“Related party transactions have been a feature of a number of financial scandals in recent years, many of which have had in common the dominance of the company by a powerful chief executive who was also involved with the related parties.”
It is prevalent for related party transactions to be part of business because cultural and political forces lead to a relationship-based system in market economies.. Sir David Tweedie’s statement portrays the reality of the situation quite well. Accounting and financial problems often linger and can worsen throughout the years if there is no good governance in place to underpin and mandate good conduct and good judgment of a company. A good governance practice must include both policy and processes for managing Related Party Transactions to reduce corporate risk and protect members’ interests.
But where to start? As a basic understanding of the concept, Related Party Transaction is defined as a transaction entered into by a company or its subsidiaries which involve the interest, direct or indirect, of a related party. Related Party refers to director, major shareholder or persons connected with any such director or significant shareholder.
I will illustrate situations where Related Party Transactions may arise and the requirements of which parties need to comply to avoid illegal and void transactions being entered into. I will then explain via hypothetical situations where related party transactions may happen. It is important to recognize that not all related party transactions can be anticipated—that is why there must be a process in place to deal with the problem before it is too late to do anything about it.
Here is a not-uncommon scenario. Company ABC Berhad is a listed company and the Company’s nature of business is property development with core competency in development and raw real estate with development potential. The shareholders of the Company are Company DEF Sdn Bhd (40%), Company GHI Sdn Bhd (30%) and Company JKL Sdn Bhd (30%). The Directors of Company ABC Berhad are Encik Ali, Encik Lim and Encik Ramu. Audited Financial Statements for the Financial Year ended 31 March 2016 shows the net assets of Company ABC Berhad is RM6,000,000.00.
One day Company ABC Berhad decides to develop a new project in and they are looking for a parcel of raw land in Setia Alam, for the project.
Company Director Encik Ali proposes to Company ABC Berhad to acquire a parcel of land in Shah Alam which belongs to his stepson, Encik Saiful. Encik Ali convinces the other Directors of Company that the land poses real opportunity Company ABC Berhad and Encik Saiful have a discussion on the terms and conditions of the acquisition of the land. They come into an arrangement for consideration price of RM2,000,000.00 for the acquisition of said land. Is this a related party transaction under Malaysia law?
We need to see whether the parties, Company ABC Berhad and Encik Saiful are legally considered to be related to each other within the concept of Related Party Transaction? Under Section 122A of Companies Act 1965, a person shall be deemed connected with a director if he is a member of that director’s family. Section 122A (2) of Companies Act 1965 has further defined that stepchildren shall be considered to be part of director’s family. In view of this section, Encik Saiful is deemed to be connected/related with Encik Ali, one of the directors Company ABC Berhad.
So how must the Company deal with this problem? First, Section 132E of Companies Act 1965 provides a company shall not carry any transaction where a person connected with such a director dispose of his non-cash assets of the requisite value to the Company. The transaction shall be void unless the transaction has been approved by resolution of the company at a general meeting. Encik Ali being “related” to the seller, Encik Saiful must also abstain from voting during the Board of Directors meeting.
Second, was the action of acquiring the Land by the Company is a type of transaction that falls within the concept of Related Party Transaction? Since Company ABC Berhad is a listed company, Clause 10.2 (l)(i) of Chapter 10 of the Companies Act provides that the act of acquiring an asset by Company is part of the definition of ‘transaction’ under Related Party Transaction.
Third, we need to ask what is the percentage ratio of the transaction involved, or stated another common way, is it a material transaction? Materiality is calculated from the value of the assets compared to the net assets of Company ABC Berhad. We can refer to the consideration of the transaction or refer to the value stated in the valuation report to establish the value of the Land. If the percentage ratio is calculated to be 0.25% or more, the Company is required to make an announcement of the transaction to Bursa Malaysia Berhad as soon after the terms of transaction have been agreed unless the value of the consideration is less then RM500,000.00 or it is a recurrent Related Party Transaction. If the percentage ratio is 5% or more, the Company is required to (i) announce the transaction to Bursa Malaysia Berhad as soon after the terms of the transaction have been agreed (ii) issue a circular to its shareholders and obtain shareholders’ approval in general meeting and (iii) appoint an independent adviser who is a corporate finance adviser within the meaning of the Security Commission’s Principal Adviser Guidelines before the terms of transaction are agreed upon. If the percentage ratio is more than 25%, in addition to the above requirements, Company ABC Berhad is required to appoint a main adviser, who is a Principal Adviser before the terms of transaction are agreed upon.
But there are additional requirements for many related party transactions. In our hypothetical, the property developer must submit to Bursa Malaysia Berhad two (2) copies of the valuation report on the Land concerned and a copy of the valuer’s opinion letter immediately after the Company announces the transaction or at least one month before submitting the draft circular.
Confusing? Yes. Important to understand, very much so! . There are many possible transactions which could be entered by parties such as disposal and leasing of assets, establishment of joint ventures, the provision of financial assistance, or any business transaction or arrangement entered into by company or its subsidiaries with a Related Party which can be categorized as potential Chapter 10 Transactions. Each transaction may have a different method in calculating the percentage ratio as per Clause 10.03.
Related Party Transactions are not totally prohibited in business as long as the interested parties and details of transactions are properly disclosed The time for every company to ensure they are applying the highest possible standards of ethical, moral and legal business conduct is before they enter into these type of transactions. Hindsight may not save you from a serious legal infraction. ,
Business leaders the Directors that have a duty to achieve good and coherent corporate governance in Malaysia. Each company must ensure their employees understand these policies and procedures. That begins with the proper identification and evaluation of any transaction that might be considered a Related Party Transaction under the the Companies Act 1965 and related laws. A legal advisor is a necessity in this evaluation. If you need one, or don’t know if you need one, do not hesitate to call me.
Najwa Aqilah Mansor
Mohamed Ridza & Co.
Tel: +603- 20924822