Private Credit In Listed Companies: The RPT Dilemma

Listed companies are frequently called upon to support the ambitions of their subsidiaries. Private credit investors often require the listed entity to be a party to security arrangements (such as pledges, guarantees, etc.) when the subsidiary/associate entity is the principal borrower. This is where Related Party Transaction (RPT) provisions under SEBI’s (Listing Obligations and Disclosure Requirements) Regulations, 2015 (Listing Regulations) become relevant.

It’s at this point the listed company must ask itself:

1. Will the transaction qualify as an RPT under the Securities and Exchange Board of India’s (SEBI’s) Listing Regulations?
2. If it does, what value needs to be ascribed to it to determine whether it is a ‘material RPT’ requiring shareholder approval?
3. If ‘material RPT limits’ gets refreshed each financial year?

A. Security Agreement = RPT?

RPT¹ means a transaction involving a transfer of resources, services or obligations between:

Such transactions would be viewed as RPTs regardless of whether a price is charged. Also, a “transaction” with a related party shall be construed to include a single transaction or a group of transactions in a contract.

All RPTs require prior approval² of the audit committee. The independent directors in the audit committee of the listed company need to approve the RPT. The regulations also provide for omnibus approvals. We’ve discussed that in detail here.

As is the case with most laws, applying the RPT provisions can throw up practical challenges and nuances.

Often, a question which comes up is whether a security given by the listed entity for a subsidiary qualifies as an RPT?

Short answer, it should.

The definition of RPT opens with - ‘a transaction involving a transfer of resources, services or obligations..’.

Since the ‘obligation’ to make good the lender/investor is being transferred to the listed entity by the subsidiary in the event of a default, the transaction should qualify as an RPT. Therefore, any transaction involving a mortgage, guarantee or a similar undertaking should be categorised as an RPT.

B. If security creation is an RPT, when will it be ‘material RPT’ requiring shareholder approval?

An RPT becomes material³ if such transaction with a related party (when individually or taken together with previous transactions) during the financial year exceeds the lower of Rs. 1000 crore or 10% of the annual consolidated turnover of the listed entity as per the last audited financial statements. To illustrate, if the annual consolidated turnover of the listed entity is Rs. 7000 crore, any security creation over Rs. 700 crore will be considered ‘material RPT’.

All such material RPTs require prior shareholder approval through a resolution in which no related party is allowed to vote. So basically, the promoter and entities related to the promoter need to sit out, most commonly referred to as a ‘majority of minority’ vote. This is often tricky, since the vote would entirely depend on the will of public shareholders.

But how do you determine materiality for a security where the underlying liability for the listed entity is contingent and gets crystalised only upon default?

Should the value of the RPT be zero until the liability is crystalized or should the entire amount of potential liability be considered on Day 1 to determine materiality for shareholder approval? Consider a mortgage agreement for instance – should the RPT value be the book value, or the total amount repayable, or the fair value of the property as on the date of security creation?

A recent informal guidance by SEBI in the case of Bajaj Finserv is relevant here⁴ . Bajaj Finserv held 74% in Bajaj Allianz General Insurance Company (its material unlisted subsidiary). The remaining 26% is held by Allianz SE. Bajaj Finserv and Allianz are not related parties. But Bajaj Allianz and Allianz SE are.

Now, Bajaj Allianz General Insurance Company and Allianz SE have entered into a re-insurance treaty⁵ . One of the questions Bajaj Finserv went to SEBI with was if this transaction qualifies as an RPT, and if yes, what will be the value of the reinsurance contract? The question is relevant to determine ‘materiality’ and shareholder approval requirement. In answering the question, SEBI first examined what a reinsurance treaty entails to begin with. Essentially, a reinsurance treaty comprises three components – premium ceded, commission and claims. While the first two are known upfront, claims are not.

So, to determine ‘materiality’, should the value of the RPT just be the premium income for the reinsurer or the claim amount that may be payable by the reinsurer or the net settlement amount i.e. premium less commission less claim amount? In response, SEBI said the net settlement amount should be considered as transaction value for the RPT.

That doesn’t quite address the issue though, since a company will never know what the ‘net settlement value’ could be at the end of each quarter/ year. SEBI simply reiterated the law – i.e. materiality is ascertained based on actual amounts paid. It is up to the companies in question to determine how to ascertain it.

Applying this in the context of security creation, is it possible to say that the value of security is unclear and should therefore not constitute a ‘material RPT’? Will be difficult. SEBI’s approach in the context of RPTs appears simple – ascertain the actual value and where you cannot, proceed on the conservative side (which was reiterated in the Linde Case⁶ – read our analysis here).

Also, commercially speaking, no lender would be willing (in general) to take the risk of shareholders rejecting the resolution for enforcement at a later date. Therefore, listed companies may have to ascertain ‘materiality’ based on the total amount of liability guaranteed/ backstopped by it, and accordingly decide whether shareholder approval is required or not.

C. Another relevant aspect for material RPTs is whether the ‘material RPT limits’ refresh each financial year?

Yes. For instance, let’s say a listed company has an annual turnover of Rs. 11,000 crores. In the first year, the listed company approves a guarantee worth Rs. 700 crore for a subsidiary without having to obtain shareholder approval. Is it now possible for the listed company to again provide another guarantee of Rs. 700 crores in the next year without obtaining shareholder approval (assuming turnover remains the same)? The answer is Yes. Would it be considered as Rs. 1,400 crores of guarantees issued in the second year or just Rs. 700 crores? Should be the latter, i.e. Rs. 700 crores. Essentially, continuing RPT obligations do not spill over to the next financial year while ascertaining the materiality threshold.

Also, to be clear, the materiality threshold (for shareholder approval purposes) is determined after clubbing all contracts with the same related party in a financial year.

Conclusion

The essence of the regulations and SEBI’s approach in cases like Linde clearly indicates that the intention is to adopt a conservative stance when it comes to compliance with RPT provisions. Governance begins where mere compliance ends, and the regulator has consistently emphasized that companies must adhere to the law not just in its letter, but also in its spirit.

In India, where promoter-driven and closely held companies are common, the potential for abuse through RPTs is relatively high. Consequently, boards must exercise diligent oversight whenever any liability is being created for the listed company.

Companies would be prudent not to structure transactions in a way that seeks to circumvent the shareholder approval requirements. Similarly, attempting to change the nomenclature of financial instruments to evade the Listing Regulations obligations is ill-advised. After all, a rose by any other name would smell as sweet.

¹ Regulation 2(zc), Listing Regulations: https://shorturl.at/NZqfv
² Regulation 23(2): All related party transactions and subsequent material modifications shall require prior approval of the audit committee of the listed entity: [Provided that only those members of the audit committee, who are independent directors, shall approve related party transactions.]
³ Regulation 23(1), Listing Regulations: https://shorturl.at/NZqfv
⁴ SEBI Informal Guidance in the matter of Bajaj Finserv Limited: https://shorturl.at/gGIVH.
⁵ (General Insurance - Reinsurance) Regulations, 2000: ‘treaty’ means a reinsurance arrangement between the insurer and the reinsurer, usually for one year or longer, which stipulates the technical particulars and financial terms applicable to the reinsurance of some class or classes of business.
⁶ Securities And Exchange Board of India Order In Respect of Linde India Ltd, WTM/AB/CFID/CFID -SEC3/30578/2024.