Related Party Transactions -Section 188 of Companies Act, 2013

INTRODUCTION

Companies Act, 2013 has unveiled a new era in the Indian Corporate Sector which places more reliance on disclosure norms rather than on approvals. One such area is “related party transactions” which is covered under Section 188 of Companies Act, 2013. As per Ministry of Corporate Affairs Notification dated 26^th March, 2014, section 188 came into force on 1^st April, 2014. While the Companies Act, 1956 warranted approval of Central Government for related party transaction by large cap companies, Companies Act, 2013 calls for larger disclosures with members’ approval.

The new regime for related party transactions seems complex because the definition of ‘related party’ has changed significantly. Holding company, subsidiary company, associate company and fellow subsidiary company have been included which will have significant impact on transactions between group companies. The scope of transactions has been significantly enhanced and proposes to cover sale, purchase, leasing of any property of any kind (including immovable property).

Section 188 provides for the matters that require the consent of Board of Directors of Company or prior approval of the members in case of special resolution. It also mentions that the agenda of the Board meeting at which Resolution is proposed to be passed should disclose the name of the related party and nature of relationship; the particulars and material terms of the contract or arrangement, any advance paid or received for the contract or arrangement, if any, etc.

DEFINITIONS :

• Related Party [Section 2(76)] “related party”, with reference to a company, means—
  1. a director or his relative;
  2. a key managerial personnel or his relative;
  3. a firm, in which a director, manager or his relative is a partner;
  4. a private company in which a director or manager is a member or director;
  5. a public company in which a director or manager is a director or holds along with his relatives, more than two per cent. of its paid-up share capital;
  6. 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;
  7. any person on whose advice, directions or instructions a director or manager is accustomed to act:
     Provided that nothing in sub-clauses (vi) and (vii) shall apply to the advice, directions or instructions given in a professional capacity;
  8. any company which is—
     1. a holding, subsidiary or an associate company of such company; or
     2. a subsidiary of a holding company to which it is also a subsidiary;
  9. such other person as may be prescribed;

  As per Rule 3 of Companies (Specification of Definitions details) Rules, 2014 (Chapter I), the following persons shall be deemed to be a related party :

  1. Director or KMP of the Holding Company
  2. Relative of Director or KMP of the Holding Company
• Relative [Section 2 (77)]‘‘relative’’, with reference to any person, means any one who is related to another, if—
  1. they are members of a Hindu Undivided Family;
  2. they are husband and wife; or
  3. one person is related to the other in such manner as may be prescribed;
• Key Managerial Personnel [Section 2 (51)]“key managerial personnel”, in relation to a company, means—
  1. the Chief Executive Officer or the managing director or the manager;
  2. the company secretary;
  3. the whole-time director;
  4. the Chief Financial Officer; and
  5. such other officer as may be prescribed;
• Office or place of profit [Section 188]the expression “office or place of profit” means any office or place—
  1. where such office or place is held by a director, if the director holding it 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;
  2. where such office or place is held by an individual other than a director or by any firm, private company or other body corporate, if the individual, firm, private company or body corporate holding it receives from the company anything by way of remuneration, salary, fee, commission, perquisites, any rent-free accommodation, or otherwise;

NATURE OF APPROVAL

1. Every company needs to seek the consent of Board of Directors for entering into any related party transaction, as listed below :
   1. sale, purchase or supply of any goods or materials;
   2. selling or otherwise disposing of, or buying, property of any kind;
   3. leasing of property of any kind;
   4. availing or rendering of any services;
   5. appointment of any agent for purchase or sale of goods, materials,services or property;
   6. such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company; and
   7. underwriting the subscription of any securities or derivatives thereof, of the company.
2. Where any director is interested in any contract or arrangement with a related party, he shall not be present at the meeting when such matters are being discussed.
3. In case of following transactions the company shall obtain prior approval by a special resolution:
   1. where paid-up share capital of the company is equal to or exceeds ten crore rupees;
   2. sale, purchase or supply of any goods or materials exceeding twenty five percent of the annual turnover;
   3. selling or otherwise disposing of, or buying, property of any kind exceeding ten percent of net worth;
   4. leasing of property of any kind exceeding ten percent of the net worth or turnover;
   5. availing or rendering of any services exceeding ten percent of the net worth;
   6. appointment to any office or place of profit in the company, its subsidiary company or associate company at a monthly remuneration exceeding two and half lakh rupees;
   7. remuneration for underwriting the subscription of any securities or derivatives thereof of the company exceeding one percent of net worth;
4. If a member is a related party, he shall not vote on special resolution, to approve such contract or arrangement.
5. In case of wholly owned subsidiary, the special resolution passed by the holding company shall be sufficient for the purpose of entering into the transactions between wholly owned subsidiary and holding company.

