Protection Of Minority Shareholders And Related Party Transactions

Update: 2023-02-16 06:17 GMT
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The Company is an artificial entity incorporated under the Companies Act, 2013[1] (hereinafter, ‘Company Act’), and conducts its affairs through its board of directors who owe a duty to take care towards all the stakeholders of the company and to conduct the affairs of the company in a neutral and unbiased manner. Shareholders of a Company can be in broad terms divided into...

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The Company is an artificial entity incorporated under the Companies Act, 2013[1] (hereinafter, ‘Company Act’), and conducts its affairs through its board of directors who owe a duty to take care towards all the stakeholders of the company and to conduct the affairs of the company in a neutral and unbiased manner. Shareholders of a Company can be in broad terms divided into majority shareholders and minority shareholders. Majority shareholders are those who have more than 51% or more voting rights and shares in the Company; minority shareholders would mean having less than 50% voting rights and shares in the company.

The General norm is that the will of the majority shall prevail in the Company; however, in certain cases, the consent of the minority shareholders required for approval of a resolution as the majority shareholders due to some conflict are precluded from voting such resolutions. Both the Companies Act and the SEBI guidelines contain several provisions that empower and protect the minority shareholders from any kind of oppression and mismanagement by the majority shareholders and seek to ensure fair play and protection of the minority shareholders in the company.

Legal Provisions On Protection Of Minority Shareholders – Laws And Cases

Chapter 16 of the Companies Act provides for prevention of oppression and mismanagement within the Company whereunder any eligible shareholder can approach NCLT under section 241/242 seeking redressal of his grievances if the activities of the Company are being carried detrimental to the public interest or interest of the Company or in any manner which is prejudicial to their interest. Under section 242, the NCLT can grant several reliefs to the applicant such as modification of the agreement, removal of a director, setting aside any purchase or sale of goods, service etc. Further, the minority shareholders also have several rights such as the right to be heard at AGM and other meetings, legal right to institute class-action suit against the Company under section 245 of the company Act, appointment of directors under section 163 through the principle of proportional representations etc.

The concept of protection of minority shareholders viz-a-viz majority shareholders can be traced to the famous case of Foss V. Harbottle[2] wherein it was held that rule of the majority shall prevail in the Company, but it is not an absolute rule. In certain instances the minority shareholders can approach the courts, such as when the acts committed by the Company is ultra vires or illegal or where there is breach of fiduciary duties or in case of oppression and mismanagement in the Company, irregularities in the Company such as notice of resolution not given to minority shareholders etc.

The SEBI, established under the Securities and Exchange Board of India Act, 1992[3], has in order to protect the rights of the minority shareholders and to promote transparency, accountability and healthy corporate governance has enacted several rules and regulations such as SEBI (Takeover Code), 2011, SEBI (Listing Obligation and Disclosers Requirements), SEBI (Buy-back of Securities) Regulations 2018, SEBI (Delisting of equity shares) Regulations, 2021 etc. for example, under the SEBI (LODR), the companies are statutorily required to constitute risk management committees and stakeholder relationship committees and to periodically disclose shareholding patterns and material events. Similarly, under the SEBI (ICDR) Regulations, 2018, the Company willing to offer further public offers, preferential issue, rights issue, bonus issue has to follow the ICDR guidelines and regulates anchor investments, disclosures of risk factors, financial information of the issuer, material and legal developments, details about the board of directors and management, promoters’ contribution and lock-in period etc. Apart from this regulation, as per the Clause 49 has several provisions relating to composition of Audit committee, Board requirements and limitations, provisions relating to subsidiary company such as reporting of significant transactions to the holding company etc.

Similarly, under the SEBI Takeover Code the target company has to at regular intervals at reach the required threshold public disclosures, and SEBI is also empowered to appoint investigating officers either suo moto or on a complaint that the Company is indulging in any practices which are in violation of the takeover code. Similarly, the SEBI and the Companies Act also requires every Company to mandatorily have independent directors on its board and have to constitute various committees such as audit committee, nomination and remuneration committee to oversee the affairs of the Company. Notably, the then chairman of SEBI has stated that the rights of the minority shareholders in India are even stronger than the rights of minority shareholders in the USA[4] and the World Bank's Doing Business 2020 report has ranked India at the 13th position in terms of protection granted to minority shareholders[5].

