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BY 4.0 license Open Access Published by De Gruyter December 4, 2021

Related Party Transactions – a closer look at the emergence of the new EU regime

  • Rolf Skog EMAIL logo

The Amended Shareholders’ Rights Directive adopted in 2017 pushed the regulation of related party transactions high up on the Member States’ legislative agenda. The Directive requires binding rules addressing related party transactions in listed companies. This article takes a closer look at the discussions and negotiations in the EU institutions leading up to the Directive adopted and ends with some reflections on the EU legislative process, drawing on my decades long ministerial experience of negotiating and implementing EU legislation in the field of company law, including this one.

I. Introduction

A well-known problem confronting limited companies with many shareholders is the risk that the company will take decisions regarding transactions which are not intended to promote the interests of all its shareholders, or not promote the interest of the shareholders at all. Potential scenarios involve transactions which are instead envisioned to promote the interests of members of the company’s board of directors or management, or transactions which are designed to promote the interests of only one or several shareholders in particular.

This problem is often addressed in legal and economic literature by reference to “related party transactions”, RPT. The term has no precise definition. The first component, “related party”, originally pertained to board members and company management, but now more frequently includes large shareholders as well. The second component of the term, “transactions”, is at its root used to describe transactions by which a company acquires or disposes of various assets. Applying a somewhat more far-reaching interpretation, the second component can also incorporate agreements which govern various types of services, borrowing or lending money, and the provision of collateral. Allowing for an even more expansive meaning, related party transactions may also include, for example, decisions regarding remuneration of board members or managing directors. Sometimes even decisions not to carry out a certain transaction – in order to yield to some related party who will instead pursue the transaction – are regarded as related party transactions. The broader the meaning ascribed to the term, the more it appears that the problem involving related party transactions is a subset of the general conflicts of interest problem that exists in most limited companies.[2] This complicates discussions regarding specific legal rules for company decisions on related party transactions.

It should be kept in mind at this juncture that transactions between a company and a related party are not always per se “problematic” in the sense that they are always or often detrimental to the collective of shareholders.[3] Many related party transactions are carried out every day to the benefit of the shareholders, not the least within groups of companies. The problem arises when a company pursues a related party transaction in such a way that it is incompatible with the interest of the shareholders in maximising company value, as is normally the case when the transaction is deliberately not carried out on market terms and conditions in order to benefit, directly or indirectly, the related party.

The reality that a limited company can take decisions regarding transactions for the benefit of related parties and to the detriment of the collective of shareholders has been recognised since the infancy of the limited company form. Legal history is full of examples.[5] The problem is a nearly inevitable consequence of the organisation of limited company and is addressed in company legislation throughout the world.[6] Given the fact that related party transactions are not detrimental by definition, the problem cannot efficiently be addressed by prohibiting such transactions in general. Rather, the solution often takes the shape of rules which oblige corporate bodies to act in the interest of the company and, thereby, the collective of shareholders and to subject shareholders to equal treatment.[7] This is also achieved, for example, by the application of conflict-of-interest rules to board members of the company.

The risk associated with related party transactions that are unfavourable to the company is also addressed by accounting rules, typically by virtue of requirements according to which companies must provide information in their annual reports regarding transactions carried out with related parties during the financial year.

The overall purpose of these rules is to minimise the risk of harmful related party transactions, a goal which may be presumed to reinforce confidence in the limited company and the stock market and, thereby, ultimately reduce capital costs.

II. Related party transactions in the modern corporate governance discussion

Notwithstanding the presence of the company- and accounting-law regimes, the risk of related party transactions detrimental to the shareholders plays a prominent role in the modern corporate governance discussion. In many countries, regulatory schemes and opportunities to subsequently prosecute transgressions of the rules are regarded as inadequate to mitigate the risk of harmful related party transactions, particularly transactions involving large shareholders. The OECD Committee on Corporate Governance drew attention to this problem in several country studies at the beginning of the 2000’s and noted in a 2012 global survey that, “Around the world one of the most commonly heard complaints about corporate behaviour relates to self-dealing transactions by corporate insiders that can either be management, directors and/or controlling entities or shareholders”.[8]

