I Background:
With the growing participation of investors and other stakeholders in companies, the question of transparency in arrangements with related parties has often been a topic of much debate and discussion. To usher increased degree of transparency in such transactions, to determine the exact financial position of the entity, Section 188 was introduced in the Companies Act, 2013 placing the onus on the Board of Directors to review, approve, explain and recommend such related party arrangements to shareholders for seeking their approval.
Considering the wide coverage of Related Party Transaction in the Companies Act, 2013 (‘the Act’) it is suggested to strengthen the identification and monitoring of Related-party Transactions (‘RPTs’), a framework outlining the roles and responsibilities, disclosure requirements, communication, and monitoring requirements would need to be defined.
II Definition of Related Party
In precedent to entering into any transaction with the related party, it is important to identify the Related Party. In pursuant to subsection 76 of section 2 of the Companies Act, 2013 Related Party with reference to a company means:
i) a director or his relative;
ii) a key managerial personnel or his relative;
iii) a firm, in which a director, manager or his relative is a partner;
iv)a private company in which a director or manager or his relative is a member or director;
v) 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;
vi) 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;
vii)any person on whose advice, directions or instructions a director or manager is accustomed to act:
viii) any body corporate which is—
- a) a holding, subsidiary or an associate company of such company;
- b) a subsidiary of a holding company to which it is also a subsidiary; or
- c) an investing company or the venturer of the company;
- ix) a director other than an independent director or key managerial personnel of the holding company or his relative with reference to a company, shall be deemed to be a related party
Note:
- i) For the points (vi) and (vii) will not be applicable for any advice, directions or instructions given in professional capacity
- ii) In the sub-point (c) of point (Viii), the 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.
iii) Further Point (viii) will not apply to the private Company with respect to section 188 of the Act.
III Related Party Transaction (Section -188)
In pursuant to Section 188 of the Act, any contract or arrangement with a related party for the below-mentioned transaction will be termed as Related party transactions:
a) sale, purchase or supply of any goods or materials;
b) selling or otherwise disposing of, or buying, property of any kind;
c) leasing of property of any kind;
d) availing or rendering of any services;
e) appointment of any agent for purchase or sale of goods, materials, services or property;
f) such related party’s appointment to any office or place of profit in the company, it’s subsidiary company or associate company; and
g) underwriting the subscription of any securities or derivatives thereof, of the company.
Note:
- i) Here any office or place of profit means
– 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;
– 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.
IV Nature of Approval Required
A- Board Approval:
In pursuant to sub-section (1) of section 188 of the Act, every company irrespective of its capital needs to seek approval from the Board of Directors in the duly convened board meeting for entering into related party transactions.
In pursuant to Rule 15 of Companies (meeting of the board and its powers) Rules 2014, a director who has an interest in the contract with such related party must not be present at the meeting during the discussions concerning the subject matter of the contract or arrangement.
B- Need for Members Approval
In pursuant to the first proviso of subsection (1) of Section 188 of the Act, prior approval of the company by a resolution will be required for entering into such contract or arrangement for the company having a paid-up share capital of not less than such amount, or transactions not exceeding such threshold as prescribed below:
| Sl. No. | Specified transactions | Threshold |
| 1 | Sale, purchase or supply of any goods or material, directly or through the appointment of agent | Amounting to 10% or more of the turnover of the Company |
| 2 | Selling or otherwise disposing of or buying a property of any kind, directly or through the appointment of an agent, | Amounting to 10% or more of the net worth of the Company |
| 3 | Leasing of property any kind | Amounting to 10% or more of the turnover of the Company |
| 4 | Availing or rendering of any services, directly or through the appointment of an agent, | Amounting to 10% or more of the turnover of the Company |
| 5 | Appointment to any office or place of profit in the company, it’s subsidiary company or associate company | Exceeding Rs. 2,50,000/- per month |
| 6 | Remuneration for underwriting the subscription of any securities or derivatives thereof | Exceeding 1% of the net worth of the Company |
Note:
i) It is clarified that the limits specified in points (1) to (4) shall apply for transactions or transactions to be entered into either individually or taken together with the previous transactions during a financial year.
ii) For calculation of net worth and turnover in the above thresholds will be based on the audited financial statement of the preceding financial year.
iii) For entering into a transaction between the wholly-owned subsidiary and holding company resolution passed by the holding company will hold good.
iv) If a member is a related party then he shall not be eligible to vote on such resolution for approval of any contract or arrangement which may be entered by the Company. Further if in any company 90% or more in number are relatives of the promoter or are related parties then they shall be eligible to vote on such resolution.
