There has been a lot of noise around related party transactions — as recent as Tuesday when differences between the promoters of IndiGo, India's biggest airline, escalated into a full-blown corporate battle — and how a bigger exposure to related parties is a sign of bad corporate governance. But is that always the case? Not really. As long as such transactions are done at arm’s length, they should be treated as any other transactions.

What is a related party transaction?

Entities frequently carry part of their business activities through subsidiaries, joint ventures and associates. So, any financial/operational relationship can be termed as a related party transaction.

As per law, the following are the related parties to any entity (subject to further conditions):

A person or a close member of that person’s family related to the reporting entity.

An entity related to the reporting entity.

Close members of the family of a person are those family members who may be expected to influence or be influenced by that person in their dealings with the entity.

Any transaction between a company and its related party is called a related party transaction:

Sale, purchase or supply of any goods or materials.

Selling or otherwise disposing of, or buying a property of any kind.

Leasing of property of any kind.

Availing or rendering of any services.

Appointment of any agent for purchase or sale of goods, materials, services or property.

Such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company.

Underwriting the subscription of any securities or derivatives thereof, of the company.

Need for related party disclosure?

Of course, in such circumstances, the entity does have the ability to influence the financial and operating policies of such subsidiaries/JVs/associates as they have some controlling stake.

A related party relationship could have an effect on the profit or loss and financial position of a company. Related parties may enter into transactions that unrelated parties would not. For example, an entity that sells goods to its parent at a cost may not sell goods on the same terms to another customer, meaning the transaction amount between related parties may differ from those of unrelated parties for the same deal. This requires knowledge of an entity’s transactions, outstanding balances; also includes commitments and relationships with related parties. The profit or loss and financial position of an entity may be affected by a related party relationship even if related party transactions do not occur. The mere existence of the relationship may be sufficient to affect the transactions of the entity with other parties.

Are related party transactions banned?

Not really, as long as they are done on arms’ length basis. They are regulated by certain conditions as provided in Section 188 of the Companies’ Act, by the means of which they can be disclosed to the board and shareholders for them to ratify. Prior approval from the Audit Committee is to be obtained. If the transactions fall within the meaning of Section 188, then these need to be disclosed in the board report for prior approval. A justification is required to be given in support of the transactions. If the transactions are beyond the threshold limits given below, then they need to be disclosed in the General Meeting for approval by special resolution.

Arm’s length transactions?

An arm's length transaction is a business deal in which the buyers and sellers act independently and do not have any relationship to each other. The concept of an arm's length transaction assures that both parties in the deal are acting in their own self-interest and are not subject to any pressure or duress from the other party.

In the case of Interglobe Aviation, the allegations are that related party transactions are not done at arms’ length basis, however, EY study has cleared related party transaction allegations barring some procedural irregularities.

First Published:Jul 10, 2019 12:18 PM IST