CSR & Related Party Transactions

Would it be ‘Related Party Transaction’ if CSR grant is contributed by a company to a charitable institution (CSR Implementing Agency registered either as a trust, society or Section 8 Company) and where the Director or key managerial personnel of the Company or his/her relative is also a trustee (of that grant receiving charitable institution)? This appears to be a question that quite a few Companies seem to be asking recently.

Who is a ‘Related Party?’

Section 2(76) of the Indian Companies Act, 2013 defines the term “Related Party” to include:

1. a director or his relative;
2. a ‘key managerial personnel’ or his relative;
3. a firm, in which a director, manager or his relative is a partner;
4. a private company in which a director or manager or his relative is a member or director;
5. a public company in which a director and manager is a director and holds along with his relatives, more than two per cent of its paid-up share capital;
6. any ‘body corporate’ whose Board of Directors, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager;
7. any person on whose advice, directions or instructions a director or manager is accustomed to act:

Provided that nothing in sub-clauses (6) and (7) shall apply to the advice, directions or instructions given in a professional capacity;

8. any company (excluding a private company) which is:

• a holding, subsidiary or an associate company of such company; or
• a subsidiary of a holding company to which it is also a subsidiary;

9. Such other person as may be prescribed (this includes a director or key managerial personnel of the holding company or his relative with reference to a company).

Who is a ‘Relative?’

A ‘Relative’ as per Section 2(77) and Rule 4 of the Companies (Specification of definitions details) Rules, 2014 includes:

1. Members of HUF
2. Husband & Wife
3. Father including Step Father
4. Mother including Step Mother
5. Son including Step Son & his wife
6. Daughter & her Husband
7. Brother including Step Brother
8. Sister including Step sister

Who is a ‘Key Managerial Personnel?’

‘Key Managerial Personnel’ (KMP) refers to a group of people who are in charge of maintaining the operations of the company. KMP includes persons who have authority and responsibility for planning, directing and controlling the activities of the reporting enterprise. Chief Executive Office, Chief Financial Officer, Company Secretary, Whole Time Director are the Key Managerial Personnel.

Are ‘Related Party Transactions’ Banned or Illegal?

Related Party Transactions are not illegal or banned per se. However, they are regulated by certain conditions as provided under section 188 of the Indian Companies Act, by the means of which they can be disclosed to the Board and shareholders for them to ratify.

To begin with, prior approval from the Audit Committee is to be obtained and if the transactions fall within the meaning of Section 188, then these need to be disclosed in the Board Report for prior approval and justification is required to be given in support of the transactions. If the transactions are beyond the threshold limits, then they need to be disclosed in the General Meeting for approval by Special Resolution.

Thus, to reiterate ‘Related Party Transactions’ are neither banned nor illegal. These are regulated by processes and procedures which must be followed by the company.

Processes and Procedures

Section 188(1) of the Indian Companies Act provides that except with the consent of the Board of Directors given by a resolution at a Meeting of the Board and subject to such conditions as may be prescribed, no company shall enter into any contract or arrangement with a related party with respect to:

1. sale, purchase or supply of any goods or materials;
2. selling or otherwise disposing of, or buying, property of any kind;
3. leasing of property of any kind;
4. availing or rendering of any services, directly or through appointment of agent, exceeding ten per cent of the turnover of the company or rupees fifty Crore, whichever is lower;
5. appointment of any agent for purchase or sale of goods, materials, services or property;
6. such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company; and
7. Underwriting the subscription of any securities or derivatives thereof, of the company.

Disclosure

The agenda of the Board meeting at which the resolution is proposed to be moved should disclose:

1. the name of the related party and nature of relationship;
2. the nature, duration of the contract and particulars of the contract or arrangement;
3. the material terms of the contract or arrangement including the value, if any;
4. any advance paid or received for the contract or arrangement, if any;
5. the manner of determining the pricing and other commercial terms, both included as part of contract and not considered as part of the contract;
6. whether all factors relevant to the contract have been considered, if not, the details of factors not considered with the rationale for not considering those factors; and
7. Any other information relevant or important for the Board to take a decision on the proposed transaction.

Abstain

Where any Director is interested in any contract or arrangement with a related party, such director should not be present at the meeting during discussions on the subject matter of the resolution relating to such contract or arrangement.

Also, no member of the company should vote on the resolution, if he is a related party, to approve any contract or arrangement which may be entered into by the company. However, MCA has exempted private companies from this requirement vide notification dated 5th July, 2015.

Does CSR fall under section 188?

In our opinion, CSR grant (which is in the nature of a mandatory charitable expenditure by the company for public welfare activities with no personal financial benefit derived by any related party) does not appear to fall within the purview of Section 188(1) of the Indian Companies Act 2013.

Ordinary Course of Business

Also, as per Companies (Amendment) Act, 2015 transactions entered into by the company in its ordinary course of business and undertaken at arm’s length do not need any prior approval. Whether the transaction entered into is ‘ordinary course of business’ or not would depend on the particular business activity of the company.

One may consider certain factors such as size, volume, frequency and purpose of transaction to determine whether the transaction is in ordinary course or not.

In our opinion since CSR is mandatory under law (under section 135 of the Indian Companies Act 2013) for certain companies, the very purpose of the CSR grants by the Company’s Board (on the recommendation of the CSR committee) to the company’s own foundation or an ‘implementing agency’ (registered either as a trust, society or section 8 company with track record of three years of service) would be a transaction entered into by the company in its ordinary course of business and to fulfill a compliance and regulatory requirement under law.

Arm’s Length Transaction

‘Arm’s Length Transaction’ means a transaction between two related parties which is conducted as if they are unrelated and such that there is no conflict of interest. If the transaction is conducted and carried out in a fair, justifiable manner without any trace of influence of the parties it would be a transaction at arm’s length.

Transactions which are not biased (by the relationship of the parties) and conducted as if with an unrelated party are exempted from compliance under Section 188 of the Act.

Thus, if a transaction fulfills the criteria of ‘ordinary course of business’ and ‘arms length transaction’, no approval is required under section 188 of the Indian Companies Act.

Conclusion

Thus, in our opinion:

1. It would not be ‘Related Party Transaction’ if CSR grant is contributed by a company to a charitable institution (CSR Implementing Agency registered either as a trust, society or Section 8 Company) and where the Director or key managerial personnel of the Company or his/her relative is also a trustee (of that grant receiving charitable institution).
2. CSR grant (which is in the nature of a mandatory charitable expenditure by the company for public welfare activities with no personal financial benefit derived by any related party) does not appear to fall within the purview of Section 188(1) of the Indian Companies Act 2013.
3. CSR transactions entered into by companies at arm’s length are in the ordinary course of business and do not need any prior approval.
4. Even if a company feels that the transaction could be deemed as Related Party Transaction, it can always follow the process and procedure laid down under the Indian Companies Act 2013 to mitigate any possible risk of violating the law.