COMMON ERROR OF THE INDEPENDENT DIRECTORS ON THE RPT TRANSACTION - A Case From The SEBI Prosecution.

 Corporate Governance Practice Audit  

* Birendra K Jha                                                                                                                                                                       Independent Director, IICA ( Ministry of Corporate Affairs ); Corporate Governance  Practice Audit; CSR Social Impact - CSR Planning & Implementation;  Expert Company Law -SEBI Law - Social & Environmental Law   EMail: birendrajha03@yahoo.com

COMMON ERROR OF THE INDEPENDENT DIRECTORS ON THE RPT TRANSACTION:  

This is common error of the Independent Directors. When promoters are strong, they bypass the shareholders. The Independent Directors remain here as helpless spectators. Either they do not know the Corporate Governance Law or they remain silent.  

The strong promoters  use this route to bypass the shareholders for gaining unexplained benefit and avoid the shareholders. The Independent Directors fail here to deliver independent judgement. We will see here, how the Independent Directors have failed to deliver the independent judgment in a case. They have failed  to understand the difference between the "Prior Approval" and the "Post Facto Approval".  

A case is cited here where SEBI prosecuted a company on the disclosure default on the  RPT.  

This case discloses what serious error has been done by the Independent Directors.  The Directors have failed in understanding the Related Party Transaction Law. Honestly, if company discloses RPT, on any amount of transaction, rather  then waiting for the "Threshold Limit" to cross, shall save them from the prosecution. This needs provision in the policy for disclosing RPT Transaction on any amount voluntarily.  This voluntary practice shall build confidence among the shareholders and investors. Not disclosing RPT is an offence. In any case this should must be avoided. 

Unfortunately most of the Independent Directors are not trained. The Independent Directors may be best electrical engineers or software engineers. But they are useless on the board as Independent Directors, if they  fail to understand and protect the Corporate Governance Law here. 

Here the Secretarial Compliance Audit has also failed. Mostly the Independent Directors rely on the Secretarial Compliance Audit. This is poor practice. The Independent Directors should use their own mind. They should read their own Independent Judgement. The case is elaborated here is a good learning lesson for the Independent Directors. This is also a learning lesson for the entire Board of Directors and the Company Secretary in practice.    

BACKGROUND OF THE CASE 

1. Parent Company ( in short : Promoter Company )  is a listed company in National Stock Exchange of India Ltd.  and BSE Ltd. It has a financial relation with a   company  ( in short: Subsidiary Company ). The Subsidiary Company is a related party to the Promoter Company by virtue of forming a part of the Promoter Company. The Securities and Exchange Board of India ( “SEBI”) received an exceptional report from NSE, inter alia, raising concerns that Promoter Company  had not taken approval of the shareholders before entering into Related Party Transaction  with the Subsidiary Company. Thereafter, SEBI conducted an examination in the matter within the examination period 2023 to 2024. Based on the examination, it was observed that the Promoter Company   had failed to take prior approval of the shareholders’ for entering into material RPT with the Subsidiary  Company.

2. It was further observed that the Promoter Company had failed to update its RPT policy as mandated under the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015. Therefore, it was alleged that the Promoter Company had violated the provisions of regulations 23(1) and 23(4) of the SEBI LODR Regulations.

3. SEBI served a Show Cause Notice in 2024  to the Promoter Company in terms of Rule 4 read with section 15-I of the SEBI Act to show cause as to why an inquiry should not be held against the Promoter Company  and why penalty, should not be imposed on it in terms of the provisions of section 15HB of the SEBI Act for the aforementioned violations alleged to have been committed by the Promoter Company.

4. SEBI framed following charges: 

a) Failure to take shareholders’ "Prior Approval" for the Material RPT Transaction.

b) Failure to update RPT related policy 

5. SEBI framed charges that during the course of examination, it was observed that the Promoter Company  had, inter alia, disclosed the following RPT in the stock exchanges during the year 2023:

Name of the counterparty transaction : Related Company

Relationship : Promoter's Company

Nature of Transaction: Inter Corporate Deposit

Amount : Rs. Below Rs 7 Crore

6.  In this regard, National Stock Exchange of India Ltd  had sought clarification from the Parent Company  as to whether prior approval of the shareholders had been taken under regulation 23(4) of the LODR Regulations for the material RPTs entered during the period. In response, the Parent Company  stated as under:

There were no material Related Party Transactions entered into during the said period  and thereby not calling for prior approval of shareholders.

National Stock Exchange of India Ltd served another notice  to the Parent Company where it mentioned that the threshold limit has crossed. The financial transaction pertaining to inter-corporate deposit of the specified amount  is more than the threshold limit. This is Material Transaction. 

In response to the National Stock Exchange of India Ltd  notice, the Parent Company replied that there is no  deliberate action and the company agreed to initiate the process of obtaining the consent of the shareholders immediately. It requested humbly to condone the lapse.

Clearly the Parent Company admitted the charge. 

7. However, the Parent Company obtained subsequent approval of the shareholders for the RPTs. In this regard, SEBI LODR Regulation 23(4), states as under:

“All material related party transactions and subsequent material modifications as defined by the audit committee under sub-regulation (2) shall require prior approval of the shareholders through resolution and no related party shall vote to approve such resolutions whether the entity is a related party to the particular transaction or not."

8.  Hence, if Law is read clearly. Under the Law  vide the SEBI LODR  Regulation 23(4), there is a clear mandate of  “prior approval” of the shareholders for the material RPT. A post facto approval of the shareholders would not be a permissible way to deal with the material RPT. In view of the above, it was alleged that the Parent Company had violated clearly the provisions of Regulation 23(4) of the LODR Regulations 2015.

9.  It was also observed that the definitions of related party and related party transaction in the policy were based on the provisions of the Companies Act, 2013. The definition of related party in the RPT policy was not in line with the amendments made in the Companies Act, 2013 with respect to section 2(76)(viii). The Parent Company RPT policy continued to provide the old definition. The policy was not updated. In this regard, it was also alleged that the Promoter Company  failed to take into account the relevant provisions of the LODR Regulations concerning the related party and related party transactions as per updated definition in its RPT policy.

Hence it also violated Regulation 23. (1)of the LODR Regulations.  The LODR Regulations 23 (1)  stated clearly that the listed entity shall formulate a policy on materiality of related party transactions and on dealing with related party transactions including clear threshold limits duly approved by the board of directors and such policy shall be reviewed by the board of directors at least once every three years and updated accordingly.  The listed entity failed to execute this duty. The Board of Directors failed here. 

10. Thus the charges now centered around: 

a) No "Prior Approval" of Shareholder on the RPT Transaction 

b) No upgradation of policy on the RPT and Review by the Directors. 

11. The "Prior Approval" is needed to be understood in view of the following judgement delivered in the case of 

a) Bajaj Hindustan Ltd. v. State of UP [(2016) 12 SCC 613]:  Prior Approval is not to be replaced with the word Post Facto Approval. 

b) Independent Sugar Corporation Ltd. v. Girish Sriram Juneja and Ors. [ 2025 INSC 124]: The legislative intent behind  the "prior approval" is not a flexible provision but a certain necessary exigencies.

12. In view of the judgments cited above, it is clear that the term "Prior Approval" appearing in SEBI LODR Regulation 23 (4) has to be given its due meaning, which in this case does not permit "Post Facto Approval" of the shareholders for a material RPT. 

13. After considering the entire facts and circumstances of the case, the material available on record, the Parent Company was charged under  Section 15-I of the SEBI Act read with Rule 5 of the Rules. The Company hereby imposed  monetary penalty  under section 15HB of the SEBI Act.