Related Party Transactions Under Companies Act: Approvals, Disclosure & Compliance

Summary: Related Party Transactions, or RPTs, are transactions between a company and persons or entities connected with its management, ownership or group structure, including directors, promoters, subsidiaries, associates, relatives of directors or other related entities. The Companies Act, 2013 does not automatically prohibit such transactions but establishes safeguards to promote transparency, fairness and proper corporate governance. Section 188 is the principal provision and operates with Sections 2(76), 177, 184 and 189 and the applicable rules. The framework requires companies to identify related parties, determine whether transactions fall within specified categories, obtain Board or shareholder approval where applicable, disclose interests, maintain statutory registers and make prescribed corporate disclosures. Section 188 covers transactions including sale, purchase or supply of goods or materials, property transactions, leasing, services, appointment of agents, appointment to an office or place of profit and underwriting. Transactions that are both in the ordinary course of business and on an arm’s length basis may fall within the statutory exemption. Companies must nevertheless assess and document both conditions. Rule 15 prescribes Board agenda disclosures and shareholder approval thresholds, while Section 184 requires directors to disclose their interests. Section 177 provides Audit Committee oversight for applicable companies, including omnibus approvals in prescribed circumstances. Section 189 and Form MBP-4 deal with maintenance of records, while Section 134 and Form AOC-2 address prescribed Board’s Report disclosures. Listed companies must additionally consider Regulation 23 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. Proper RPT governance therefore requires identification, approval, documentation, disclosure and continuing monitoring rather than treating approval as a mere formality.

Introduction

Related Party Transactions, or RPTs, are transactions between a company and persons or entities connected with its management, ownership or group structure. These may include directors, promoters, subsidiaries, associates, relatives of directors or other related entities. Such transactions are not automatically prohibited because they may arise in the ordinary course of business. However, they require greater scrutiny since related parties may be able to influence pricing, terms or decision-making in a way that could create a conflict of interest.

The Companies Act, 2013 provides a structured framework to ensure that RPTs are transparent, fair and properly approved. Section 188 is the principal provision dealing with such transactions and should be read together with Sections 2(76), 177, 184 and 189 and the Companies (Meetings of Board and its Powers) Rules, 2014. These provisions help companies identify related parties, obtain necessary Board or shareholder approvals, disclose interests, maintain records and ensure proper corporate governance.

What Is a Related Party Transaction?

A related party transaction is essentially a transaction or arrangement between a company and a person or entity having a specified relationship with that company. The Companies Act does not treat every transaction with every connected person in exactly the same manner. The first step is therefore to determine whether the person or entity falls within the statutory definition of a “related party” under Section 2(76). The second step is to determine whether the proposed transaction falls within one of the categories covered by Section 188.

The law focuses on relationships because parties having common ownership, management, family connections, control or significant influence may not necessarily negotiate transactions in the same manner as completely independent parties. Accordingly, related party regulation aims to ensure that company resources are not diverted, transferred or used on unfair terms merely because a person connected with management is involved.

Who Is Considered a Related Party Under Section 2(76)?

Section 2(76) provides an extensive definition of “related party.” It covers, among others, a director and the director’s relative, key managerial personnel and their relatives, certain firms and companies in which directors, managers or their relatives are interested, persons whose instructions management is accustomed to follow, and specified holding, subsidiary, associate, fellow-subsidiary, investing and venture relationships.

For example, if a director is a partner in a partnership firm, that firm can fall within the related party definition. Similarly, a private company in which a director, manager or relevant relative is a member or director may qualify as a related party. A public company can also become a related party where the statutory relationship and shareholding conditions under Section 2(76) are satisfied.

The definition further includes a body corporate that is the company’s holding company, subsidiary, associate company, fellow subsidiary or investing company/venturer in the circumstances prescribed by the Act. Rule 3 of the Companies (Specification of Definitions Details) Rules, 2014 further provides that a director, other than an independent director, or key managerial personnel of the holding company, or their relative, may also be treated as a related party with reference to the company. This makes it important for companies to maintain an updated related party master list rather than determining the relationship only when a transaction arises.

