had approved the allocation without obtaining a valuation report or assessing the potential financial impact on public shareholders.
In the RHFL case, SEBI took into account the circumvention of due diligence, involvement of connected entities, and lack of disclosure as evidence of a scheme to defraud investors. In the Linde case, SEBI criticized LIL’s board for proceeding with the RPT after receiving legal opinions that shareholder approval was unnecessary, despite shareholders having initially rejected the transaction.
SEBI’s recent enforcement orders underscore the importance of transparency and robust governance in managing RPTs. Companies should consider the financial impact of all obligations when determining whether related party transactions compliance is required. Apart from that, independent valuations should be conducted when appropriate. Furthermore, agreements that involve the relinquishment of rights or business opportunities to related parties should be carefully assessed. It is no longer sufficient to follow the formal requirements of the law; companies must also consider the substance and potential consequences of their actions. Boards are expected to act with prudence and care, ensuring that public shareholders’ interests are not adversely affected by RPTs.
SEBI's evolving approach to regulating related party transactions indicates that higher standards of governance are now the norm. The regulator has shown that it will enforce stringent compliance measures to protect public shareholders. Hence, the companies must adopt a forward-thinking approach to governance. The companies must carefully balance the interests of the business with those of public shareholders to ensure long-term success and compliance.