What Are Related Party Transactions?

Corporate governance is a cornerstone of investor confidence in public companies, and Related Party Transactions (RPTs) are a key area of focus for regulators. These transactions involve the exchange of resources, services, or obligations between related entities or individuals connected to the company. While some RPTs are legitimate and beneficial, others may be used to divert resources unfairly, impacting minority shareholders. This article explains what related party transactions are, how they are regulated in India, and why they matter to investors.

A Related Party Transaction is a business deal or arrangement between two parties who are joined by a pre-existing relationship, often involving control, influence, or familial ties.

These parties could include:

• Directors or Key Managerial Personnel (KMPs)
  

• Subsidiary and holding companies
  

• Joint ventures or associates
  

• Close family members of senior executives
  

• Entities controlled by these individuals
  

Under the Companies Act, 2013 and SEBI (LODR) Regulations, the following are classified as related parties:

• Director or their relatives
  

• Key Managerial Personnel or their relatives
  

• Holding, subsidiary, or associate companies
  

• Firms in which the directors or managers are partners
  

• Companies with common directors or promoters
  

• Any person or entity with significant influence over the company

Many corporate governance scandals in India and globally have involved RPTs:

• IL&FS: Controversial transactions between group entities without proper disclosure
  

• Satyam: Inflated earnings and fraudulent RPTs to related real estate companies
  

• Videocon Group: Related party loans that contributed to the group’s financial distress

Although not inherently illegal, RPTs have the potential for conflicts of interest and misuse of company assets. Hence, regulatory oversight ensures:

• Transparency in company operations
  

• Fair treatment of minority shareholders
  

• Prevention of fraud and asset stripping
  

• Improved investor confidence
  

Related party transactions (RPTs) are governed by a combination of corporate and securities regulations, primarily including:

Companies Act, 2013

Section 188 of the Companies Act mandates:

• Board approval for most RPTs
  

• Shareholder approval for transactions exceeding prescribed thresholds
  

• Disclosure in financial statements and board reports
  

SEBI (LODR) Regulations

Applicable to listed companies:

• Audit Committee approval required for all material RPTs
  

• Mandatory disclosure to stock exchanges
  

• No related party can vote on resolutions where they are involved
  

• Material RPTs defined as those exceeding 10% of annual consolidated turnover

Transparent reporting and timely disclosures are essential for regulatory compliance and investor trust. Key requirements include:

Financial Statements

RPTs must be disclosed in the notes to accounts, showing:

• Nature of the relationship
  

• Details of the transaction
  

• Amount involved
  

• Outstanding balances
  

Stock Exchange Filings

Material RPTs must be reported to exchanges within 30 days of shareholder approval or execution.

Audit Committee Oversight

Listed companies must place all RPTs before the Audit Committee for review and approval.

If not properly monitored, related party transactions can lead to significant financial and governance risks, such as:

Asset Diversion

Promoters may siphon off funds or assets under the guise of business transactions.

Shareholder Value Erosion

Non-arm’s length transactions can result in unfair pricing, harming the company’s financial health.

Reputational Damage

Public exposure of controversial RPTs can damage investor trust and market valuation.

Investors can find RPT disclosures in:

• Annual Reports (Notes to Accounts and Board Reports)
  

• Corporate announcements on stock exchange websites
  

• SEBI-mandated filings (Regulation 23 of LODR)
  

Staying informed about a company’s RPT practices can offer early warnings about governance lapses.

Related party transactions are an essential yet sensitive aspect of corporate governance. While many are legitimate, others can be used to mask poor practices. With evolving regulations and increased scrutiny, both companies and investors must understand how these transactions work and what they signal. Staying alert to RPT disclosures can empower investors to make more informed decisions.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.