Meaning of “Relative”

The concept of relative is important because several categories under Section 2(76) extend to relatives of directors, managers and key managerial personnel. Section 2(77), read with Rule 4 of the Companies (Specification of Definitions Details) Rules, 2014, covers relationships including members of a Hindu Undivided Family and spouses. The prescribed list also covers father, including stepfather; mother, including stepmother; son, including stepson; son’s wife; daughter; daughter’s husband; brother, including stepbrother; and sister, including stepsister.

Companies should therefore collect complete and periodically updated disclosures from directors and key managerial personnel instead of limiting related party identification to corporate entities.

Transactions Covered Under Section 188

Section 188 does not apply merely because two parties are related. The transaction must also fall within one of the categories specified under Section 188(1). These include sale, purchase or supply of goods or materials; buying or selling property; leasing property; rendering or availing services; appointment of an agent for buying or selling goods, materials, services or property; appointment of a related party to an office or place of profit in the company, subsidiary or associate; and underwriting the subscription of securities or derivatives of the company.

For example, if a company purchases raw materials from a firm in which its director is a partner, Section 188 may become relevant. Similarly, renting an office building owned by a related party, appointing a related person as a consultant or appointing a director’s relative to a remunerated position can potentially fall within the RPT framework. The substance of the transaction should be examined rather than merely its title.

Why Does the Companies Act Regulate Related Party Transactions?

Related party transactions create a natural possibility of conflict of interest. Consider a situation where a company purchases property from an entity owned by a director. An independent seller would normally negotiate to obtain the highest possible price, while the buyer would seek the lowest commercially reasonable price. When the same persons influence both sides of the transaction, normal commercial negotiation may be weakened.

The Companies Act therefore does not automatically prohibit such transactions. Instead, it introduces safeguards such as disclosure of interests, Board approval, shareholder approval in specified cases, Audit Committee oversight where applicable, maintenance of registers and disclosure in corporate reports. The objective is to ensure that the transaction is transparent and commercially justifiable rather than being used to provide an unfair benefit to connected persons.

Board Approval Under Section 188

Section 188 provides that applicable contracts or arrangements with related parties require the consent of the Board of Directors through a resolution passed at a meeting of the Board, subject to the statutory exceptions. Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014 requires the Board agenda to disclose important details including the name of the related party, nature of the relationship, nature and duration of the arrangement, material terms, value, advances paid or received, manner of determining pricing and commercial terms, and other information necessary for directors to take an informed decision.

This requirement is important because Board approval should not become a mechanical formality. Directors should receive enough information to determine why the transaction is necessary and whether its commercial terms are reasonable. Where an interested director is involved, Rule 15 further restricts that director’s participation in the discussion of the related party transaction.

Disclosure of Interest by Directors

Section 184 operates alongside Section 188. Every director is required to disclose specified concerns or interests at the first Board meeting in which the person participates as a director, at the first Board meeting of every financial year, and whenever there is a change in previously disclosed interests. Where a director has a direct or indirect interest in a particular contract or arrangement covered by Section 184(2), the director must disclose the nature of that interest when the matter is considered.

The statutory framework also restricts the interested director from participating in the relevant Board discussion in circumstances covered by the section. The disclosure of general interests is ordinarily made through Form MBP-1 under the Companies (Meetings of Board and its Powers) Rules, 2014. Regularly updating MBP-1 disclosures is therefore an important first step in identifying related party transactions.

Ordinary Course of Business and Arm’s Length Basis

One of the most important exceptions under Section 188 relates to transactions that are both:

in the ordinary course of business; and

on an arm’s length basis.

Section 188 states that its approval requirements do not apply where a transaction is entered into in the ordinary course of business and is on an arm’s length basis. The Act describes an arm’s length transaction as one conducted between related parties as though they were unrelated, so that there is no conflict of interest. Both conditions are important.

A transaction may be part of the company’s ordinary business but still be priced favourably for the related party. Conversely, a transaction may be on market terms but fall outside the company’s normal business activities. Therefore, companies should independently test both conditions before relying on the exemption.

What Is the Ordinary Course of Business?