V Exemptions
i) The above -mentioned board/member’s approval will not apply to the transactions entered into by the company in its ordinary course of business which is on arm’s length basis.
ii) The requirement of member’s approval will not be applicable for transactions that are entered between a holding company and its wholly-owned subsidiary whose accounts are consolidated with such holding company and placed before the shareholders at the general meeting for approval.
VI Disclosures
Disclosure norms under the companies act, 2013 is explained in detail below:
A: Board Meeting
In pursuant to the Rule 15 of Companies (meeting of the board and its powers) Rules 2014, the agenda at the board meeting in which a resolution is to be passed should consist of the following information:
i) Name and nature of the relationships with the related party
ii) Nature, duration, and particulars of the contract
iii) Material terms of the arrangement or contract
iv) Any advance has been paid or received for the arrangement
v) The manner of determining the price and commercial term, both of which form a part of the contracts and the once that are not considered part of the contract
vi) Any other relevant or vital information
B: General Meeting
In pursuant to the Rule 15 of Companies (meeting of the board and its powers) Rules 2014, the explanatory statement is to be annexed to the notice of the general meetings in pursuant to section 101 of the Act and should consist of the following information:
i) Name of the related party
ii) Name of the director or KMP who is related
iii) Nature of relationship
iv) Nature, material terms, monetary value and particulars of the contract
v) Any other relevant or vital information
C: Disclosure by Interested Directors
Every director of a firm who has any direct or indirect interest involved in the contract or entered into or about to be entered should disclose the nature of the concern at the meeting of the board in which such contract or arrangement is discussed.
D: Disclosure in the Board’s Report
Every related party transaction will be disclosed in the board`s report along with the justification for entering into the contract or arrangement.
E: Disclosure in Register
Every Company has to maintain one or more registers in Form MBP 4 and will enter the particulars of the contract or arrangements with a related party.
VII Voidable contracts or arrangements:
i) If any contract or arrangement is entered by a director or any other employee without the approval of the board or by way of resolution in the general meeting and the same is not been ratified by the board or at the shareholders meeting within 3 months from the date of such contract or arrangement shall be voidable at the option of the Board or as the case may be of shareholders.
ii) If the contract or arrangement is with a related party to any director or is authorized by any other director, the directors concerned shall indemnify the Company against any loss incurred by it.
iii) It is at the discretion of the company to proceed against a director or any other employee who had entered into such a contract or arrangement in contravention of the provisions of this section for recovery of any loss sustained by it as a result of such contract or arrangement.
VIII Punishment for non-compliance
Any director or any other employee of a company, who had entered into or authorized the contract or arrangement in violation of the provisions of section 188 of the Act shall
i) In case of a listed company, be punishable with imprisonment for a term which may extend to one year or with fine which shall not be less than Rs. 25,000/- but which may extend to Rs, 5,00,000/- or with both; and
ii) In case of any other company, be punishable with fine which shall not be less than Rs. 25,000/- but which may extend to Rs. 5,00,000/-.
Conclusion: The provisions relating to related party transactions are one of the most amended provisions under the Act. “Related party transactions” is one of the critical tests of corporate governance. Related party relationships are a normal feature of business and commerce. Related party transactions are a source for companies to operate separate parts of their activities through subsidiaries, associates or joint ventures. This kind of transactions will have a significant effect on the financial position of the reporting company and transaction with unrelated parties.
Disclaimer: The entire contents of this document have been developed based on relevant provisions and are purely the views of the authors. Though the author has made utmost efforts to provide authentic information, however, the authors and the company expressly disclaim all and any liability to any person who has read this document, or otherwise, in respect of anything, and consequences of anything done or omitted to be done by any such person in reliance upon the contents of this document.