Within the EU, attention was first drawn to the RPT-problem by the European Corporate Governance Forum, an expert group appointed by the Commission at the beginning of the 2000’s and tasked with providing the Commission with guidance in the area of corporate governance. In a statement in 2011, the expert group recommended that the Commission consider the implementation of common decision and information rules in the Member States regarding related party transactions in listed companies.[9]

The Commission took the recommendation of the expert group ad notam. A mere couple of weeks later, the Commission presented a Green Paper entitled “The EU Corporate Governance Framework” and presented in an “open consultation” the issue of whether company law protection of minority shareholders within the Union required specific rules concerning related party transactions.[10] In keeping with the trends in the global corporate governance debate, institutional shareholders and asset managers were supportive of such rules at the EU level, while business organisations were more apprehensive.

The Commission, which strongly emphasised the need to improve the attractiveness of large European companies on the global capital market, supported the stance adopted by the institutional investors and indicated in the Company Law Action Plan presented the following year, 2012, that it would put forward a proposal regarding regulation of related party transactions.[11] The Commission followed through two years later.

III. The Commission’s proposal for EU rules on related party transactions

The Commission’s proposal for RPT-regulation was included in the proposal for a directive amending the Shareholder Rights Directive which was presented in the spring of 2014.[12] The overall purpose of the proposed Directive was to improve corporate governance in European listed companies. By virtue of reforms in miscellaneous areas, the engagement of shareholders would increase, and shareholders would exercise greater influence in certain areas, including decisions regarding related party transactions.

The proposal to regulate related party transactions was closely aligned with the recommendation of the European Corporate Governance Forum.[13] The proposal had two fundamental components. One of them addressed ex ante publication of related party transactions while the other concerned a procedure governing the decision making regarding such transactions.

On the issue of publication, the proposal entailed that the existing ex post regime requiring publication of completed transactions primarily in the annual accounts of a company was to be supplemented with an ex ante regime. Listed companies should be required to publish, not later than the date of execution of the transaction, transactions with related parties in the event the value of the transaction corresponded to more than one per cent of the company’s assets. A company was also to publish a sort of fairness opinion from an independent third party certifying that the transaction was carried out on market terms and confirming that it was fair and reasonable from the perspective of the shareholders.

According to the proposal, decisions regarding related party transactions were to be adopted by the shareholders at a general meeting in the event the transaction represented more than five per cent of the company’s assets or could have a significant impact on profits or turnover. In addition, related party transactions between the company and a shareholder would bar the shareholder from participating in the resolution of the general meeting.[14]

It was proposed that the issue of who is to be regarded as a related party was to be governed by means of reference to the “related party” term in IAS 24.

The proposal was, as mentioned, quite similar to the recommendation by the European Corporate Governance Forum. Keeping in mind the reaction of the Member States to the proposal, which I will discuss below, one might wonder whether the Commission acted somewhat hastily and uncritically in incorporating the brief recommendation – which the Forum characterised as “guidelines” – in the text of the Directive.

IV. The negotiations regarding the Commission’s proposal

The Commission’s proposed directive was submitted in April 2014 to the Council and the European Parliament, each of which began deliberations regarding the proposal. As with the original Shareholder Rights Directive, the adoption of the amending directive would require that the Council and European Parliament agreed on the content of the directive. The decision of the Council was to be taken by a qualified majority which, in practice, rendered it a necessity to obtain the support of the large Member States. In the Parliament, the decision was to be taken by a simple majority.[15]

A. The negotiations in the Council

In the Council, which was led by Greece during the first half of 2014, the basic negotiations were carried out by the Council Working Party on Company Law, consisting of officials from the relevant ministries or authorities in the Member States. The Commission presented the proposed directive to the Working Party in May 2014. At that time, the Member States had not had sufficient time to familiarise themselves with the proposal but even during the first meeting several Member States expressed considerable doubt about imposing additional administrative burdens on European companies.

I. The Italian Presidency

At mid-year 2014, the Presidency of the Council was taken over by Italy. This turned out to play a decisive role in the continued negotiations, primarily on the issue of related party transactions.