Thus, the Companies Act and SEBI seek to balance the interest of both the majority and minority shareholders, and in some cases, the consent of the minority shareholders is mandatory and without their consent, the transactions cannot take place one such example is concept of Related Party Transactions (hereinafter, 'RPT').

Provisions Relating To Related Party Transactions

Mainly there are three main sections under the Company Act which deal with RPTs: Section 2 (76) & (77), Section 188 and Section 189. These three sections have to be read in conjunction with the Companies (Meetings of Board and its Powers) Rules, 2014 and the Companies (Specification of definitions details) Rules, 2014.

Section 2 (76) of the Companies Act defines the term related party as the director, key managerial personnel or any of their relatives of the Company. A firm or private Company or public Company or any other body corporate or a person where the director or manager of the Company is having a stack by way of directorship or more than 2% equity in case of a private company or any person or body corporate accustomed to act of the directions of the director also come within the definition of a related party. Section 2(77) of the Act defines a relative as concerning any person means and includes members of HUF, husband and wife and such other manner as may be prescribed. The Companies (Specification of definitions details) Rules, 2014 lays down further relations that would be included within the definition of a related party, which includes father, mother, son, sister, brother and also includes any step related to the same.

Section 188 of the Act states that the Company shall not indulge in RPT except with the consent of the board of directors at a board meeting, and if allowed by the board, it shall be subject to such terms as the board may decide. Section 188 further states the categories wherein related party transactions is permissible with the approval of the board, which means and includes leasing of property, sale or purchase of goods or availing any services, underwriting of shares, appointment at any post of office of profit in the Company or its subsidiary, associate. Every such contract or arrangement has to be mentioned in the board report along with justifying the reason for such contract or arrangement. Proviso to section 188(1) states two exceptions to section 188(1) first exception is that any transactions entered by the Company in the ordinary course of business and which are at Arm's length shall not require approval of the board, the second exception in regard with transactions entered between holding and subsidiary company where the accounts are consolidated and approved by the shareholder at the general meeting of the Company. The word 'ordinary course of business’ has not defined under the Companies Act, but one can find the definition of the same under Company Secretary Guidance Note[6], wherein it has defined to mean and include activities that fall within the MOA/AOA of the Company, activities or transactions which are ordinary and routine in the business of the company or industry standards.

Whether the Act is in ordinary course of business or not is a question of fact, elucidating the same the Hon'ble Bombay High Court in Biswan Sugar Factory V. Commissioner of Income Tax[7] has held that merely because the Act of the Company is within the MOA/AOA of the Company would not by itself mean that the activity was in ordinary course of business of the Company. Similarly, in order to determine whether the transaction is at 'arm's length' or not, the Hon'ble Income Tax Appellate Tribunal in Iljin Automotive Private Ltd V. Commissioner of Income Tax[8] has laid down the test for the same and held that "...the determination of 'arm's length price' seeks an answer to the question – What would have been the price if the transactions were between two unrelated parties, similarly placed as the related parties in so far as nature of the product, and terms and conditions of the transactions are concerned..'

Section 188 defines Arm's length transaction as any transaction between related parties as if they are not related to each other, and there is no conflict of interest. Section 188(4) read with section 188(5) states that if any related party transactions are entered by the Company without the approval of the board or the shareholders as the case may be, then in such a case, the transactions shall be voidable at the option of the board, and the director or employee who has caused such transaction to take place and caused any loss to the Company shall indemnify the Company for the loss. Further, section 188(5) also makes such unapproved related party transactions illegal both when is done by an individual and by any other company, in case it is done by an individual an imprisonment up to one year along with fine which can extend up to 5 lakhs be imposed on the same. Section 189 states that the Company shall a register of every contract or arrangement entered into section 188 and which shall be signed by all the directors of the Company and which would be accessible during the annual general meeting of the Company. Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014 states that the related party transactions have to be approved by the board of directors or by the special resolution of the shareholders as the case may be if the prescribed threshold is triggered.

