Summary: Section 188 of the Companies Act, 2013 regulates related party transactions, mandating specific approvals and compliance. Transactions requiring board resolutions include the sale or supply of goods, property dealings, leasing, services, agent appointments, positions of profit for related parties, and securities underwriting. Related parties include directors, key managerial personnel (KMP), their relatives, certain firms, and companies with shared interests, excluding professional advisors. Relatives encompass HUF members, spouses, and specified lineal ascendants, descendants, and their spouses. Positions of profit refer to roles yielding remuneration beyond director fees, while arm’s length transactions are defined as those conducted as if unrelated. Shareholder approval via ordinary resolution is required for transactions exceeding prescribed thresholds based on turnover, net worth, or remuneration from audited financials of the previous year. Wholly-owned subsidiaries require holding company resolutions, with exemptions for inter-company dealings within consolidated accounts. Related parties cannot vote on relevant resolutions unless 90% of members are related parties or promoters. Ordinary business transactions at arm’s length are exempt from Section 188. Covered contracts must be disclosed in the Board’s Report with justifications, and non-compliant transactios are voidable at the Board or shareholders’ discretion, allowing for indemnification and recovery of losses from responsible directors or employees. Penalties include fines of INR 25 lakhs for listed companies and INR 5 lakhs for others.
Decoding Section 188 (Related Party Transactions) of the Companies Act, 2013 :-
To enter into any one of the following related party transactions we are statutorily required to pass a board resolution :-
1.Sale or supply of any goods or materials
2. Selling or buying or disposing of any property of any kind
3. Leasing of property
4. Taking or providing any services
5. Appointment of any agent for purchase or sale of goods, materials, services or property
6. Appointment of a related party in subsidiary company, associate company or any office or place of profit in the Company
7. Underwriting the subscription of any securities or derivatives of the company
Definition of a Related Party :- With reference to a company means
1.Director or his relative
2. A KMP 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 or his relative is a member or director
5. A public company in which a director or manager is a director and holds along with his relatives, more than 2 per cent of its paid up share capital
6. Any body corporate whose board of directors, MD, or manager is accustomed to act in accordance with the advise, directions or instructions of a director or manager
7. Any person on whose advise, directions or instructions a director or manager is accustomed to act
However, point f and g shall not apply if the directions, instructions or advice are given in a professional capacity
1. Any body corporate which is a holding, subsidiary or an associate company of such company
2. Anybody corporate which is a subsidiary of a holding company to which it is also a subsidiary company
3. Any body corporate which is an investing company or the venturer of the company
Investing company or venturer company means a body corporate whose investment in the company would result in the company becoming an associate company of the body corporate.
Definition of a Relative :-
1.Members of HUF
2. Husband and Wife
3. Father, Step Father, Mother, Step Mother, Sister, Step Sister, Brother, Step Brother, Son, Son’s Wife, Daughter, Daughter’s Husband
Definition of office or place of profit :-
Means any office or place :-
1. Held by a director, if the director receives anything by way of remuneration and over and above the remuneration to which he is entitled as a director by way of Salary, fee, commission, perquisites, any rent-free accommodation or otherwise
2. Other than a director, by any individual, firm, private company or other body corporate, if they are receiving anything from the company by way of remuneration salary, fees, commission, perquisites any rent free accommodation or otherwise
Definition of Arm’s length transaction :-
A transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict.
1st Proviso to Section 188 of the Companies Act, 2013
We cannot enter into any related party transaction without a Resolution (Ordinary) passed by the members of the Company, where the amount of transactions exceed following limits :-
1.Sale or supply of any goods or materials – exceeding 10% or more of the turnover of the company
2. Selling or buying or disposing of any property of any kind – exceeding 10% or more of the net worth of the Company
3. Leasing of property – exceeding 10% or more of the turnover of the company
4. Taking or providing any services – exceeding 10% or more of the turnover of the company
5. Appointment of any agent for purchase or sale of goods, materials, services or property – exceeding 10% or more of the turnover of the company
6. Appointment of a related party in subsidiary company, associate company or any office or place of profit in the Company – at a monthly remuneration exceeding two and half lakh rupees
7. Underwriting the subscription of any securities or derivatives of the company – exceeding one percent of the net worth of the Company
The Turnover or net worth as referred shall be based on the audited financial statements of the preceding financial year.
In case of WOS, the resolution as passed by the holding company shall be sufficient for the purpose of entering into the transactions between the WOS and the holding company.
4th Proviso :-
Requirement of passing the resolution will not arise for transactions between holding company and WOS whose accounts are consolidated with such holding company and placed before shareholders at the general meeting for approval.
2nd Proviso :-
No member shall approve on the resolution, if they are a related party
However, in the companies where 90% of the members are relatives or promoters or are related parties, second proviso will not be applicable
3rd Proviso :-
Provisions of Section 188 will not be applicable for those transactions entered into the ordinary course of business and also are on an arm’s length basis
Section 188(2) :-
Every contract or arrangement entered in pursuance to Section 188 (1) shall be referred to in the Board’s Report to the shareholders along with the justification for entering into such contract or arrangement.
Section 188(3) :-
Any contract or arrangement entered into without the consent of Board or Shareholders shall be voidable at the option of the Board or shareholders, as the case may be, and if the contract or arrangement is with a related party to any director or is authorised by any other director, the directors concerned shall indemnify the company against any loss incurred by it.
Section 188(4) :-
Without prejudice to anything mentioned in Section 188(3), it is open to the Company to proceed against a director or any other employee who had entered into such 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.
Section 188(5) :-
Penal Provisions :
For Listed Company :- INR 25 lakhs
Any other Company :- INR 5 Lakhs
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