Business Standard

Related-Party Transactions: Learning from the USL case

Rejection of important RPT, which is not abusive, by a small group of minority shareholders is likely to hurt the company

Asish K Bhattacharyya 

Asish K Bhattacharyya

Effective from April 1, 2014, material (in terms of size) related-party transactions (RPT) are to be approved by shareholders, who are not related parties, by a special resolution (75 per cent of polled votes in favour of the resolution). United Spirits Limited (USL) had put the provision to test recently.

Diageo, a UK based company, owns roughly 54.78 per cent shares in USL. Before acquisition by Diageo, USL was a UB group company controlled by Vijay Mallya. The company sought minority shareholders' approval to the agreements, which include the licence for manufacture and sale agreements with Diageo Brands B.V, Diageo North America and Diageo Scotland, distribution agreements with these three entities and cost sharing agreement with Diageo India private Ltd. Voting through postal ballot, USL's minority shareholders rejected the proposed contracts with Diageo.

Only 34 per cent non-promoter votes were polled. Institutions accounted for around 99 per cent of votes polled. Only 70.03 per cent of votes went in favour of the resolution. Around 30 per cent of the institutional votes polled that went against the resolution. In effect, only 10 per cent of minority votes could derail proposals, which, the company claims, are strategically important for complete integration of USL and Diageo. The results of the postal ballot shows that the company could go forward with the proposed arrangements had the rules required approval of minority shareholders by simple majority (ordinary resolution).

The government has proposed to amend the Companies Act 2013 to require minority's approval by simple majority, rather than by special resolution.

This is a welcome move. It is often difficult to form a clear judgment on whether a particular RPT is fair to the company. Therefore, garnering support from those who hold 75 per cent of minority voting rights is difficult even for an RPT that is not abusive.

As is evident in the USL case, even institutional shareholders could not build a consensus on the issue.

Rejection of important RPT, which is not abusive, by a small group of minority shareholders is likely to hurt the company rather than benefitting it. The Securities and Exchange Board of India should also amend the code of corporate governance (clause 49 of the Listing Agreement) in line with the proposed amendment in the Companies Act 2013. The new code of corporate governance (revised clause 49) requires that all existing material related-party contracts or arrangements, which are likely to continue beyond March 31, 2015, should be approved by 75 per cent of the shareholders, who are not related parties, in the first general meeting subsequent to October 1, 2014.

In compliance with this requirement, USL placed 12 resolutions before minority shareholders in an extra ordinary general meeting (EGM) held on November 28, 2013.

The minority shareholders rejected nine resolutions related to dealings with Vijay Mallya-controlled UB group companies. According to disclosures on the exchanges, institutional shareholders were instrumental in deciding the fate of the resolutions at the EGM.

The board of directors of USL approved the agreements on October 11, 2012, just before Diageo announced its agreement to take over USL on November 9, 2012.

It appears that institutions overwhelmingly felt that the agreements were not fair to the company. It is possible that the board of directors had decided in the group's interest, ignoring the interest of minority shareholders. This is not permitted. The Companies Act 2013 requires directors to act in good faith in the interest of the company, its shareholders, employees, and community and in the interest of protecting environment.

Whenever agreements are placed before shareholders for approval, they go through deeper scrutiny by proxy advisory firms, institutional shareholders and other interested stakeholders. Decisions, other than RPTs, also come under shareholders' scrutiny after disclosure. This exposes the directors to the risk of being sued for negligence in duties.

Usually, directors enjoy immunity from liability for the loss that a company might have suffered from business transactions under the 'business judgment' principle.

However, if, evidence suggests that directors did not act in good faith or had not collected adequate information or applied skills and judgment and had acted on external influence they are held accountable for the loss suffered by the company.

Companies Act 2013 mandates independent directors to get their reservations, if not resolved, recorded in the minutes of the meeting. If an independent director fails to record reservations, it will be assumed that he consented to the decision and he will be held accountable for the same. In a recent judgment, a Hyderabad court imposed fine on high-profile independent directors in the Satyam scam.

We should expect an increase in shareholder activism and judicial activism in times to come. Independent directors should be cautious in approving decisions.

Professor and Head, School of Corporate Governance and Public Policy, Indian Institute of Corporate Affairs; Advisor (Advanced Studies), Institute of Cost Accountants of India; Chairman, Riverside Management Academy Private Limited

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First Published: Sun, December 14 2014. 22:35 IST