Apart from the provisions under the Company Act, SEBI has also enacted several rules for protection of minority shareholders and to bring transparency such as Clause 49 of the listing agreement also mandates that the audit committee shall review the RPTs and review the statement on significant RPTs submitted by the management of the Company, further it also mandates that the transactions made in the ordinary course of business shall be disclosed to the audit committee and significantly related party transactions have also to be disclosed under the heading of the report of corporate governance which forms a part of the annual report of the Company. Similarly, Regulation 23 of the SEBI (LODR) Regulations states that all related party transactions will require approval of the audit committee, and every listed Company has to enact a policy on materiality concerning related party transactions, further, such transactions also have to be disclosed to the stock exchange and website of the Company. Due to different provisions under both the Companies Act and SEBI (LODR) Regulations in some instances, there are chances of overlapping for example, under the LODR, shareholder's approval is required if the turnover of the transactions exceed 10% of the turnover, so a reading of the Companies Act read with the LODR would mean that even if approval in certain transactions are exempted from companies act the permission for the same would have to be sought under the LODR for example, there is no need of approval if the transactions is made in ordinary course and at Arm's length but no such exemptions are available under the SEBI LODR. Similarly the Companies Act, 2013 prohibits all the interested parties from voting, but SEBI LODR prohibits all the related parties from voting.

Section 188 of the Act read with the Company Meeting Rules, 2014 states that the approval of the shareholder is required if certain threshold is triggered and no member who is related to the party shall vote in any resolution of the Company, this sometime results in situation where the approval of the minority shareholders becomes very crucial for the approval of the RPTs such as in case where the related party is relative of the promoter/director of the Company having majority shareholding in the Company for example in India many companies are family-owned and most of the directors of the family come from the same family in such cases the role of the minority shareholders becomes very crucial for approval of the related party transaction for example a study in the year 2007 found that that in over 100 listed companies on the BSE the share of the promoters in these companies is over 48%, further the study also found that in BSE top 500 companies showed a similar trend with over 49% shares of the companies being owned by the promoters[9]. Considering the same, recently by the Company (Amendment) Act, 2017[10], the Central Government has made an exception under Section 188(1), stating that where the more than 90% shares of the Company are owned by promoters of their relatives, then in that case even related party can also vote in resolutions relating to related party transactions.

Both the SEBI and the Company Act contains several provisions so as to balance of interest of both majority and minority shareholders and to ensure that there is transparency, accountability and good corporate governance in the Company. While it is the norm that the rule of the majority shall prevail in the Company, there are certain exemptions to this general norm, one of which concerns the approval or disapproval of RPTs. In order to avoid conflict of interest in the Company and there is no favouritism or partisan Act by the related parties, section 188 of the Companies Act have debarred from voting from such RPTs, and even the related party cannot be present in such meeting where the RPTs is being discussed.

The author is an Advocate, views are personal.

[1]The Companies Act, 2013 (Act No. 18 of 2013)

[2](1843) 2 Hare 461

[3]The Securities and Exchange Board of India Act, 1992 (Act No. 15 of 1992)

[4]SEBI, ‘India’s minority shareholders have stronger rights than in the US’, Hindustan Times (June 3, 2016) Available at https://www.hindustantimes.com/business/india-s-minority-shareholders-have-stronger-rights-than-in-the-us-sebi/story-58Q4NTwwGNgBX6kTgNcraI.html (last visited on 08th February, 2023)

[5]Press Trust of India, ‘India's score on protecting minority investors has slipped, need to sharpen focus: Finance Minister official’, Nov 24, 2020, available at https://timesofindia.indiatimes.com/business/india-business/indias-score-on-protecting-minority-investors-has-slipped-need-to-sharpen-focus-finance-ministry-official/articleshow/79390869.cms (Last visited on 13th February, 2023)

[6]Company Secretary Guidance Note on Board Meetings, available at https://www.icsi.edu/media/webmodules/GN_on_Meetings_of_BOD_3122020.pdf (last visited on 28th February, 2022)

[7]AIR 1950 Bom 200

[8](2011) 16 Taxmann.Com 225

[9]Shaun Mathew, Hostile Takeovers in India: New Prospects, Challenges, and Regulatory Opportunities, 3 COLUM. BUS. L. REV. 800, 833 (2007).

[10]Company (Amendment) Act, 2017, Act No. 1 of 2018, Ministry of Corporate Affairs, Government of India


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