In order to understand the progress of the negotiations, it is necessary to recall the legal situation concerning related party transactions in the large Member States at the time the negotiations started. In brief, France, the United Kingdom and Italy had implemented related party transaction rules which were similar to the Commission’s proposal in so far as pertained to the regulations which were ex ante in character, i. e., requiring publication and a certain decision-making procedure for related party transactions. However, the rules were formulated quite differently in the three Member States. The French rules had long been implemented in law and were supplemented by relatively extensive jurisprudence.[16] The rules were based on a combination of publication and decisions at the board level with subsequent approval by the shareholders at general meetings.[17] The rules in the United Kingdom were incorporated in part in the Companies Act and in part in the listing rules issued by the Financial Conduct Authority for so-called premium listed companies on the London Stock Exchange.[18] The latter and, in this context, most interesting rules were based on a combination of publication and, as regards large transactions, resolutions adopted by general meetings.[19] The Italian rules were for the most part entirely new. Only three years before were they introduced in the rules and regulations of the Italian Financial Supervisory Authority (CONSOB) and were based on a combination of publication and decisions by “independent” board members.[20] Germany had no rules approximating those proposed by the Commission. There, related party transactions were addressed on an ex post basis with reference to the rules regarding, among other things, equal treatment of shareholders in conjunction with, inter alia, so called hidden distributions. Related party transactions in groups of companies were addressed in the German Konzernrecht.[21]

During the Italian Presidency, the Council Working Party was led by a high-ranking official from the CONSOB, Marcello Bianchi, who had played a prominent role a couple of years prior in the drafting of the Italian related party transaction rules.[22] In terms of expertise, there can be no doubt that this afforded the Presidency a very strong position during the negotiations both in relation to most Member States as well as in relation to the Commission. It also established a solid foundation for a dialogue with the rapporteur in the European Parliament, a subject to which I will return.

The first meeting with the Working Party during the Italian Presidency took place at the end of July in 2014. The meeting focused on the related party transaction rules. Several Member States once again expressed concerns that the regime would enhance the administrative burden on companies and cause even fewer companies to tap the public equity market. It was clear at the meeting that Germany and France, with their differing points of departure, were quite sceptical about regulating related party transactions in the directive at all. Germany was concerned that it would be compelled to amend its legislation pertaining to corporate groups, and also believed that the decision-making regime proposed by the Commission was incompatible with the dualistic German corporate-governance model. France did not, in short, wish to alter its existing related party regime. In addition, the United Kingdom, whose related party transaction regime obviously had influenced the Commission’s proposal, did not welcome the proposal.[23] The rules were deemed, among other things, to apply too broadly while at the same time being too specific. Italy’s resistance to the proposal was expressed, during the Presidency period, not explicitly but rather through the actions of its chairmanship.

The Commission defended the proposal, but the Presidency decided early on to draft a new proposal which was presented in mid-November.[24] As is customary, the proposal was presented as a Presidency “compromise” proposal, but it was de facto very far from the Commission’s proposal in critical respects.[25] Hardly surprising, the proposal was instead substantially inspired by the Italian RPT-regime.

The Commission’s proposal was based on the notion that related party transactions which were substantial from a shareholder perspective were to be published and, if they were sufficiently large, were to be decided by means of a particular procedure. This was also the overall procedure in the Presidency proposal, but the differences were great upon closer examination.

The only aspect that actually remained unaltered was the definition of related party. On this point, the Presidency text was identical to the Commission’s proposal – the related party definition was the same as in IAS 24. Consistently, the related party definition in the Italian regime was based on IAS 24.[26]

On the other hand, as regards the transactions which were to be covered by the regime, the Presidency proposal in practice entailed abandoning the fundamental harmonisation idea of the Commission. While the Commission’s proposal contained fixed thresholds regarding the size of the transactions which were to be covered by the regime (one per cent to publish and five per cent to apply the special decision-making procedure), the proposed “compromise” entailed that the Member States themselves would get to decide on the thresholds for “substantial” transactions which would be the subject of publication and the special decision-making procedure.