The Companies Act does not provide a single mathematical test for deciding whether a transaction is in the ordinary course of business. Generally, the company should examine its memorandum and objects, historical business practices, frequency of similar transactions, nature of operations, industry practices and whether such transactions normally arise while conducting its business.

For example, purchasing raw materials may ordinarily be part of business for a manufacturing company. However, purchasing an unrelated investment property from the promoter may not automatically qualify merely because the company is permitted to own property. The assessment should therefore be supported by facts and appropriate documentation.

What Is an Arm’s Length Transaction?

An arm’s length transaction is one structured as though the related parties were independent of one another. In practical terms, the company should be able to demonstrate that the price, credit period, contractual terms, security, service conditions, margins and other commercial terms are comparable with what independent parties would reasonably agree.

Evidence supporting arm’s length pricing can include independent quotations, third-party contracts, market-price comparisons, valuation reports, transfer-pricing studies, tender processes, comparable transactions or independent professional assessments. Simply stating in the Board minutes that a transaction is “at arm’s length” without maintaining supporting evidence may not provide a strong compliance record.

When Is Shareholder Approval Required?

Not every related party transaction requires shareholder approval. Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014 specifies financial thresholds. Where the prescribed limits are reached, prior approval of the company through an ordinary resolution is required under Section 188, subject to applicable exemptions. The earlier requirement of a special resolution was changed to a resolution/ordinary resolution.

The currently prescribed thresholds include:

Nature of Transaction	Threshold for Shareholder Approval
Sale, purchase or supply of goods/materials, directly or through an agent	10% or more of turnover
Selling, disposing of or buying property, directly or through an agent	10% or more of net worth
Leasing of property	10% or more of turnover
Availing or rendering services, directly or through an agent	10% or more of turnover
Related party appointment to office/place of profit	Monthly remuneration exceeding ₹2.5 lakh
Underwriting securities or derivatives	Remuneration exceeding 1% of net worth

The turnover or net worth for these thresholds is computed on the basis of the audited financial statements of the preceding financial year. For specified transaction categories, individual transactions are aggregated with previous transactions during the same financial year for determining whether the threshold has been reached.

Can a Related Party Member Vote on the Resolution?

Section 188 generally restricts a member who is a related party from voting on the shareholder resolution approving the related party contract or arrangement. However, the Act contains exceptions. For example, the restriction does not apply where 90% or more of the members, in number, are relatives of promoters or are related parties.

Private companies also receive certain exemptions under MCA notifications.

Among them, the restriction under the second proviso to Section 188(1) has been relaxed for qualifying private companies, subject to the conditions prescribed through the relevant MCA exemption notifications. Therefore, private companies should not automatically apply the public-company voting restriction without examining the applicable exemption notification.

Special Position of Private Companies

Private companies enjoy important relaxations relating to related parties. Under MCA Notification G.S.R. 464(E) dated June 5, 2015, clause (viii) of Section 2(76), concerning certain holding, subsidiary, associate and fellow-subsidiary relationships, does not apply to a private company for the purposes of Section 188. This can significantly affect whether certain intra-group transactions are treated as RPTs under Section 188.

The private-company exemption framework was subsequently made subject to compliance conditions relating to filing of financial statements and annual returns through the 2017 notification. Accordingly, private companies should examine both the main Act and the applicable Section 462 exemption notifications before determining their compliance requirements.

Transactions Between Holding Company and Wholly Owned Subsidiary

Section 188 also provides a specific relaxation for transactions between a holding company and its wholly owned subsidiary. The requirement for shareholder approval under the first proviso to Section 188(1) does not apply to transactions between a holding company and its wholly owned subsidiary where the subsidiary’s accounts are consolidated with the holding company and placed before shareholders at the general meeting for approval. This exemption should not be interpreted as automatically removing every other legal or accounting requirement that could apply to the transaction.

Role of the Audit Committee

For companies required to constitute an Audit Committee under Section 177, related party transactions are subject to an additional layer of oversight. Section 177 provides that approval or subsequent modification of transactions with related parties falls within the Audit Committee’s responsibilities. It also permits the Audit Committee to grant omnibus approvals subject to prescribed conditions.

