It’s not uncommon that every company in its day-to-day business enters into various transactions with parties with whom they are related or have common interests. Although such transactions are themselves legal, they may create conflicts of interest or impel other illegal situations and can impact the financial position of the company. Therefore in order to protect the interest of stakeholders and maintain transparency in business such kind of transactions with Related Parties are being regulated.
Section 188 of the Companies Act, 2013 (the Act) specifically deals with Related Party Transactions which further captivate other provisions of the Act including Section 166, 173, 177, and 184. In this article, an attempt is made to explain and amplify the coverage, scope, and intent of ‘Related Party Transactions.
In order to understand Related Party Transaction, first we need to identify who are the related parties, Section 2(76) read with Rule 3 of Companies (Specification of definitions details) Rules, 2014 of the Act defines related parties.
Related party with reference to a company means:
1. a director or key managerial personnel or relative thereof;
2. a firm, in which a director, manager, or his relative is a partner;
3. a private company in which a director or manager or his relative is a member or director;
4. a public company in which a director or manager is a director AND holds along with his relatives, more than two percent of its paid-up share capital;
5. (a) any Body Corporate whose Board of Directors, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager.
(b) any person on whose advice, directions, or instructions a director or manager is accustomed to act.
6. holding, subsidiary, or an associate company of such company.
7. subsidiary of a holding company to which it is also a subsidiary.
8. investing company or the venturer of the company.
Explanation—” investing company or the venturer of a company” means a body corporate whose investment in the company would result in the company becoming an associate company of the body corporate
Note: In case of private companies and specified IFSC Public Company this clause shall not apply-Exempted vide MCA Notification dated 5th June 2015 and 4th January 2017
9. Director is other than an independent director or key managerial personnel of the holding company or his relative.
Note: Term relative in relation to a person means and includes Father, Mother, Son, Son’s wife, Daughter, Daughter’s husband, Brother, Sister, members of a HUF, Husband and wife
Related Party Transaction
Not all transactions with related parties are construed as related party transactions, the Act has provided an exhaustive list of such transactions, let us examine that.
Provisions regarding Related Party Transaction are encapsulated under 188 of the Companies Act, 2013 (“the Act”) read with rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014 which provides that a company cannot enter into any contract or arrangement with a related party except with the prior approval of Board or Shareholders as the case may be with respect to following transactions :
|Related Party Transactions u/s 188 which requires prior approval of the Board of Directors||Limits of Transactions exceeding which approval from the shareholders is required|
|Sale, purchase, or supply of any goods or material, directly or through the appointment of any agent*||10% or more of the turnover of the Company|
|Selling or otherwise disposing of or buying property of any kind, directly or through the appointment of agent*||10% or more of the Net Worth of the Company|
|Leasing of property of any kind*||10% or more of the turnover of the Company|
|Availing or rendering of any services, directly or through the appointment of agent*||10% or more of the turnover of the Company|
|Such related party’s appointment to any office or place of profit in the Company, its subsidiary or associate Company||at a monthly remuneration exceeding Rs. 2,50,0000/-|
|Underwriting the subscription of any securities or derivatives thereof, of the company||1% of the net worth
of the Company
* All the above limits are to be taken on all transactions are done on a financial year basis.
Note: The turnover or net worth shall be taken on the basis of the Audited Financial Statement of the preceding financial year.
“office or place of profit” means any office or place where such office or place is held by —
a) Director and he receives from the company anything by way of remuneration over and above the remuneration to which he is entitled as director, by way of salary, fee, commission, perquisites, any rent-free accommodation, or otherwise;
b) an individual other than a director or by any firm or private company or other body corporate, if they receive from the company anything by way of remuneration, salary, fee, commission, perquisites, any rent-free accommodation, or otherwise.
Requisite approvals required for Related Party Transactions (RPT)
Once we have identified the RPT, we need to check what kind of approval is required to execute the RPT under the Act and whether there is an exemption for it.
Approval from Board
Whenever a Company enters into any Related Party Transaction u/s 188 up to limits mentioned above, prior approval by way of resolution from the Board of Directors of the Company will be required. [Section 188(1)]
Provided that, If a director is interested in any contract or arrangement with a related party, such director shall not be present at the meeting during discussions on such resolution. [Rule 15(2)]
However, if a contract or arrangement falls under the ambit of Section 184(2) where a Director is interested other than contract or arrangement referred in Section 188(1), in that case, the director can participate in the Resolution in the following cases:
- In case of a Private Company or Specific IFSC Company after disclosure of interest.
- In case Section 8 Company where transaction amount does not exceed Rupees 1 lakh.
[Exempted vide Notification(s) dated 5th June 2015]
Here, it can be noted that exemption under Section 184(2) is provided while, no exemption is provided from Rule 15(2) which means that in the case of RPT where all directors are interested in the matter or where quorum can not be formed u/s 173, such company needs to take approval from shareholders in General Meeting but what about a private company where interested directors themselves holds majority shares in the company? Does that mean in that case also we need to take the matter to the General Meeting only.
Approval from Shareholders
Whenever a Company enters into any Related Party Transaction exceeding the limits mentioned above it needs to take approval by way of resolution from the shareholders of the Company.
