Role Of Audit Committee In Related Party Transactions

September 16, 2016

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In this blog post, Kunal Bhargava, a student of New Law College, Bharti Vidyapeeth University, Pune, who is currently pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, discusses the role and functioning of Audit Committee with respect to Related Party Transactions under Companies Act, 2013 and various recent developments by way of amendments.

Introduction

The Companies Act, 2013 can be called the Act of disclosures, declarations, and compliances. It conveys the intent to radically raise the bar on corporate governance in India and meeting the global standards. It makes a paradigm shift; from a control based regime to a trust based regime.

Under the Companies Act, 2013, the Audit Committee has been given a significant role and responsibility to regulate and determine the Related Party Transaction and to design the control procedure of the company internally. The role of the committee has been sharpened with specific responsibility and onuses relating to pre-approvals, modifications and non-compliances of related party transactions apart from general valuation and other financial responsibilities.

This article will help the readers to understand the role and functioning of Audit Committee with respect to Related Party Transactions under Companies Act 2013 and various recent developments by way of amendments.

What is a Related Party Transaction?

A Related Party Transaction is a transaction between a company with its related party/parties. The Companies Act, 2013 has expanded the scope of transactions of Company with related parties that can be treated as Related Party Transactions. Following transactions are included within the ambit of related party transaction:

Sale, purchase or supply of any goods or materials;
Selling or otherwise disposing of, or buying, 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; and
Underwriting the subscription of any securities or derivatives thereof, of the company.

The following transactions are exception to related party transactions:

Transactions undertaken in ordinary course of business
Transactions arising out of restructuring, mergers or acquisition.
Transactions entered between holding and its wholly owned subsidiary company duly approved by shareholders.
Transactions in case of private holding companies and its subsidiaries and associates.

Audit Committee and its Composition

An Audit Committee is a committee established by and amongst the Board of Directors of the Company. The purpose of establishing such committee is overseeing the financial position of the Company. Effective oversight of financial reporting process is fundamental to preserving the integrity of markets.

Under the provisions of Section 177 of Companies Act, 2013 it becomes mandatory for constituting the Audit Committee for every Listed Company, and every unlisted public company which satisfies the following conditions:

paid up capital of Rs.10 Crores or more, or
turnover of Rs.100 Crores or more, or
aggregate outstanding loans or borrowings or debentures or deposits exceeding Rs.50 Crores.

The paid up share capital or turnover or outstanding loans, or borrowings or debentures or deposits, as the case may be, as existing on the date of last audited Financial Statements shall be taken into account for this rule.

The Audit Committee shall comprise of the following:

Minimum 3 directors with the majority being independent directors (in the case of companies registered under Section 8, the requirement of independent director has been done away with. (Notification G.S.R. 466(E) dated 05.06.2015).
The majority of members of Audit Committee including its Chairperson shall be persons with the ability to read and understand financial statements.

Role of Audit Committee in Related Party Transaction (RPT)

The functioning and the role of Audit Committee for dealing with Related Parties Transactions of the Company are provided under the provisions of Section 188 of the Companies Act, 2013 read with Companies (Meetings of Board and its Powers) Rules, 2014. It mandates for certain compliance requirements for Audit Committee approval for the related parties transactions.

As per Companies Act, 2013 read with the Companies (Meetings of Board and its Powers) Second Amendment Rules, 2015, as notified by the MCA on 14th December 2015 each and every RPTs shall be placed to the Audit Committee and require prior approval of Audit Committee.

Audit Committee proves significant in Related Party Transactions. It is responsible for assessing the modifications in the Accounting Policies and practices adopted by the Company.
It must monitor Company’s policies that are not in accordance with the Accounting Standards issued by the Institute of Chartered Accountants of India and the reasons for their inconsistency with such standards.
Audit Committee may grant omnibus approval for related party transactions subject to the following conditions:

(l) The Audit Committee shall after obtaining approval of the Board of Directors, specify the criteria for making the omnibus approval which shall include the following, namely:-

(a) the maximum value of the transactions, in the aggregate, which can be allowed in a year;

(b) maximum value per transaction which can be allowed;

(d) review, at such intervals as the Audit Committee may deem fit; related party transaction entered into by the company under each of approval made;

(e) transactions which cannot be subject to the Omnibus by the approval Audit Committee.

(2) The Audit Committee shall consider the following factors while specifying the criteria for making omnibus approval, namely: –

(a) Repetitiveness of the transactions (in past or future);

(b) the justification for the need of omnibus approval.

(3) The Audit Committee shall satisfy itself on the need for omnibus approval for transactions of repetitive nature, and that such approval is in the interest of the company.

(4) The omnibus approval shall contain or indicate the following: –

(a) name of the related parties:

(b) nature and duration of the transaction;

(d) indicative base price or current contracted price and the formula for variation in the price, and

(e) other information relevant or important for the Audit Committee to take a decision on the proposed transaction:

Provided that where the need for related party transaction cannot be foreseen and details above are not available, audit committee may make omnibus approval for such transactions subject to their value not exceeding Rupees One Crore per transaction.

(5) Omnibus approval shall be valid for one financial year and shall require fresh approval after the expiry of such financial year.

6) No Omnibus approval for transactions of selling or disposing of the undertaking of the company.

(7) Any other conditions as the Audit Committee may deem fit.

It shall review the statement of significant related party transactions, submitted by the management. Audit Committee must ensure the disclosure of materially significant related party transactions that may have potential conflict with the interests of the company at large.

Conclusion

The role of the Audit Committee in 2013 Act has been expanded in comparison with 1956 Act, and it further seems the scope is going to increase by the proposed Companies Amendment Bill 2016.The proposed Companies Amendment Bill 2016, will make the role of Audit Committee clearer, if implemented, it will clear the Recommendatory Role of Audit Committee. The proposed amendment mandates the Audit Committee to scrutinize all related party transitions whether or not it covers under Section 188. However, if transactions with Related Parties which are not coming under Section 188, and the Audit Committee does not approve it, then it shall make its recommendations to the Board. Thus the position and role of Audit Committee will be more specific and defined.