The Presidency proposal also afforded Member States greater possibilities to entirely exempt certain types of transactions from the related party transaction regime. The Commission’s proposal permitted Member States to exempt transactions between a listed company and its wholly owned subsidiaries, something which must be seen as virtually obvious in light of the purpose of the rules of protecting the shareholders of the listed company. The Presidency text expanded the exemption to also cover parties other than wholly owned subsidiaries on condition that no party related to the listed company had an interest in the subsidiary or that legislation offered adequate protection for minority shareholders in the subsidiary. The latter likely had in view in particular the German corporate group regime.

Considering the concern harboured by several Member States that the directive would substantially complicate transactions within corporate groups, the proposed “compromise” also allowed Member States to exempt transactions in the ordinary course of business carried out on normal market terms. The exemption nearly matched word for word with the corresponding exemption in the French related party transaction regime.[27]

Finally, the proposed text granted Member States the right to exempt certain types of transactions with related parties that did not entail an unequal treatment of shareholders, e. g., decisions regarding issuance of shares on a pre-emptive basis or distribution of dividends.

The Presidency proposal retained the requirement of publication of (substantial) related party transactions but, with regards to the requirement of a fairness opinion from an independent third party, a significant remise was made for certain Member States according to which the opinion could be drafted by independent board members or even by the board as such or by the management, as long as the relevant related party did not have any decisive influence on the content of the opinion.

Another and highly important difference between the Commission’s proposal and the proposed compromise related to the decision-making procedure. In the Presidency text, the requirement that substantial related party transactions were to be addressed by the general meeting was replaced by the possibility for Member States to choose between addressing the matter at the board level or the general meeting level or, as in the French rules, a combination thereof.

With these far-reaching changes in the proposal, the Italian Presidency hoped that Germany and France among others would find it easier to unify it with national law. The new proposal was also certainly regarded as having the advantage that Italy would not need to implement any changes other than possibly marginal ones in the Italian RPT-regime.

As early as the meeting of the Working Party in November 2014, the Presidency could see signs of the strategy being successful. Germany was very positive to the changes. The Presidency “compromise” seemed to have solved most of the German problems. Other Member States also appreciated the increased flexibility, even though the directive provisions would not lead to any profound harmonisation of national related party transaction rules. France, the United Kingdom and certain other Member States had views on the specifics, but the principal opposition to including a related party transaction regime in the Directive had vanished.

The Working Party met on an additional two occasions during the Italian Presidency. With one exception, the continued discussions resulted in only minor amendments to the text. The sole, more substantial amendment pertained to the requirement of a fairness opinion. It was removed in its entirety and replaced by provisions which allowed Member States to impose such a requirement at their own initiative (obviously odd from the perspective of a de minimis harmonisation directive). In this way the remaining doubt entertained by certain Member States on this point was also gone.

II. The Latvian Presidency

On 1 January 2015, the Presidency of the Council passed to Latvia, which continued to work on the proposed directive. In so far as pertains to the related party transaction rules, only one major question actually remained. As mentioned above, already in the first-proposed compromise, the requirement for the approval of the general meeting of substantial related party transactions was replaced by the possibility for Member States to choose between the approval by the board of directors or by the general meeting. However, the proposal preserved the restriction that the related party itself could not participate in the decision. In the event the transaction was carried out with a board member or with a shareholder, they would not be permitted to participate in the decision taken by the board or the general meeting, respectively. As for Italy (which, after transferring the Presidency to Latvia, explicitly declared its position), Spain and a number of smaller Member States, this was not acceptable. They wanted no prohibition whatsoever. In its eager to push the directive through, the Latvian Presidency promised to examine whether this matter could also be left to be decided upon at national level.[28] It did not go quite so far but, prior to the last meeting of the Council Working Party in March 2015, the Presidency presented a complex amendment which entailed that Member States could allow a shareholder who is a related party to participate in voting on the transaction in question, “provided that national law ensures appropriate safeguards which apply before or during the voting process to protect the interests of the company and of the shareholders who are not a related party, including minority shareholders, by preventing the related party from approving the transaction despite the opposing opinion of the majority of the shareholders who are not a related party or despite the opposing opinion of the majority of the independent directors”. The specific meaning of this amendment could hardly have been obvious to everyone at the negotiations table, but it was sufficient to humour the Member States which opposed the prohibition.[29]

A couple of weeks after the last meeting of the Working Party, the Council approved, in April 2015, the result of the Working Party negotiations. The position of the Council prior to the impending deliberations with the European Parliament was thus established. But what had been the reaction by the European Parliament to the Commission’s original proposal?