Rule 6A allows omnibus approval, particularly for repetitive related party transactions. The Audit Committee must establish criteria covering annual aggregate limits, per-transaction limits, disclosures, review frequency and transactions that cannot use the omnibus route.

Where a transaction cannot be foreseen in advance and complete details are unavailable, omnibus approval may be granted subject to a limit of ₹1 crore per transaction. Such omnibus approval cannot remain valid for more than one financial year, and fresh approval is required thereafter. It also cannot be used for the sale or disposal of an undertaking. This enables companies with frequent recurring RPTs to manage compliance efficiently without eliminating Audit Committee supervision.

What Information Should Be Placed Before the Board?

Rule 15 requires meaningful disclosure to the Board before it approves the transaction. The agenda should explain who the related party is and how that person or entity is related to the company. It should also describe the nature and duration of the arrangement, its material terms and monetary value, advances paid or received, the basis for determining pricing and other commercial considerations.

If certain factors relevant to the transaction were not considered, the Board should also be informed of those factors and the reasons for excluding them. In practice, companies should ideally attach supporting quotations, valuation material, benchmarking studies, commercial justifications, draft agreements or other evidence that allows directors to evaluate the transaction properly.

Explanatory Statement for Shareholder Approval

Where shareholder approval is required, adequate information must be provided to members before they vote. Rule 15 requires the explanatory statement accompanying the general meeting notice to contain details such as the name of the related party, name of the related director or KMP where applicable, nature of the relationship, material terms and monetary value of the arrangement, and any other information necessary to enable shareholders to make an informed decision.

The objective is to prevent shareholders from being asked to approve a transaction without understanding the nature of the conflict or the economic impact on the company.

Register of Related Party Contracts – Form MBP-4

Section 189 requires companies to maintain one or more registers containing particulars of specified contracts and arrangements covered by Section 184(2) and Section 188.

Under Rule 16, this register is maintained in Form MBP-4. The register records information such as the date of the contract, name of the party, interested director, nature of relationship or interest, principal terms, whether the transaction is at arm’s length, Board approval details, transaction value and shareholder approval where applicable.

Entries should be made promptly and maintained in chronological order. The register is kept at the registered office and is also subject to statutory inspection and presentation requirements. Proper maintenance of MBP-4 is often overlooked even where companies correctly obtain Board approval.

Disclosure in the Board’s Report and Form AOC-2

Section 134(3)(h), read with the Companies (Accounts) Rules, 2014, requires specified particulars of contracts or arrangements with related parties referred to in Section 188(1) to be disclosed through Form AOC-2 as part of the Board’s Report. Form AOC-2 separately captures contracts or arrangements that are not at arm’s length and material contracts or arrangements entered into on an arm’s length basis.

Companies should therefore reconcile the related party disclosures appearing in the financial statements, Board’s Report, AOC-2, MBP-4 register, Audit Committee minutes and Board minutes. Inconsistency across these documents can create avoidable compliance concerns.

Financial Statement Disclosures

Related party compliance does not end with Section 188 approvals. Applicable accounting standards, including Ind AS 24 for companies following Indian Accounting Standards and relevant accounting standards for other companies, may require disclosure of related party relationships, transactions, outstanding balances, commitments and key management compensation.

The accounting concept of a related party may not always be identical to the definition used solely for Section 188. Therefore, companies should separately perform both the Companies Act compliance test and the financial reporting disclosure test.

What Happens If Approval Was Not Obtained?

Section 188 provides a mechanism for dealing with certain transactions entered into without the required approval. Where a director or employee enters into a contract or arrangement without obtaining the required Board or shareholder approval and the transaction is not ratified by the appropriate authority within three months, the contract or arrangement can become voidable at the option of the Board or shareholders, as applicable.

Where the contract involves a related party of a director or was authorised by another director, the concerned directors may also be required to indemnify the company against losses. The company also retains the ability to proceed against the responsible director or employee to recover losses arising from the contravention. Ratification should therefore not be treated as a routine substitute for obtaining proper prior approval.

