Context:
In a large listed company in the garments and apparels segment, Related Party Transactions demonstrated clear conflicts of interest. They did not meet either of the requirements of the transactions being in the ordinary course of business and at arm’s length pricing. Should the Audit Committee have been caught napping, while this drama was being played out?

• In 2017, a Proxy Advisory Firm (PAF) asked shareholders to vote against a resolution for selling a valuable property of the Company situated in a posh area of Mumbai to the promoters of the Company.
• According to the PAF’s estimates, this transaction would result in an opportunity loss of over INR 6,500 crores for the Company and its shareholders. The Company’s valuation report had put the value of the transaction at INR 7,100 crores, but it was proposing to sell the property to the promoter at over 90% discount to market rates.
• The fairness of the Audit Committee (AC) of the Company was also questioned, especially since one of the promoters, who was a direct beneficiary from the transaction, was a member.
• The explanatory statement to the shareholders stated that
  1. The promoters/ Directors have been staying in the said property for years.
  2. In March 1994, the Company entered into an agreement with one of its wholly-owned subsidiaries (WOS), for a period of 9 years, to lease 4 flats at INR 6,000 per month per flat. Sub-leasing was allowed under this agreement.
  3. In March 2003, the Company entered into a fresh lease agreement with the WOS, for a period of 9 years, at the rate of INR 6,000 per month per flat. In turn, the WOS executed fresh deeds of sub-lease with 4 sub-lessees for 9 years at INR 7,500 per month per flat. (The sub-lessees included 2 promoters/ Directors and 3 members of the promoter’s Greater HUF).
  4. Since the building needed reconstruction, in 2007, a Tripartite Agreement was entered into between the WOS and the 4 sub-lessees, to demolish the building and erect a new structure. Pursuant to each of the Tripartite Agreements, the terms of which were identical, all the 4 sub-lessees were to hand over possession of the said flats to the Company, and agree to surrender their tenancy rights.
  5. The Company further agreed that upon completion of the new structure, it would offer to sell to the sub-lessees, apartments in the new structure, at the rate of INR 9,000 per square foot (carpet).
  6. 4 separate Tripartite Agreements were entered into in November, 2007.
  7. Temporary alternate accommodation was provided to all 4 sub-lessees.
  8. In 2016, the occupancy certificate for the property was received. The capital work costed approx INR 270.27 crores.
  9. In 2016 and 2017, 3 of the sub-lessees sent letters to the Company exercising their option to purchase the new apartment.
  10. Meanwhile, 2 of the sub-lessees had filed 2 separate arbitration petitions in the Bombay High Court.
• The explanatory note ended by stating that
  1. The shareholders should bear in mind that if they reject the resolution, then dispute would happen between the counterparties as per the Tripartite Agreement. Such potential disputes would be protracted and costly, and would result in financial or other liabilities on the Company. In such a situation, the Company would also be entitled to take appropriate legal defenses and remedies.
  2. In case of approval, the Company would offer apartments for sale to its related parties (being the sub-lessees), at a price which was significantly lower than the current prevailing market rate. This might result into a significant loss to the Company.
• The total expenditure incurred by the Company for providing the alternate accommodation was INR 40.95 crore (INR 8 lakhs per month for each sub-lessee, which later increased to INR 12 lakhs per month for each sub-lessee). The Company had provided alternate accommodation to sub-tenants at approximately 99% discount, giving an unfair economic benefit to the promoters.
• In response to the report of the PAF, the Company stated that it adhered to the highest level of Corporate Governance. Consequently, and given that the offer was required to be made by the Company under the Tripartite Agreement, the Company took a legal advice, and deferred the matter to shareholders for their decision. This was since the transaction was a related party transaction (RPT), which was in not in the ordinary course of business.
• The Company further stated that all the relevant facts pertaining to this matter had been set out in the Annual General Meeting (AGM) notice for shareholders to take a considered view. Needless to say, the promoters, being interested parties, would abstain from voting on this matter.
• Shareholders rejected the resolution in the AGM, with 97.67% of the votes being cast against the resolution.
• Based on news, in June, 2017, SEBI initiated a preliminary enquiry against the Company over Corporate Governance lapses. It issued notices to the Board and the Audit and Remuneration Committee for not complying with SEBI LODR Regulations. SEBI had questioned as to why the information about the Tripartite Agreement relating to the property was not disclosed to the Stock Exchanges and investors over the last ten years.
• In January, 2019, SEBI issued a Show Cause Notice against the Company.
• The SEBI order stated that the Tripartite Agreement was a deemed RPT. Any payment arising out of the Tripartite Agreement should also have been considered as an RPT. Therefore, AC approval was required for payments made pursuant to the tripartite agreement from December 1, 2015 under SEBI LODR Regulations.
• It was also noted by SEBI that the Company had failed to disclose the litigation, and its expected financial implications, filed against the Company by the sub-tenants in January, 2017 for possession of apartments in the newly constructed property, as per the Tripartite Agreement. As the disclosure was material in nature, the Company had violated SEBI LODR Regulations.
• SEBI imposed a penalty on the Company stating that considering the stature of the Company, it was expected that the Company would maintain a higher level of due diligence in its compliance with the provisions related to Corporate Governance. However, the Company had not only failed to do so but also allowed the sub-lessees to unduly benefit at a loss to itself and its public shareholders.