source Business Standard
Companies Act likely to jolt realty firms
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RAGHAVENDRA KAMATH
Mumbai,
20 April
The
recently- enacted Companies Act, 2013, is expected to give a jolt to real
estate companies, already facing a severe fund crunch due to falling sales
and high debt on books.
Section
185 of the Act, among other things, says a company cannot give loans to (or
provide security on a loan taken by) a person in whom its director is
interested.
According
to the Act, “ any person in whom a director is interested” could mean a
director of a lending company or its holding firm, or a partner or relative
of any such director, or a firm in which any such director or relative is a
partner, or a private company of which any such director is a director or
member.
Sai
Venkateshwaran, partner &head ( accounting advisory services) at KPMG in
India, says promoter directors of several real estate companies could
potentially be covered under this law, as many of them are directors of both
parent and subsidiary companies. “ It could become a liquidity issue for many
realty companies. Earlier, funds raised by one company could be freely
transferred to another group firm where there was need for liquidity. With
the new rules, companies’ ability to balance liquidity needs across group
entities gets restricted,” Venkateshwaran explains.
Though
the corporate affairs ministry has clarified that a company can lend to its
fully- owned subsidiaries, Venkateshwaran doubts this will apply on realty
firms.
That’s
because many real estate companies only partly own their subsidiaries —
project partners, including land owners, private equity contributors and
other investors bringing in capital, too, are owners.
Turn
to Page 7 >
Move
to improve transparency but make liquidity more difficult to come by TOUGH
TIMES AHEAD
Some
Companies Act clauses that might pose a challenge for realty developers
CLAUSE:
No related- party transactions IMPACT: Realty developers have to capitalise
each project company and can’t take surplus money out CLAUSE: Secure
debentures with properties or assets with equivalent value IMPACT: Developers
need to find enough assets or properties to secure debentures CLAUSE: If
convertible preference shares are issued, value of that must be determined
beforehand and taken as total capital of the company IMPACT: Risk of losing
majority ownership of a company to NBFCs of PE funds CLAUSE: A company is
treated as listed if any of its securities is listed on the exchanges IMPACT:
Unlisted companies might have to adhere to conditions meant for listed
entities
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Companies Act likely to jolt realty firms
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ASK Investment Holdings Managing Director Sunil Rohokale suggests related- party transactions were earlier used as a way to siphon off funds, since developers floated different special- purpose vehicles for different companies.
“There
used to be a free flow of funds from holding companies to subsidiaries. The
changes in the Companies Act will ensure each project will be capitalised
sufficiently and surplus cash will not be given to directors or taken out of
a company,” he says.
JC
Sharma, vice- chairman of realty company Sobha Developers, says it might
affect some developers in the short term but will bring strength to investors
and buyers over a longer period.
Consultants,
however, say the clause that asks for issue of debentures to be secured
through creation of a charge on properties or assets of a company, with value
sufficient for payment of debentures and interests thereon, could also pose a
challenge to real estate companies.
Typically,
in real estate, land and properties are given as charge to banks, and
debentures are secured with future receivables that are not shown on the
company’s balance sheet.
“If
you are issuing secured debentures to non- banking financial companies, the
Act requires it to be secured against properties or assets with value
equivalent to that of debentures,” says Venkateshwaran, adding raising funds
from NBFCs through debentures might become difficult now, as such financiers
might not invest through unsecured debentures.
ASK’s
believes the government needs to clarify on the clause. “ The Act says you
have to secure debentures with identifiable securities. But, many a time,
that is not possible if you are giving a pool of securities to multiple
lenders. It will be a burdensome exercise for realty companies,” he says.
For
instance, developers sometimes give land as security to a bank and create
secondary charge or ‘ pari passu’ on the same asset if they are to take a
second loan from another bank. “ In such cases, it will become a challenge
for developers,” Rohokale adds.
Real
estate companies, which normally allot convertible shares to NBFCs or PE
funds on a preferential basis, will also face a challenge in doing so. The
Act says if shares are offered on a preferential basis with an option to
apply for and get equity shares allotted, the price of the resultant shares
will be determined beforehand. This will make use of convertible preference
shares challenging, as the conversion price is usually linked to the expected
return at the time of conversion ( and not based on a price determined at the
time of issue).
The
Act also considers convertible preference shares as part of total share
capital in determining the holding- subsidiary relationships. This, experts
say, will make an NBFC or a fund parent in a project where the borrowing
company has a small equity capital base. For instance, if a company has ₹
10 crore worth of equity share capital and issues convertible shares of ₹
50 crore to an NBFC on a preferential basis, the company will be considered a
subsidiary of the NBFC or fund, and not a company with 100 per cent equity
shares.
“NBFCs
will find out new avenues to deploy their funds but it is more of a challenge
for realty firms,” Venkateshwaran says. However, Sobha’s Sharma says this
clause will improve debt- equity ratios of realty companies. “ It will lead
to a higher equity base and improve our ability to raise more money through
debt,” he adds.
