9.2 Related Party Transactions (RPT) Policy and Governance

9.2 Related Party Transactions (RPT) Policy and Governance

In corporate finance and capital markets, Related Party Transactions (RPTs) are commercial contracts or financial arrangements entered into between a corporation and its insiders, controlling shareholders, or affiliated group companies. While intra-group contracts and related party dealings can generate operational synergies and administrative efficiencies, they create acute conflicts of interest and expose minority stockholders to the risk of abusive tunneling—the siphoning of corporate assets, opportunities, or profits to controlling insiders through non-arm's length terms.

To safeguard capital market integrity, the Securities and Exchange Commission enacted SEC Memorandum Circular No. 10, Series of 2019 (Rules on Material Related Party Transactions for Publicly-Listed Companies), complementing the statutory fiduciary rules of the Revised Corporation Code of the Philippines (RA 11232).

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Statutory Foundation: Self-Dealing and Interlocking Directors

The regulation of RPTs in the Philippines is rooted in the fiduciary duties established by the Revised Corporation Code (RCCP):

1. Contracts of Self-Dealing Directors (Section 31)

Under Section 31 of the RCCP, a contract between the corporation and one or more of its directors, trustees, officers, or their spouses and relatives within the fourth civil degree is voidable at the option of the corporation, unless all of the following conditions are met:

• The presence of the interested director in the board meeting approving the contract was not necessary to constitute a quorum;
• The vote of such director was not necessary for the approval of the contract;
• The contract is fair and reasonable under the circumstances;
• In the case of an officer, the contract has been previously authorized by the board of directors.

2. Contracts Between Interlocking Directors (Section 32)

Contracts between corporations with interlocking directors (directors serving on both boards) are generally valid if there is no fraud and the contract is fair and reasonable. However, if the interlocking director's interest in one corporation is substantial (holding stock exceeding twenty percent (20%) of the outstanding capital stock) and nominal in the other, the contract becomes subject to the stricter self-dealing rules of Section 31.

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SEC Memorandum Circular No. 10, Series of 2019

SEC MC No. 10-2019 mandates that every publicly listed company (PLC) formulate, implement, and publicly file a comprehensive Material Related Party Transactions Policy. This policy must establish transparent procedures for identifying, reviewing, approving, and disclosing related party dealings.

Defining Related Parties

Under SEC MC No. 10-2019, covered related parties encompass:

1. Corporate Affiliates: The company's parent company, subsidiaries, fellow subsidiaries, joint ventures, and associates under common control;
2. Directors and Key Management Personnel: Members of the board of directors, the CEO, COO, CFO, Corporate Secretary, Treasurer, and executive officers who possess authority and responsibility for planning, directing, and controlling company operations;
3. Substantial Stockholders: Any person or juridical entity that directly or indirectly holds beneficial ownership of ten percent (10%) or more of the voting shares of the company;
4. Close Family Members: Spouses and relatives of directors, officers, or substantial shareholders up to the fourth civil degree of consanguinity (bloodline) or affinity (marriage). This includes parents, children, siblings, grandparents, grandchildren, great-grandparents, great-grandchildren, uncles, aunts, nephews, nieces, and first cousins;
5. Related Entities: Any entity over which an individual related party (or their close family members) exercises significant influence or holds substantial equity.

                      Related Party Ecosystem (SEC MC No. 10-2019)
                                         │
         ┌───────────────────────────────┼───────────────────────────────┐
         ▼                               ▼                               ▼
Corporate Entities              Individual Insiders              Family & Associates
- Parent Company               - Directors                      - Spouses
- Subsidiaries                 - Executive Officers             - Relatives to 4th Degree
- Affiliates & JVs             - Substantial Owners (≥10%)      - Controlled Entities

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The Materiality Threshold and Aggregation Rule

Not all related party transactions require exhaustive board and regulatory clearance. SEC MC No. 10-2019 establishes a precise quantitative threshold distinguishing ordinary operational RPTs from Material Related Party Transactions (MRPTs).

The 10% Total Asset Threshold

An RPT is statutorily classified as Material if it involves an amount, singly or in the aggregate, equal to or exceeding ten percent (10%) of the company's total consolidated assets, based on its latest audited financial statements (AFS).

$\text{MRPT Threshold} = \text{Transaction Value} \ge 10\% \times \text{Total Assets (Latest AFS)}$

The 12-Month Aggregation Rule

To prevent corporate insiders from circumventing the 10% materiality threshold by breaking down large contracts into smaller, piecemeal arrangements, SEC rules enforce the 12-Month Aggregation Rule:

• Any series of transactions entered into within a twelve (12) month period with the same related party (or related parties under common control) must be aggregated.
• Once the cumulative value of these aggregated contracts reaches or exceeds the 10% total asset threshold, all subsequent transactions within that 12-month window become subject to full MRPT board approval and disclosure mandates.