B. The discussions in the European Parliament

In April 2014, the Commission’s proposed directive with the original proposal for a regulation of related party transactions was submitted simultaneously to the Council and the European Parliament where it was addressed by the Legal Affairs Committee (JURI). As is customary, a rapporteur was appointed to prepare a report for the Parliament with a proposal for any amendments to the Commission’s proposal. The Italian parliamentarian, Sergio Cofferati, was appointed to the role of rapporteur, which likely created favourable conditions for the communications with the Italian Presidency of the Council.

While the interest of the European Parliament in corporate governance issues in general and the Commission’s proposal for amendments to the Shareholders’ Rights Directive was relatively substantial, interest focused primarily on aspects of the proposal other than the regulation of related party transactions. From political perspectives, it was primarily those elements of the proposal which concerned remuneration of board members and directors which were of interest.

In December 2014, the rapporteur presented a draft report regarding the Commission’s proposal. A number of parliamentarians expressed views regarding the draft resulting in a reworking which related, among other things, to the rules regarding related party transactions. In July 2015, the Parliament supported the report.

The European Parliament’s views on the related party transaction regulation corresponded very closely to the result of the negotiations in the Council. There is every reason to believe that the Council Working Party – not the least under the Italian Presidency – had a good relationship with the rapporteur and his staff who otherwise hardly possessed any expertise regarding related party transactions.

It is likely that the Italian side, including interest organisations in the Italian business community, also made contact with influential members of parliament in this context. Examining the proposals for amendments to the draft of the Parliament’s report which was submitted to the parliamentarians in the spring of 2015, it is notable, among other things, that Italian parliamentarian Giovanni Toti submitted a number of proposals concerning the related party transaction rules which reflected word-for-word the Council’s proposal.[30]

C. The trialogue

In the summer of 2015, just over one year after the Commission presented the proposal for amendments to the Shareholders’ Rights Directive, the positions of the Council as well as the European Parliament were already clear. It was obviously quickly worked out, and anyone might have believed that the Council, the Parliament and the Commission could also chisel out the final text of the directive in a concluding trialogue in a relatively short period of time.

Yet, this was not the case at all. The reason was that the European Parliament, in its report on the Commission’s proposal, had not limited itself to the questions addressed by the proposal but had also introduced an entirely new subject, namely the so-called country-by-country reporting of the profits and tax payments made by multi-national companies. Both the Council and the Commission were firm in their opposition to raising this issue in the Shareholders’ Rights Directive, but the Parliament maintained its position until such time as the matter, one year later, was resolved by means of another EU directive.[31]

Only in the spring of 2017 was the decision-making process concluded in all respects. The Council and European Parliament stood behind the result of the trialogue and, in June, the directive regarding amendments to the Shareholders’ Rights Directive was published in the Official Journal.[32]

V. The final result

The negotiations regarding the related party transaction regulation resulted in a regime which only on the surface approximated the Commission’s original proposal. While it is an ex ante regime, it is a very diluted one. First of all, it leaves to the Member States to determine which transactions are “substantial” and are to be covered by the regulation. Secondly, it does not require the decision regarding such transactions to be taken by the shareholders but, rather, allow it to be taken at the board level. Thirdly, the regime indeed requires that decisions regarding related party transactions to be published no later than at the time they are executed, but does not require that companies present a fairness opinion to support the assessment by shareholders and the market of the transaction. Finally, the regulation also contains a number of exemptions which leave ample room for Member States to limit its area of application.

