This content is from: Local Insights

To be or not be... interested?

Group holding structures and family business do result in related party transactions (RPT). A lot has been written as to how RPT can and do short change minority shareholders and even creditors. The Securities and Exchange Board of India (Sebi) has consistently been in favour of establishing a voting system where a majority of disinterested shareholders vote for RPT at shareholders meetings.

Sebi in its Board meeting held on February 7 2011 has decided to recommend to the Ministry of Corporate Affairs (MCA) to suitably amend Clause 166 of the Companies Bill, 2009 (Companies Bill) to disallow interested shareholders from voting on the special resolution of the prescribed RPT. Sebi is of the view that this will protect small and diversified shareholders in companies from abusive RPT. While apparently, Sebi possesses the power to regulate listed companies; this recommendation to the MCA presents an intention to extend Sebi's vision to even unlisted companies.

The present (Indian) Companies Act, 1956 (Companies Act) requires directors of a company to disclose their interest and prohibits interested directors from participating or voting in the Board meetings. It must be kept in mind that by virtue of share qualification, a director can also be a direct or indirect shareholder and under present regime he is not precluded from voting in the general meeting.

The Companies Act makes any restriction over the voting rights of the shareholders other than those provided under the Companies Act, void. It appears that Sebi's perspective on the recommendation is to prevent short changing through RPT. On the same note, internationally, the OECD has also shown its concern over RPT and recommended only disinterested shareholders to vote on it.

The Indian corporate regime has not really been pro-minority shareholders though the law appears to be so. Protection of minority shareholder interest has been the underlying principle behind most corporate governance initiatives. The current recommendation also seems to be motivated from securing the interest of the minority shareholders in addition to their recourse of approaching the judiciary under oppression and mismanagement.

Sebi's recommendation should be examined in conjunction with the amendment to Securities Contracts (Regulation) Rules, 1957 (SCRR) which has increased the non-promoter minimum shareholding to 25% in a listed company. Even though this doesn't eliminate the risk of RPT, but it does help in broadening the non-interested shareholder base of a company.

However this might also will give rise to a ironic situation where a competitor holding even as low as 5-10% of voting rights of a listed company might be able to influence the decision making of the company if, for instance, the promoter and other related party hold 75% of voting rights in the company (which implies that by virtue of being 'interested' they are precluded from voting).

While we appreciate the need to prevent abusive RPTs and create a level playing field for all stakeholders, the fundamental democratic decision making process within corporates cannot be sidelined.

Runa Ghosh and Arunabh Choudhary

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