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Approval Architecture: RPT Committee and Board Governance

To ensure that material related party transactions are executed strictly on arm's length terms (terms no less favorable than those obtained from unrelated third parties), the SEC prescribes a rigorous two-tier internal review and approval process:

1. Review by the RPT Committee

Under Recommendation 3.5 of the Code of Corporate Governance for PLCs, the Board should establish a dedicated Related Party Transactions Committee:

• Composition: Composed entirely of non-executive directors, a majority of whom must be independent directors;
• Leadership: Must be chaired by an independent director;
• Mandate: Evaluates the commercial rationale, terms, pricing, and potential conflict of interest of the proposed transaction before it is submitted to the full Board of Directors. The committee must confirm that no corporate opportunity is misappropriated and that minority shareholders are not disadvantaged.

2. Board Approval Threshold

Once endorsed by the RPT Committee, the Material Related Party Transaction must be formally approved by the full Board of Directors under strict voting parameters:

Mandatory Recusal of Interested Directors

Any director who has a personal, financial, or familial interest in the transaction must:

• Formally disclose the nature, extent, and value of their interest to the board;
• Recuse themselves completely from board deliberations and negotiations;
• Abstain from voting on the transaction. The interested director's presence cannot be counted toward the required quorum for that resolution.

Stockholder Ratification Alternative

In circumstances where a majority of the independent directors is unavailable (e.g., due to vacancies, recusal, or dissent), SEC rules permit the MRPT to be submitted to the shareholders for ratification. The transaction must be ratified by stockholders representing at least two-thirds (2/3) of the outstanding capital stock, excluding shares held by the interested related party.

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Independent Third-Party Valuation and Fairness Opinions

To ensure that transaction terms are fair, reasonable, and commercially defensible, the Board must substantiate the transaction value with an independent benchmark:

• Mandatory Requirement: The company must engage an independent financial adviser or accredited third-party valuation provider;
• Fairness Opinion: The valuation provider issues an independent fairness opinion certifying that the proposed pricing, interest rates, asset valuations, or payment structures reflect fair market terms;
• Accreditation: The valuation provider must be duly registered and accredited by the SEC and the PSE, possessing zero financial interest in the transaction or the parties involved.

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Regulatory Disclosure and Filing Requirements

Transparency is the ultimate safeguard against abusive related party transactions. SEC MC No. 10-2019 establishes stringent reporting deadlines:

1. Advisement Report on Material Related Party Transactions

• Statutory Filing: The company must submit an Advisement Report on Material Related Party Transactions to the SEC and the PSE;
• Filing Deadline: Within three (3) calendar days from the date of the execution of the transaction contract or agreement;
• Required Disclosures: Identity of the related party, exact relationship, transaction value, percentage of total assets, commercial justification, summary of the fairness opinion, and certification of board approval (confirming the 2/3 board vote and independent director majority).

2. Integrated Annual Corporate Governance Report (I-ACGR)

A comprehensive summary of all material and non-material related party transactions entered into during the preceding calendar year must be disclosed in the company's annual I-ACGR, detailing compliance with the approved Material RPT Policy.

3. Financial Statement Notes (PAS 24)

Under Philippine Accounting Standard 24 (PAS 24 / PFRS), related party relationships, transaction amounts, outstanding balances, loan terms, and commitments must be disclosed in the Notes to the Audited Financial Statements.

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Comparison: Ordinary RPTs vs. Material RPTs

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Practical Exam Traps and Regulatory Pitfalls

• Trap 1: The 10% Base Metric. Exam questions often test whether the 10% threshold applies to gross revenues, net income, or market capitalization. Remember: It is strictly ten percent (10%) of total consolidated assets based on the latest audited financial statements.
• Trap 2: Calendar Days vs. Business Days. The Advisement Report must be filed within three (3) calendar days, not three business days. If a contract is executed on a Friday, the filing cannot wait until the following Wednesday.
• Trap 3: Family Relationship Degrees. The scope of related parties extends to the fourth civil degree of consanguinity or affinity (including first cousins and aunts/uncles). It is not restricted merely to immediate household members.
• Trap 4: Board Approval Threshold. Watch out for options suggesting a "simple majority of the board." MRPT approval strictly requires a two-thirds (2/3) supermajority of the entire board, and that supermajority must include a majority of the independent directors.