Penalties for Violation of Section 188

The penalty provisions of Section 188 were amended through the Companies (Amendment) Act, 2020. Under the current framework, a director or employee who enters into or authorises a contract or arrangement in violation of Section 188 is liable to a penalty of ₹25 lakh where the company is a listed company, and a penalty of ₹5 lakh in the case of any other company.

The amendment replaced the earlier criminal punishment structure under Section 188(5) with monetary penalties. However, financial penalties are not the only consequence of non-compliance. An improperly handled transaction can also result in recovery proceedings, voidability of the contract, director liability, audit qualifications, governance concerns and reputational damage.

Related Party Transaction Compliance Process

A company should not wait until the annual audit to identify RPTs. A more effective system begins with obtaining annual and event-based disclosures from directors and KMP and creating a comprehensive related party database. Whenever a new vendor, customer, consultant, landlord, employee, agent or group-company transaction is proposed, the counterparty should be checked against the related party database.

If the counterparty is related, the company should determine whether the transaction falls within Section 188. It should then determine whether the transaction is both in the ordinary course of business and at arm’s length. Where the exemption cannot be relied upon, the company should obtain the necessary Audit Committee approval, where applicable, followed by Board approval and shareholder approval where the Rule 15 thresholds are reached. The company should subsequently execute the agreement, make the appropriate MBP-4 entry, maintain supporting documentation and ensure appropriate disclosures in the Board’s Report and financial statements.

Importance of Arm’s Length Documentation

One of the most significant practical issues in RPT compliance is proving that a transaction is genuinely at arm’s length. For example, assume a company takes an office building on rent from its promoter. Simply stating that the monthly rent is reasonable may not be sufficient from a good-governance perspective. The company could instead maintain quotations for comparable properties, an independent rental valuation or evidence of prevailing market rents in the area.

Similarly, where professional services are obtained from a related entity, the company may compare rates with unrelated service providers or demonstrate the specialised expertise and pricing methodology used. Strong documentation is especially important because an arm’s length conclusion may determine whether the approval requirements of Section 188 apply.

Common Mistakes Companies Make in Related Party Transactions

A frequent mistake is assuming that every group-company transaction is automatically exempt. Another is assuming that a transaction is in the ordinary course of business merely because the company has carried out similar transactions in the past. Companies also sometimes obtain Board approval but fail to assess Rule 15 shareholder thresholds. Others correctly approve the transaction but fail to update MBP-4 or provide the necessary disclosure in the Board’s Report.

Another common problem occurs when companies determine arm’s length pricing without keeping any evidence supporting the conclusion. Failure to update directors’ MBP-1 declarations can also result in related parties being missed entirely. For companies having an Audit Committee, entering transactions without routing them through the applicable Audit Committee approval process can create an additional compliance issue even where Section 188 requirements have otherwise been considered.

Related Party Transactions in Listed Companies

Listed companies operate under an additional regulatory layer. Along with the Companies Act, 2013, listed entities may also be required to comply with Regulation 23 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. The SEBI framework contains its own definition, approval requirements, materiality concepts, Audit Committee requirements, shareholder approval rules and disclosure obligations.

The SEBI definition of related party and related party transaction is broader in several respects than the Companies Act framework. The current LODR framework defines related parties by reference to Section 2(76) of the Companies Act or applicable accounting standards and separately regulates related party transactions by listed entities. Therefore, a listed company should never assume that compliance with Section 188 alone completes its RPT obligations.

Why Proper RPT Governance Matters

Related party compliance is not simply about obtaining signatures or passing resolutions. RPT regulation protects shareholders from situations in which persons controlling a company may use company resources for private benefit. It also provides directors with a structured mechanism for demonstrating that transactions involving connected persons were commercially justified.

Strong RPT governance can improve transparency, reduce conflicts of interest, provide better audit trails and increase investor confidence. It is particularly important in promoter-driven businesses, family-owned companies, corporate groups, joint ventures and businesses where several entities share common directors or management personnel.

Practical Example

Suppose ABC Limited proposes to purchase raw material worth ₹12 crore from XYZ Private Limited, in which one of ABC Limited’s directors has the relationship specified under Section 2(76). Assume ABC Limited’s turnover as per its preceding audited financial statements is ₹100 crore.

