The Related-Party Funding Test: How Facility Funds Reach Promoter Families Through Channels the Disclosure Framework Does Not Capture

The borrower does not transfer facility funds directly to the promoter’s personal account. That would be visible in the bank statement, documented in the ledger and immediately flagged by even the most cursory monitoring review. No promoter who intends to divert facility funds would create a direct trail.

Instead, the transfer occurs through layers. Each layer adds distance between the borrower and the ultimate beneficiary. Each layer has its own documentation, its own business justification and its own legal identity. Each layer, examined independently, looks legitimate. The layers, examined as a connected sequence, reveal a transfer mechanism that the disclosure framework was not designed to detect.

The borrower pays Rs 50 lakh to Vendor X for “technical consulting services.” Vendor X is a sole proprietorship operated by the promoter’s wife’s brother. The proprietorship has no employees, no other clients and no visible consulting capability. It was established four months before its first invoice to the borrower. Vendor X transfers Rs 45 lakh to Entity Y, a private trust whose beneficiaries are the promoter’s minor children. Entity Y uses the funds to purchase a residential flat in Pune.

The borrower’s financial statements show a Rs 50 lakh payment to a vendor for services. The payment is classified as an operating expense. The vendor is not disclosed as a related party because the connection (wife’s brother’s proprietorship) sits outside the scope of the standard related-party self-declaration, which captures directors, KMP, their spouses and dependent children but does not systematically extend to the extended family network through which related-party arrangements are commonly structured in Indian promoter-led businesses.

Why self-declaration fails as a control

The Companies Act, 2013 requires related-party disclosure. The disclosure relies on self-declaration by directors and KMP. The declarations are submitted annually. They capture what the declarant chooses to disclose. They do not capture what the declarant chooses not to disclose, either because the connection is genuinely unknown (a director may not know that a vendor is controlled by a distant relative) or because the connection is deliberately excluded (the arrangement was structured specifically to fall outside the disclosure requirement).

The architecture of diversion exploits this gap. A promoter who wishes to extract value from the borrower does not route the extraction through a disclosed related party (that would be detected). The promoter routes it through a counterparty that is connected through a relationship the disclosure framework does not require to be declared: a relative’s proprietorship, a trust controlled by family members, a company incorporated by an associate, a partnership where the connection is one or two layers removed from the promoter.

The Twelve-Layer Independence Verification

Northrop’s detection methodology does not rely on self-declaration. It independently tests every significant counterparty across twelve dimensions.

1. Common registered addresses (the vendor’s registered office is the same building, floor, or unit as the borrower, the promoter’s residence or another group entity)
2. Common directors, current or historical (the vendor had a director who also served on the borrower’s board, even if the directorship has since been resigned)
3. Common shareholders, including through layered entities (the vendor is owned by a company that is owned by the promoter’s family trust)
4. Common employees across payroll and contractor records (a person on the borrower’s payroll also appears on the vendor’s records)
5. Common contact information (shared phone numbers, email addresses, fax numbers, or IP addresses used for filing)
6. GST data connections (consecutive or similar GSTINs, filing patterns that mirror the borrower’s, common PAN-linked entities)
7. Bank account connections (the vendor’s bank account shares a signatory with the borrower or with the promoter personally)
8. Transaction timing patterns (payments to the vendor concentrate at quarter-end, or the vendor invoices only when the borrower needs to show expenditure)
9. Common intermediaries (the same chartered accountant, the same company secretary, the same registered office provider services both the borrower and the vendor)
10. Counterparty substance (incorporation date, paid-up capital, employees, premises, other customers, filed returns, operational activity)
11. Pricing anomaly (the vendor charges significantly above the market rate for the same goods or services without quality or service justification)
12. Round-tripping indicators (funds paid to the vendor return to the borrower or to a connected entity within a defined window)

A counterparty that fails five or more layers is not necessarily fraudulent. But the probability that the counterparty is genuinely independent of the borrower, when it fails on five dimensions simultaneously, is low enough to warrant detailed investigation.

Fund flow tracing for flagged counterparties

For every counterparty flagged by the twelve-layer test, the money is traced beyond the initial payment. Where did the Rs 50 lakh go after it reached Vendor X? Was it retained (the vendor used it to fund its operations, pay its staff, purchase its own supplies)? Or was it forwarded (the vendor transferred 80% or more of the received amount to another entity within a short window)?

If the funds were forwarded, the receiving entity is subjected to the same twelve-layer test, and its onward transfers are traced in turn. The trail continues until the money reaches a natural person, a property, an investment or an asset.

Identifying the ultimate beneficiary

The ultimate beneficiary is the person or entity that receives the economic benefit of the diverted funds. In the example above, the ultimate beneficiary is the promoter’s family (through the trust that purchased the property). The beneficiary may be the promoter directly (funds reaching the promoter’s personal account), the promoter’s family (through trusts, family companies, or joint holdings), a connected business (capitalised with the diverted funds), or a personal investment (property, securities, deposits) held in a name connected to the promoter.

The identification of the ultimate beneficiary converts the finding from “Rs 50 lakh was paid to a vendor without substance” (which the borrower can explain as a commercial misjudgment) to “Rs 45 lakh of facility funds were used to purchase a property for the promoter’s children” (which the borrower cannot explain as anything other than diversion).

Quantification and reporting

The total facility funds that reached connected parties through indirect channels are quantified. The quantification includes: the aggregate amount diverted, the percentage of the facility, the number of channels used, the intermediary entities involved, the ultimate beneficiaries identified and the assets or investments acquired with the diverted funds.

The finding is presented to the lender’s forensic committee in the prescribed format, with every link in every chain traced to a primary document (bank statement, MCA filing, property registration record, trust deed) and the working paper file assembled for independent retracing.

Northrop applies this test in forensic audits and related-party exposure reviews. Business@NorthropIndia.com | +91 92899 25657.