The final result might lead to a number of reflections. The first is how skilfully Italy handled its Presidency position and took advantage of the opportunities offered by the situation. Fundamentally, the final result is very close to the Presidency “compromise” presented by the Italian chairman to the Council Working Party already at the beginning of the Italian Presidency period. All of the amendments to the proposal subsequently brought about by the negotiations in the Working Party were liberating in nature – they further enhanced the freedom of the Member States and thereby their possibility to preserve existing related party regulations. The provisions of the Directive which were ultimately adopted did not bring about any change in the Italian related party transaction rules.

Did Italy put its interests ahead of those of the Union? Perhaps. But, looking back on directive negotiations in which I have participated over the years, I have difficulty recalling any Member State in the Presidency seat acting differently. In the negotiation context, it is for most Member States an obvious strategy to preserve its own national regime wherever possible. This also applies during a Presidency.

As regards the Italian Presidency, one must also keep in mind that the ItalianRPT-regulation had been introduced only a couple of years earlier and was drafted following extensive discussions and analyses of the problem.[33] The Italian regime was undeniably a modern one in many respects. It is easy to understand that a change was not readily wanted.

Another reflection is that the Commission, on the issue of the related party transaction regulation, largely did not live up to its general duty to harmonise company law in the Member States as established in the European Treaty.[34] The Commission’s proposal was abandoned, and the final rules grant such extensive discretion to Member States that the harmonisation effect is quite limited.[35] Is this regrettable? The issue does not allow for an easy answer. Naturally, one critical aspect is whether it at all can be taken for granted that harmonisation will benefit European businesses.[36] If this is not the case, the lack of harmonisation is easy to accept and perhaps it would have been even better if the Commission had made no proposal at all regarding RPT-regulation. Nonetheless, even if the harmonisation concept is embraced, the view might instead be that harmonisation should be achieved through less detailed and more principle-based directives. In other words, that the Member States should be given plenty of room to take decisions regarding the manner in which the result is to be achieved. The final directive provisions concerning related party transactions can perhaps be described in such terms.

Furthermore, the efforts of the Commission cannot be judged exclusively on the basis of its mission to contribute to the harmonisation of company law. An important rationale for amending the directive as such, and not the least for including a RPT-regulation, was to boost the confidence of globally active investors in European listed companies. In many Member States, there were no related party transaction rules whatsoever of the type addressed in the global corporate governance discussion. In these Member States, the related party transaction regime in the Directive, albeit quite diluted, at least put the issue on the agenda of the national regulator. This is exemplified by Germany which supplemented the existing ex post regime with certain ex ante regulations when implementing the Directive.

A third reflection pertains to the powerful position held by the Council and, above all, the large Member States on the Council during the negotiations. When the Presidency overcame the initial French, British and German resistance, the matter was nearly complete. The European Parliament had almost no independent influence on the final result.

And what about the lobbying activities of various interest organisations? The answer is that there was a great deal of this kind of activity in the form of consultation responses and miscellaneous submissions, opinions and personal contacts. Still, this was nothing specifically unique to this particular piece of EU legislation. In short, the scenario can be described such that institutional investors expressed in various ways their support for the basic idea behind the Commission proposal, i. e. to provide the shareholders with greater influence on related party transactions, while business organisations argued for a more flexible regime that would allow Member States to maintain the status quo to the greatest possible extent.

A fourth reflection, which may be made concerning almost all directives, pertains to the quality of the regulation. It is obvious that the text of a directive which takes up difficult and complex corporate governance issues, that is negotiated over a brief period of time, and which is subject to compromises amongst 28 Member States, leaves much to be desired. The text is not, and cannot be, exhaustive and leaves considerable scope for interpretation in many areas. What constitutes a correct interpretation in those cases may only be authoritatively determined by the ECJ. Yet, in implementing the directive, it is the national legislatures which are required to adopt a position since the business community, primarily companies, which are to apply the national rules adapted to the directive must at a minimum, receive some assurance regarding the implications of the rules. In this situation, it is hardly helpful to the legislature to learn from the former Presidency that in this case the directive adopted “provides more for guidance than for stringent rules”.[37]

Published Online: 2021-12-04
Published in Print: 2021-12-02

© 2021 Rolf Skog, published by Walter de Gruyter GmbH,Berlin/Boston

This work is licensed under the Creative Commons Attribution 4.0 International License.

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