Proxy advisory firms Institutional Investor Advisory Services and InGovern Research Services did not raise any objections to Hyundai Motor India’s proposed transactions, which add up to more than ₹31,500 crore.
Hyundai Motor India’s board resolutions for the seven transactions will pass even if all institutional and retail investors vote against them, given that its South Korean parent controls over 82% of the company’s shares.
The two-day e-voting on the seven resolutions will close on the evening of 13 March. These transactions involve the purchasing of engines, parts, machinery, moulds, body parts, and engineering construction services.
It is a commonly accepted practice among companies, especially ones that are part of large groups, to enter into related-party transactions for sourcing raw materials and parts and for availing certain services.
But why do such related-party transactions tend to attract controversy? Mint explains.
Why do companies enter into related-party transactions?
Related-party transactions are part of structuring a business and establishing separate entities focused on specific activities.
For Hyundai Motor India or any other automobile manufacturer, it does not make sense to house all activities involved in manufacturing a car in one factory or under one company, as each activity requires a level of expertise, specialisation and precision.
It is common for automobile manufacturers to promote multiple ancillary units—some as wholly owned subsidiaries or joint ventures—to make specific parts used to assemble a vehicle. Some of these ancillary units may be suppliers to other manufacturers too.
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A company making steel pipes may have associate companies with mining rights for iron ore or coal, and for producing power. Many manufacturers prefer to buy from related and associate companies as they will have greater control over quality and production.
The scope of related-party transactions is not limited to dealing in goods and services. It could involve a transfer of business or property. Also, the related party need not be a subsidiary, a joint venture, or a group company. A related party could be an entity promoted by the relatives of a company’s promoters, its directors or their relatives, its key managerial personnel, or even by someone with close business ties with it.
Why is there a need to regulate related-party transactions?
It is widely believed that transactions between related parties will be priced or valued differently than deals between two unrelated businesses. Several related-party transactions have been found to be ‘abusive’ or ‘unfair’ to non-promoter shareholders.
Over-invoicing by a supplier company when sending goods or providing service to a related buying company is one such practice. This helps the buying company to show higher expenses and lower profit and tax liability while the supplier (usually, a smaller company) would show higher income and higher profits.
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Such valuation of a transaction hurts the interest of non-promoter and minority shareholders of the buying company while benefiting the promoters of the supplier company. This is a form of siphoning out resources from a company.
To protect the interests of minority shareholders and non-promoters, the law requires that transactions between related parties follow the arm’s length principle—i.e., such a transaction should be at the same valuation as if it were between two independent entities.
What do the Companies Act and Sebi’s regulations mandate?
Over the years, various laws and regulations have been put in place in India and across all major jurisdictions to ensure greater transparency in transactions between related parties and to ensure that these are valued appropriately and fairly in the books of accounts.
Listed companies have to adhere to the requirements spelt out by the market regulator, the Security and Exchange Board of India. Under the Sebi (Listing Obligations and Disclosure Requirements) Regulations, a listed company is required to seek the approval of its audit committee before entering into a transaction with a related party.
If a transaction is ‘material’, the company has to seek prior approval from its shareholders. A material related-party transaction is one that exceeds ₹1,000 crore in value in a financial year or which accounts for more than 10% of a company’s annual consolidated turnover as per its last audited financial statement, whichever is lower.
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All seven transactions listed by Hyundai Motor India for shareholders’ approval are above the ₹1,000-crore threshold.
Unlisted companies need to comply with the provisions of the Companies Act, 2013, which requires the approval of the board of directors for related-party transactions. Shareholders’ approval is required in the form of ordinary resolution where the transaction value is above a prescribed threshold.
Also, all companies have to comply with accounting standards on related-party transactions and income tax laws when preparing their accounts.
