Tuesday, June 11, 2013

Related Parties and Approval of Related Party Transactions

CMA Circular 14 of 2012 made changes to the definition of an “independent director” and also led to amendments to the definition of a “related party”.

The following are considered as related parties in respect of public joint stock companies:

(a) any person who has held directorship(s) during the last twelve months at the company in question, the parent company, or an affiliate or sister concern of the company;

(b) any person who is the chief executive officer or general manager of the company or is an employee of the company holding a position which is linked and requires direct reporting to the board of directors of the company;

(c) any person holding or controlling 10% or more of voting rights in the company in question, the parent company, or an affiliate or sister concern of the company;

(d) any person who is an associate/affiliate of any of the natural persons mentioned above.  This includes parents, sons, daughters and spouse(s) of such natural persons.  It also includes the businesses in which such natural persons own, collectively or individually, at least 25% of the voting rights; and

(e) any person who is an associate/affiliate of any of the juristic persons mentioned in (a), (b) and (c) above.  This includes the parent company, affiliates and sister concerns of such juristic persons and their directors and employees.  This also includes the businesses in which such person holds at least 25% of the voting rights and the businesses whose directors manage the business as per the directions of the joint stock company in question.

The above definition of a related party is particularly important in connection with the requirement of approval of related party transactions of public joint stock companies.  The Code of Corporate Governance for public joint stock companies states that a related party shall not have any direct or indirect interest in any transactions involving the related public joint stock company (the “Company”) except in certain limited situations.  The situations in which a related party can enter into a transaction with the Company include the following:

(a) The normal contracts and transactions in the ordinary course of business without any differential advantage accruing to the related party.  The Annual General Meeting (“AGM”) of the Company needs to be notified of these transactions on an ex post-facto basis every year.  The normal transactions mean routine transactions carried out on a regular basis in order to achieve the Company’s main objectives (absence of such transactions may lead to non-attainment of the company’s objective);

(b) Contracts entered through a transparent mode of open tendering or limited tendering after obtaining and evaluating at least three independent bids in accordance with the guidelines prescribed by the audit committee of the Company.  These contracts can be executed provided that the most suitable tender shall be chosen and the AGM shall be notified of these transactions on an ex post-facto basis every year;

(c) The board may approve the related party transactions, based on the recommendation of the audit committee, in case of small value transactions which are within the monetary limits prescribed in the procurement manual of the Company (which should be filed with the CMA); and

(d) Through prior approval of the AGM of the Company, after due recommendation by the audit committee, provided that the following information (as a minimum) has been provided to the shareholders (in addition to the opinion/recommendation of the audit committee and the board):

  • The name of the related party;
  • The nature and extent of the interest of such related party in the transaction;
  • The value of the related party transaction;
  • The validity period of the proposed arrangement;
  • Any other relevant information; and
  • In the case of an acquisition or disposal of assets, an independent valuation.
The approval of the AGM of the Company in this respect needs to be obtained prior to the start of the transaction.  Moreover, the approval of the AGM cannot be of a general nature and needs to be explicit for each transaction with complete details of the specific transaction mentioned in the approval.  Furthermore, the concerned related party is not allowed to participate in the voting in respect of such approval at the AGM.

It is important to note that the auditors of the Company are required to report, during the subsequent year, about the proper performance of the responsibilities of the related party with regard to the approved related party transaction.  It is also pertinent to mention that the Code of Corporate Governance provides that any transaction between a related party and the Company shall be considered null and void if it has been undertaken in violation of the relevant provisions of the Code of Corporate Governance.  This will not have an adverse impact on the shareholders of the Company and any damages resulting from such transactions shall be borne by the concerned related party.

In view of the above-mentioned rather broad definition of related party, the process for approval of any related party transaction and the consequences of breach of approval requirements, it is very important that public joint stock companies carefully consider the nature of transactions being undertaken by such companies to determine if a transaction can potentially be considered as a related party transaction.