Shubi Arora

In addition to analyzing Indian law when it comes to shareholder meetings and voting procedures as discussed in Part I of this series, the Asian Corporate Governance Association (ACGA) White Paper on Corporate Governance also analyzed the Indian regime with respect to affiliate transactions and preferential warrants.  It concluded that that current regulations are weak and must be overhauled if minority shareholders are to be afforded adequate protection. 

To be sure, transactions with affiliated entities often serve legitimate purposes.  However, in India, where many businesses are old family-owned establishments, the inherent desire to run the business for the benefit of the family coupled with a weak regulatory regime is a recipe for potential abuse.  An obvious flaw when it comes to affiliate transactions is that Indian laws do not contain any requirement for independent shareholder approval when it comes to material affiliate transactions.  Also, disclosure requirements for such transactions are limited.  Further, even if certain actions are prohibited, penalties for non-compliance are usually nominal. 

According to the ACGA, the lack of effective rules in this area can lead to abuse and negative consequences for investors in India.  For instance, companies could (1) spin off valuable assets from listed companies to unlisted private entities for the benefit of controlling shareholders, (2) spin off investments in groupf companies to a holding company, valuing the investments at a steep discount, and then buy back shares of the holding company from the market, or (3) shift new business to unlisted private entities and let an affiliate listed company pay for operational costs.  The temptation to exploit the lack of effective rules is compounded when the business is family-owned.  For instance, controlling shareholders may seek to spin-off assets to appropriate large amounts of wealth for personal or family use or to effect inter-generational transfers of wealth. 

In an effort to remedy the deficiencies within the existing regime, the ACGA recommends that (1) independent shareholders approve material transactions above certain limits, (2) disclosure requirements for material transactions be enhanced, (3) independent financial advisors and board committees determine whether material transactions are fair and reasonable to all shareholders, (4) independent directors exercise their duties more diligently, and (5) companies with numerous related transactions establish related-party transaction committees to evaluate such transactions. 

Closely related to the issue of affiliate transactions is that of preferential warrants.  The ACGA notes that warrants are typically issued as a sweetener and accompany a rights issue or a new issue of bonds or preferred stock.  However, in India this is rarely the case.  Rather, warrants are offered to controlling shareholders on a preferential basis. 

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