Since ₹12 crore represents 12% of turnover, the transaction crosses the Rule 15 threshold of 10% for sale, purchase or supply of goods or materials. The company must first determine whether the transaction is in its ordinary course of business and whether it is genuinely at arm’s length.

If both tests are satisfied, the Section 188 exemption may apply. Nevertheless, other requirements, including Audit Committee approval where applicable, accounting disclosures or SEBI requirements for a listed company, must be independently checked. If the transaction is not in the ordinary course or is not at arm’s length, appropriate Board approval would be required and, because the prescribed threshold is reached, prior shareholder approval by ordinary resolution would generally also be required, subject to applicable exemptions. The company should then maintain evidence of approvals, update its statutory register and make the relevant disclosures.

Conclusion

Related Party Transactions under the Companies Act, 2013 are not prohibited, but they require careful identification, evaluation, approval and disclosure. Companies may regularly transact with subsidiaries, associates, directors, promoters, relatives or other connected entities for genuine business purposes. However, such transactions should be transparent, commercially justified and properly documented. Section 188 should be read together with Sections 2(76), 177, 184 and 189, applicable rules, accounting standards and SEBI requirements for listed entities. Companies should assess whether the transaction is in the ordinary course of business, conducted at arm’s length and within the prescribed approval limits.

A strong RPT compliance framework helps companies prevent conflicts of interest, protect stakeholder interests, maintain good corporate governance and reduce the risk of penalties or regulatory issues.

Frequently Asked Questions (FAQs)

Q1. What is a Related Party Transaction under the Companies Act, 2013?

Ans. A Related Party Transaction is a transaction between a company and a related person or entity covered under the Act. It may involve goods, property, services, leasing, agency arrangements, office or place of profit, or underwriting activities.

Q2. Who is considered a related party under the Companies Act, 2013?

Ans. A related party may include directors, key managerial personnel, their relatives, certain firms or companies in which they are interested, holding companies, subsidiaries, associate companies, fellow subsidiaries and other persons or entities connected through control or influence.

Q3. Which section governs Related Party Transactions?

Ans. Section 188 of the Companies Act, 2013 primarily governs Related Party Transactions. It should be read with Section 2(76), Section 177, Section 184, Section 189 and the Companies (Meetings of Board and its Powers) Rules, 2014.

Q4. Are all Related Party Transactions prohibited?

Ans. No. Related Party Transactions are not prohibited merely because the parties are related. They are permitted when the applicable approval, disclosure, pricing and documentation requirements are followed. The law focuses on fairness, transparency and proper corporate governance.

Q5. What types of transactions are covered under Section 188?

Ans. Section 188 covers sale or purchase of goods, property transactions, leasing, rendering or availing services, appointment of agents, appointment to an office or place of profit, and underwriting subscription of securities or derivatives of the company.

Q6. Is Board approval required for every Related Party Transaction?

Ans. Board approval may be required where the transaction falls under Section 188 and does not qualify for the ordinary-course and arm’s-length exemption. The approval should generally be given through a resolution passed at a properly convened Board meeting.

Q7. When is shareholder approval required for an RPT?

Ans. Shareholder approval is required when a transaction covered under Section 188 crosses the prescribed financial thresholds under Rule 15, subject to applicable exemptions. The threshold varies depending on whether the transaction involves goods, property, services, leasing, remuneration or underwriting.

Q8. What is an arm’s length transaction?

Ans. An arm’s length transaction is one conducted between related parties on terms similar to those that independent parties would normally agree upon. Pricing, credit terms, services, margins and other commercial conditions should be fair and commercially justifiable.

Q9. What does ordinary course of business mean?

Ans. Ordinary course of business refers to transactions that normally arise while carrying on the company’s regular business activities. Factors such as business objects, industry practices, transaction frequency, historical conduct and commercial purpose may help determine whether a transaction qualifies.

Q10. Is a transaction exempt if it is only at arm’s length?

Ans. No. For the Section 188 exemption, the transaction generally needs to be both in the ordinary course of business and on an arm’s length basis. Satisfying only one condition may not be sufficient to claim the exemption.