However, a Member of a company who is a related party cannot vote on such resolution for the approval of RPT in General Meeting except:
(i) in case of Private Company and Specified IFSC Public Company [exempted vide MCA Notification dated 5th June 2015 and 4th January 2017]
(ii) in a company where 90% or more members are relatives of promoters or are related parties. [3rd Proviso to Section 188(1)]
Further, in order to ensure smooth functioning in the company, certain exemptions from taking approval either from Board or Shareholders are provided under the Act:
(i) No approval will be required (from Board/ shareholders) in case transaction is entered into by the company is in ordinary course of business AND on an arm’s length basis.
Note: arm’s length transaction means a transaction between two related parties that is conducted as if they were unrelated so that there is no conflict of interest.
(ii) Transactions entered into between a holding company and its wholly-owned subsidiary whose accounts are consolidated do not require approval from shareholders even if it exceeds the limit and resolution passed by the holding company will be sufficient for the purpose of entering into the transaction.
Note: If a company avails of the exemption provided in Rule 6 of the Companies (Accounts) Rules, 2014 read with Section 129(3) of the Act, and does not consolidate accounts of its subsidiary, then it will not be entitled to avail the aforesaid exemption from obtaining approval of the shareholders.
(iii) in the case of a Government company no approval is required from shareholders even if it exceeds the limits:
• Where contracts or arrangements entered into by it with any other Government company, Central or State Government or combination thereof.
• Where it’s an unlisted government company and takes approval from concerned ministry. [exempted vide MCA Notification dated 02nd March 2020]
Role of Audit Committee in case of Related Party Transactions
Where a Company has an Audit Committee, such company requires approval for transactions with related parties in terms of section 177(4)(iv) of the Act read with Rule 6A of Companies (Meetings of Board and its Powers) Rules, 2014.
Further, the Audit Committee may make omnibus approval in the interest of the company for such RPTs proposed to be entered into by the company subject to the following:
- The Audit Committee will specify the criteria for making the omnibus approval after obtaining approval of the Board of Directors.
- The Audit Committee will consider the following factors while specifying the criteria for making omnibus approval, namely: –
(a) the repetitiveness of the transactions (in past or in future);
(b) justification for the need for omnibus approval.
- The omnibus approval shall contain or indicate the following: –
(a) name of the related parties;
(b) nature and duration of the transaction;
(c) the maximum amount of transaction that can be entered into;
(d) the indicative base price/ current contracted price and the formula for variation in the price, if any; and
(e) any other information as the audit committee may deem fit.
- where the need for related party transactions cannot be foreseen and aforesaid details are not available, the audit committee may make omnibus approval for such transactions for value not exceeding Rs. 1 crore per transaction.
- Omnibus approval shall be valid for a period of one financial year and fresh approval will be required after the expiry of such financial year. However, omnibus approval can’t be made by the audit committee for transactions in respect of selling or disposing of the undertaking of the company.
It may be noted that Audit Committee approval will not be required for transactions entered into between a holding company and its wholly-owned subsidiary company other than for transactions referred to in section 188.
[Note: while all transactions with related party need approval from Audit Committee, only RPTs under Section 188 requires approval from Board in addition to Audit Committee approval]
- Every contract or arrangement entered into under section 188(1) shall be referred to in the Board’s report in Form AOC-2 to the shareholders along with the justification for entering into such contract or arrangement. [Section 188(2), Section 134(3)(h) read with Rule 8 of Companies (Accounts) Rules, 2014]
- Section 189(1) of the Act read with rule 16 of the Companies (Meetings of Board and its Powers) Rules, 2014 provides that:
Every company shall maintain one or more registers in Form MBP-4 and enter therein particulars of all contracts or arrangements to which section 184(2) or 188 applies and after entering the particulars, such register or registers shall be placed before the next meeting of the Board and need to be signed by all the directors present at the meeting.
However, as per Section 189(5), an entry in the register will not be required in case of contract or arrangement—
a) for the sale, purchase, or supply of any goods, materials, or services if the value of such goods and materials or the cost of such services does not exceed Rs. 5 lakh in the aggregate in any year; or
b) by a banking company for the collection of bills in the ordinary course of its business.
Note: In the case of section 8 company entry in the register will not be required if the transaction with reference to section 188 on the basis of terms and conditions of the contract or arrangement exceeds Rs. 1lakh. [MCA Notification dated 5th June, 2015]
Consequences of non-compliance
(i) In case RPT was entered into by a director or any other employee without obtaining the requisite approval(s), such RPT needs to be ratified by the Board or Shareholders as the case may be within 3 months otherwise they have to bear the following consequences:
- such RPT shall be voidable at the option of the Board /Shareholders.
- If such RPT is with a related party of the director or where it is authorized by any director, the director(s) concerned shall indemnify the Company against any loss incurred by it.
- Moreover, a company can proceed against such a director or any other employee for recovery of any loss sustained by it as a result of such RPT.
(ii) Any director or any other employee, who had entered into or authorized RPT in violation of the provisions of section 188 of the Act, shall be liable for a penalty-
- In case of Listed Company-25 lakh rupees
- In case of any other company- 5 lakh rupees
(iii) Any Director convicted in the offense of dealing with related party transactions under section 188 will become disqualified from being appointed as Director in a company for a period of 5 years and will be liable to vacate the office of director. [Section 164(1)(g) and Section 167(1)(a)]