Role of Audit Committee in Related Party Transactions

Role of Audit Committee in Related Party Transactions

Under the Companies Act, 2013, the whole concept of related party transactions has been capsulated in a single section, namely Section 188 which combines the erstwhile Sections 314 and 297 of the Companies Act, 1956 and also contains many new provisions within its scope. The section is deeply layered with many set of provisions and leaves the mind perplexed with its scope and coverage.
Section 188 of the Companies Act, 2013 read with Companies (Meetings of Board and its Powers) Rules, 2014 provides the detailed provisions for dealing with Related Parties Transactions of the Company. Further, it mandates for certain compliance requirements for Audit Committee approval for those related parties transactions.

Since Audit committee has been provided with lot of roles and responsibilities under the provisions of the Companies Act 2013 including approval of related party transactions among many other things, it became mandatory on the part of corporate to constitute committee under the provisions of the Section 177 of the Companies Act 2013.

Now let us see few important provisions relating to Audit Committee under the companies act 2013 for understanding its composition and scope;

AUDIT COMMITTEE (SECTION 177)

Applicability –
♠ Every Listed Company, and
♠ Every other public company
o having paid up capital of Rs.10 Crores or more, or
o having turnover of Rs.100 Crores or more, or
o having, in 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 the purposes of this rule.

COMPOSITION –

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

Every Audit Committee of a company existing immediately before the commencement of this Act shall, within 1 year of such commencement, be reconstituted in accordance with these requirements.

Companies which were not required to constitute Audit Committee under section 292A of the Companies Act, 1956 shall constitute their Audit Committee within one year from the commencement of the relevant rules (i.e. within 1 year from 01.04.2014) or appointment of independent directors by them, whichever is earlier.

FUNCTIONS OF AUDIT COMMITTEE –

Every Audit Committee shall act in accordance with the terms of reference specified in writing by the Board which shall, inter alia, include,—

the recommendation for appointment, remuneration and terms of appointment of auditors of the company (in case of government company, recommendation for remuneration only);

review and monitor the auditor’s independence and performance, and effectiveness of audit process;
examination of the financial statement and the auditors’ report thereon;
approval or any subsequent modification of transactions of the company with related parties. The Audit Committee may make omnibus approval for related party transactions proposed to be entered into by the company subject to such conditions as may be prescribed. (Companies Amendment Act, 2015, (the provision has been notified to be effective from 14.12.2015)
scrutiny of inter-corporate loans and investments;
valuation of undertakings or assets of the company, wherever it is necessary;
evaluation of internal financial controls and risk management systems;
monitoring the end use of funds raised through public offers and related matters.
OMNIBUS APPROVAL BY AUDIT COMMITTEE – CHANGES NOTIFIED
Provisions of Section 14 the Companies (Amendment) Act, 2015 (21 of 2015), that amend Sections 177 of the Companies Act, 2013 read with Companies (Meetings of Board and its Powers) Rules, 2014 have come into force vide MCA Notification S.O. 3388(E), dated December 14, 2015 which has been issued in this regard.

Revised section 177 read with the Companies (Meetings of Board and its Powers) Second Amendment Rules, 2015 as follows:
In section 177 of the principal Act, the following shall be substituted, namely:—

In section 177 of the principal Act, in sub-section (4), in clause (iv), the following proviso shall be inserted, namely:—
“Provided that the Audit Committee may make omnibus approval for related party transactions proposed to be entered into by the company subject to such conditions as may be prescribed;”

Therefore, under Section 14 of the Amendment Act 2015, it is provided that audit committee may make omnibus approval for related party transactions proposed to be entered into by the company subject to such conditions as may be prescribed.

In this connection, it is also pertinent to note that Sub-section 177(4) provides that every audit committee shall act in accordance with the terms of reference in writing of the Board. It includes subsequent modifications of transactions with related parties.

It may be noted that consequential amendments have also been made in Companies (Meetings of Board and its Powers) Rules, 2014 by Notification No. G.S.R. 972(E), dated 14-12-2015 vide Companies (Meetings of Board and its Powers) Second Amendment Rules, 2015 as follows:

In the Companies (Meetings of Board and its Powers) Rules, 2014,-

♠ After rule 6, the following rule shall be inserted, namely:-

“6A. Omnibus approval for related party transactions on annual basis.– All related party transactions shall require approval of the Audit Committee and the Audit Committee may make omnibus approval for related party transactions proposed to be entered into by the company subject to the following conditions, namely:-

(1) 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) maximum value of the transactions, in aggregate, which can be allowed under the omnibus route in a year;
(b) the maximum value per transaction which can be allowed;

(c) extent and manner of disclosures to be made to the Audit Committee at the time of seeking omnibus approval;
(d) review, at such intervals as the Audit Committee may deem fit, related party transaction entered into by the company pursuant to each of the omnibus approval made;

(e) transactions which cannot be subject to the omnibus approval by the 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 in future);
(b) 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;
(c) maximum amount of transaction that can be entered into;
(d) the indicative base price or current contracted price and the formula for variation in the price, if any; and
(e) any 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 aforesaid details 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 a period not exceeding one financial year and shall require fresh approval after the expiry of such financial year.
(6) Omnibus approval shall not be made for transactions in respect of selling or disposing of the undertaking of the company.
(7) Any other conditions as the Audit Committee may deem fit.”.
Therefore, in view of introduction of said provisions regarding omnibus approval by audit committee via the Companies Amendment Act, 2015 and notified to be effective from 14.12.2015, the provisions relating to approval of related party transactions by Audit Committee after aforesaid amendments shall be as follows:

♠ All related party transactions require prior approval of the Audit Committee.
♠ 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) maximum value of the transactions, in aggregate, which can be allowed under the omnibus route in a year;
(b) the maximum value per transaction which can be allowed;
(c) extent and manner of disclosures to be made to the Audit Committee at the time of seeking omnibus approval;
(d) review, at such intervals as the Audit Committee may deem fit, related party transaction entered into by the company pursuant to 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 in future);
b. 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;
(c) maximum amount of transaction that can be entered into;
(d) the indicative base price or current contracted price and the formula for variation in the price, if any; and
(e) Any 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 aforesaid details 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 a period not exceeding one financial year and shall require fresh approval after the expiry of such financial year.
(6) Omnibus approval shall not be made for transactions in respect of selling or disposing of the undertaking of the company.
(7) Any other conditions as the Audit Committee may deem fit.
Consequences of non-compliance under Section 188

♠ Where any contract or arrangement is entered into by a director or any other employee, without obtaining the consent of the Board or approval by a resolution in the general meeting, as the case may be, and if it is not ratified by the Board or, as the case may be, by the shareholders at a meeting within three months from the date on which such contract or arrangement was entered into, such contract or arrangement shall be voidable at the option of the Board and if the contract or arrangement is with a related party to any director, or is authorised by any other director, the directors concerned shall indemnify the company against any loss incurred by it.

♠ Additionally, the company can also proceed against a director or employee who had entered into such contract or arrangement in contravention of the provisions of this section for recovery of any loss sustained by it as a result of such contract or arrangement.

♠ Any director or any other employee of a company, who had entered into or authorised the contract or arrangement in violation of the provisions of this section shall –

(i) in case of listed company, be punishable with imprisonment for a term which may extend to 1 year or with fine which shall not be less than Rs. 25,000/- but which may extend to Rs. 5,00,000/-, or with both; and

(ii) in case of any other company, be punishable with fine which shall not be less than Rs. 25,000/- but which may extend to Rs. 5,00,000/-.

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