More
importantly, the Companies Act also says that a company will be considered a
“listed company” if any of its securities is listed on stock exchanges,
against the earlier practice of treating one as a listed company if its
equity shares are listed. “ Even if your debentures are listed, clauses
relating to a listed company will kick in and you have to live as a listed
company, despite you being privately owned,” says Venkateshwaran. ASK’s
Rohokale says the Act aims to bring in a new level of governance.
“Earlier,
many unlisted companies did things in a hush- hush way. Now, everybody has to
fall in line and be ready to be governed.”
>FROM
PAGE 1
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Related- party deals tie firms in knots
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SUDIPTO DEY & ISHITA AYAN DUTT
The
market watchdog, Securities and Exchange Board of India (Sebi) seems to have
put the cat among the pigeons when it refreshed its corporate governance code
for listed companies, in line with provisions of the new Companies Act. In
certain aspects some of Sebi’s requirements are more onerous than the
Companies Act. This includes those relating to tenure of independent
directors and number of directorship, constitution of audit committee, and
the scope of related party transactions. However, it is the last one —
related party transactions — that has caught the corporate sector in a bind.
According
to provisions in the Companies Act 2013, shareholders’ approval is required
for those relatedparty transactions where the board recommends so in case of
transactions that are not in ordinary course of business or at arm’s length.
However,
Sebi’s definition of related party transaction is much wider.
The
market regulator mandates all listed companies to lay down a policy for
material related party transactions and manner of dealing with such related
parties. Shareholders’ approval is required for all material related party
transactions. Additionally, the definition of related party also includes
close family members of directors, private companies in which directors or
key managerial personnel along their relatives have control, joint control or
significant influence as related parties.
This
has queered the pitch for most companies, especially those that regularly
transact business among subsidiary companies. “ The Sebi norms widen an
already broad definition of related party transactions.
This
would result in increased cost of compliance,” says Jamil Khatri, global
head, accounting advisory services, KPMG. Corporate law experts point out
that the new corporate governance norms increases the say of minority
shareholders while voting for such transactions, as interested parties have
to abstain from such voting. Ankit Miglani, deputy managing director, Uttam
Galva Steels points out that approval from minority shareholders for related
party transactions will have an impact on business decisionmaking. “ It will
slow us down,” he says.
The
concern now is that for businesses operating through multiple entity
structure and that need to enter into frequent material transactions with
each other, the control of the entities effectively may transfer from
majority to minority, says Yogesh Sharma, partner, Grant Thornton India LLP,
an assurance, tax and advisory firm.
Many
believe that this may defeat the objective behind the stringent conditions
that guide RPT approvals which is to give protection to the interests of
minority shareholders. “ Some companies especially with low minority
interests may prefer to weed out minority shareholders altogether and take
100- per cent control of their subsidiaries,” says Sharma. Legal experts
point out there is no requirement in the United States for shareholder
approval of RPTs as in India.
However,
market regulators remain wary of RPTs as there are several instances of high-
profile accounting frauds in recent years ( that includes Enron in the United
States and Satyam Computers in India) that have involved related party
transactions in one way or the other.
NVenkatram,
managing partner —audit, Deloitte Haskins & Sells LLP, points out that
the effectiveness of such legislation is dependent to a large degree on the
quality of enforcement. “ The monitoring and inspection capabilities of both
MCA and Sebi would need to be substantially strengthened in order to ensure
that the legislation is complied with,” says Venkatram.
Shriram
Subramanian, founder and managing director, InGovern Research Services, an
independent proxy advisory firm, agrees that though the listing agreement is
more stringent than the Companies Act 2013, it is a much needed. India does
not meet the global best practices in many of the provisions of the corporate
governance code, he says.
“The
separation of the role of chairman and MD is still a nonmandatory one. Also,
once an independent director completes two terms of five years each, they
should not be eligible to again join the board after the cooling off period
of three years. All members of the audit committee should be independent
directors,” he says. Proxy advisory firms point out tht Indian stock
exchanges need better tools for monitoring and surveillance of non-
transaction related data and announcements by companies. “The cost of non-
compliance should be higher,” adds Subramanian. The fines imposed should
enhance Sebi’s coffers and this money should be used to it increase its manpower
and other capabilities. Rana Som, former CMD of NMDC, and currently a
director in several companies, feels that Sebi guidelines will go a long way
in promoting corporate governance norms in India. “ It’s a balanced
approach,” he says. For now India Inc, seems to have its hands full while
dealing with RPTs.