EXEMPTION

The above requirements shall not apply to any transaction entered into by the company in its ordinary course of business, except transactions, which are not on an arms’ length basis.

Arm’s length transaction is a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest.

SUBSEQUENT APPROVAL

Where any contract or arrangement is entered into by a director or any other employee, without obtaining the consent then it needs to be ratified within three months from the date of contract/ arrangement. But if not ratified, such contract/ arrangement shall be voidable at the option of the board. If the contract or arrangement is with a related party to any director, or is authorised by any other director, the directors concerned will indemnify the company against any loss incurred by it.

DISCLOSURE REQUIREMENTS

1. The board report will disclose particulars of contracts/arrangements with related parties and shall also disclose justification for entering into such transactions.
2. The explanatory statement to be annexed to the notice of a general meeting shall contain the following particulars namely:-
   1. name of the related party ;
   2. name of the director or key managerial personnel who is related, if any;
   3. nature of relationship;
   4. nature, material terms, monetary value and particulars of the contract or arrangement;
   5. any other information relevant or important for the members to take a decision on the proposed resolution.
3. Every company shall maintain one or more registers in Form MBP 4, and shall enter therein the particulars of contracts/arrangements with a related party with respect to transactions to which section 188 applies.

PENALTY FOR CONTRAVENTION

Any director or any other employee of a company, who had entered into or authorized the contract or arrangement in violation of the above provisions will:

1. In case of listed company, be punishable with imprisonment for a term which may extend to one year or with fine which will not be less than twenty five thousand rupees but which may extend to five lakh rupees, or with both, and
2. In case of any other company, be punishable with fine which will not be less than twenty five thousand rupees but which may extend to five lakh rupees.

NEW ADDITIONS AS PER COMPANIES ACT, 2013

The following additions has been made with respect to related party transactions in Companies Act, 2013 as compared to Companies Act, 1956 :

1. Related Party is defined under Companies Act, 2013 as mentioned above but was not defined under Companies Act, 1956.
2. Disclosures in Board report regarding particulars of contract/ arrangement with related party has to be made under Companies Act, 2013 which was not required earlier.
3. Section 177(4)(iv) of Companies Act, 2013 requires the Audit Committee to approve or modify transactions with related parties, scrutinise inter-corporate loans and investments, etc. This was not covered under Companies Act, 1956.
4. As per Companies Act, 2013, companies are not required to obtain prior approval of Central Government which was required as per Companies Act, 1956, in case a company with a paid-up capital of not less than rupees one crore enters into a contract with related parties.
5. Transactions like Selling or otherwise disposing of, or buying, property of any kind and Leasing of property of any kind has been newly introduced under Companies Act, 2013.
6. Separate penal provisions has been provided under the Companies Act, 2013 which was not mentioned in Companies Act, 1956.
7. Section 314 (Office or place of profit) and section 297 of Companies Act, 1956 has been clubbed and is now included in section 188 of Companies Act, 2013.

CLARIFICATIONS

• As per General Circular No. 30/2014 issued by Ministry of Corporate Affairs dated 17^th July 2014 the following clarifications were given on the matters relating to Related Party Transactions:
  1. Scope of second proviso to Section 188(1) – As per second proviso, no member who is a related party shall vote on special resolution to approve contract or arrangement. It is clarified that ‘related party’ has to be construed only with reference to that contract/ arrangement for which special resolution is being passed.
  2. Applicability of Section 188 to corporate restructuring, amalgamations etc – It is clarified that transactions arising out of compromises, arrangements, etc will not be attracted.
  3. Requirement of fresh approvals for past contracts under Section 188 –  Contracts which already came into force before commencement of Section 188 of Companies Act, 2013 will not require fresh approval but if any modifications are made on or after 1^st April, 2014 then requirements of Section 188 will have to be complied with.
• As per General Circular No. 14/2014 issued by Ministry of Corporate Affairs dated 9^th June 2014, it was clarified that in view of the provisions of section 188 which take away the transactions in the ordinary course of business at arm’s length price from the purview of the related party transactions, an Independent Director will not be said to have ‘pecuniary relationship’ under section 149(6)(c) of the Companies Act, 2013.

CONCLUSION

Section 188 has made elaborate provisions to control such related party transactions and has increased transparency. Enhanced accountability for key management and Board of Directors has been given new responsibilities. Section 188 ensures that such transactions are not used as a tool to divert resources and funds of the company for personal benefit of directors or controlling shareholders.