Market
regulators remain wary of RPTs as there are several instances of high-
profile accounting frauds in recent years Sebi norms
[1]Maximum
numberof boards a person can serve as independent director ( ID) restricted
to seven and three in case the person is serving as awhole- time director in
any listed company [1]Maximum
tenure of an ID capped at 10 years. However, if a person has already served
as an ID for5 years or more on 1 October 2014, ID will be eligible for
appointment for a term of 5 years only [1]Two- thirds of the
members of audit committee shall be independent directors. The chairman of
the audit committee to be an independent director
[1]Approval
of all material
RPTs
by shareholders through special resolution with related parties abstaining
from voting [1]Related
parties includes additional relationships such as person thathas a joint
control or significant influence on the company, and fellow joint ventures
and associates [1]Boards
of companies to satisfy themselves that plans are in place for orderly
succession for appointments to the Board and senior management Companies
Act 2013
[1]Maximum
numberof directorships is capped at twenty, of which not more than ten can be
public companies. However, no specific limit is prescribed for IDs [1]The
overall term of an ID is 10 years, except that under the 2013 Act, these
requirements are applied prospectively [1]Audit committee to
be formed with majority being independent directors. No specific requirement
for chairman to be independent director [1]The Act requires
preapproval of related party transactions which are not in the ordinary
course of business or are not at arm’s length by a special resolution.
Related parties have to abstain from voting [1]Related party
covers those relationships which are defined in section 2( 76) [1]No
specific requirement Impact
[1]The
problem of sourcing the right ID on boards will be accentuated for listed
companies given the limits [1]ID’s
of listed companies will need to discontinue their board positions earlier
than whatwas contemplated under the Companies Act [1]The Sebi norms seek
to provide for greater independence for the audit committee [1]This
may result in practical difficulties particularly for transactions with
subsidiaries [1]The
Sebi norms require abroader set of parties to be identified as related
parties [1]Companies
have to put succession planning firmly on their agenda CORPORATE
GOVERNANCE SEBI SCORES OVER COMPANY LAW
Compiled
by KPMG India
Sebi’s
corporate governance code and the new company law regime have some clauses
that have many Indian companies in a bind
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FAQs:
Related Party Transactions - Expert Take
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PANKAJ CHADHA
Are
requirements of the Companies Act, accounting standard and Sebi norms with
respect to related party aligned?
No,
these requirements are not aligned.
Companies
Act 2013 requires disclosure at the time of entering into contract or
arrangement whereas accounting standard requires disclosure at the time of
entering into a transaction Clause 49 adds new class of related parties to
the definition thereof given under the Act and includes close family members,
fellow group entities, joint ventures of same third party and combinations
thereof, which are not in accounting standard or the Companies Act.
Revised
clause 49 requires shareholders’ approval for all material related party
transaction with no exception for transactions in ordinary course of business
or at armslength.
Definition
of material transactions differs.
In
case of deviation, as a thumb rule, provision of the stricter of the
applicable regulations shall be followed.
A
corporate group has several foreign subsidiaries.
Will
provisions in relation to related parties apply to foreign companies as well?
The
term ‘ company’, as defined under the Companies Act 2013, is a company
incorporated under this Act or any previous company law. Company incorporated
under the relevant legislation of a foreign country is not a ‘ company’ under
Companies Act 2013. However, transactions by Indian company with a foreign
company, which is a subsidiary, associate, fellow subsidiary, joint venture
of the same venturer or company under control of same promoter, would be covered,
based on understanding of combined reading of revised clause 49 and Companies
Act 2013.
In
case of Companies Act, is the board required to approve all related party
transactions?
The
Companies Act 2013 prescribes that a company needs approval of the audit
committee on all related party transactions and subsequent modifications
thereto. This is irrespective of whether they are in the ordinary course of
business and consummated at arms length price or they are below prescribed
thresholds.
Further,
for listed companies, clause 49 prescribes audit committee approval for all
related party transactions and shareholders approval of all material RPTs.
For
normal transactions, if company has a well laid down policy framework which
explicitly lays down terms of contract/ transaction and which are approved by
audit committee then a separate approval will be unwarranted for each such
transaction.
However,
any modification/ transaction, which was not contemplated in the framework
and approved by the audit committee in its initial approval, would require
fresh approval of the audit committee.
Legal
evaluation or a clarification from lawmakers would be necessary considering
the difficulties such an approval might impose.
What
assessment is required of the existing RPTs, if any?
All
companies are required to comply with requirements in relation with RPTs,
prospectively from the date of applicability of underlying regulation.
Any
default will be regarded as non- compliance and may attract penal provisions
under the Companies Act 2013.
The
following actions are recommended to avoid any risk of default: [1]Companies
should carefully review its related parties under the regulations and
identify all existing and new related parties together with all existing and
new contracts, arrangements and transactions, etc. Amongst other matters, the
manner of dealings shall cover aspects relating to the determination of key
terms including arm’s length price.
[1]An
immediate dialogue needs to be initiated with the audit committee to assess
and confirm their expectations from the policy and review/ approval
protocols. A careful evaluation of existing and proposed RPTs is not
unwarranted.
[1]Companies
shall develop process and methodology and make necessary changes in systems
and procedures adapting to the new set of regulations.
(The
author is Partner in the member firm of Ernst & Young Global ) For the
full version visit www. business- standard. com
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