Summary: Blue Star Limited borrowed Rs.50,00,000 from its director, Mr. Timothy Edwin, without Audit Committee approval, leading to a dispute between the statutory auditors and the Company Secretary. The auditors contended that Audit Committee approval was mandatory as it constituted a related party transaction. The Company Secretary, however, argued that since the transaction wasn’t explicitly covered under Section 188 of the Companies Act, 2013, such approval was unnecessary. Under the Companies Act, 2013, specifically Section 2(76) defining “related party” and Section 177(4)(iv) concerning Audit Committee functions, read with Rule 6A of the Companies (Meetings of Board and its Powers) Rules, 2014, a borrowing from a director is indeed a related party transaction. Even if not listed under the specific types of transactions in Section 188(1) (which primarily cover sales, purchases, services, etc.), it still falls under the broader definition of a related party transaction that requires Audit Committee approval. The Audit Committee can provide omnibus approval for such transactions, provided certain conditions are met, especially if the transaction value does not exceed Rs. 1 crore. Post-transaction approval from the Audit Committee is permissible; however, if such approval is not obtained within three months from the transaction date, the transaction becomes voidable at the Audit Committee’s option. Furthermore, if the transaction involves a director’s related party, the concerned director may be required to indemnify the company for any incurred losses. While loans from directors are not considered “deposits” under the Companies Act, they still entail specific reporting requirements, such as filing e-form DPT-3 as “Exempted Deposits” and disclosures in the Board’s report and financial statements, along with a declaration from the director that the funds are not from borrowed sources.
WHETHER BORROWING FROM DIRECTORS IS A RELATED PARTY TRANSACTION UNDER COMPANIES ACT, 2013
QUERY: Blue Star Limited has borrowed a sum of Rs. 50,00,000 from its director, Mr. Timothy Edwin. In this regard, the Company failed to obtain the prior approval of the Audit Committee constituted under the provisions of Section 177 of the Companies Act, 2013.
The Statutory Auditors of the Company expressed the view that the approval of Audit Committee was mandatory being a related party transaction.
However, the Company Secretary submitted his comment that since this transaction is not covered under the related party transaction as per Section 188 of the Act, approval of Audit Committee was not required and hence, the Company has not committed any violation of the provisions of the Act.
Referring to the provisions of the Companies Act, 2013, examine :
- Whether omnibus approval of Audit Committee was needed to the borrowings, if the transaction was not a ‘Related Party Transaction’ under Section 188 of the Act ?
- Can a post transaction approval of Audit Committee be obtained for related party transaction and if not done so, what will be the effect on the transaction ?
ANSWER:
As per Section 2(76) read with Section 177 (4) (iv), 188 of the Companies Act, 2013, and Rule 6A of the Companies (Meetings of Board and its Powers) Rules, 2014 following shall be the answers:
(i) As per Rule 6A of the Companies (Meetings of Board and its Powers) Rules, 2014, all related party transactions shall require approval of the Audit Committee and the Audit Committee may take omnibus approval for related party transactions proposed to be entered into by the company subject to the certain conditions.
As per Section 177(4)(iv), every Audit Committee shall act in accordance with the terms of reference specified in writing by the Board which shall, inter alia, include approval or any subsequent modification of transaction of the company with related parties.
Provided that the Audit Committee may make omnibus approval for related party transactions proposed to be entered into by the company subject to such conditions as may be prescribed.
Provided further that in case of transactions, other than transactions referred to in Section 188 and where Audit Committee does not approve the transaction, it shall make its recommendations to the Board.
IN THE INSTANT CASE, borrowings of sum of Rs. 50,00,000 by Blue Star Limited from its director Mr. Timothy Edwin reflects that they are related parties as per Section 2(76) and the transaction is a related party transaction though the transaction i.e. borrowings of Rs. 50,00,000 between them is not Related Party Transaction as per Section 188(1). Hence, in the given case, said transaction of borrowings, was a Related Party Transaction other than the transaction given under Section 188(1).
(ii) As per Rule 6A of the Companies (Meetings of Board and its Powers) Rules, 2014– all related party transactions shall require approval of the Audit Committee. Where the need for related party transaction cannot be foreseen and no information related to that are available, the audit committee may make omnibus approval for such transactions subject to their value not exceeding Rs. 1 Crore per transaction.
PLEASE NOTE THAT: In case of a transaction which does not involve an amount exceeding one crore rupees and which is entered into by a director or officer of the company without obtaining the approval of the Audit Committee and if it is not ratified by the Audit Committee within three months from the date of the transaction, such transaction shall be voidable at the option of the Audit Committee.
In view of above, a post transaction approval of the Audit Committee can be obtained for related party transaction and if not done so, such transaction shall be voidable at the option of the Audit Committee.
Further, in case such transaction is with the related party to any director, the director concerned shall indemnify the company against any loss incurred by it.
FREQUENTLY ASKED QUESTIONS
1. Will the loan from Directors be treated as a deposit?
Loans from Directors are not considered as deposits [Rule 2(1) (vii) of the Companies (Acceptance of Deposits) Rules, 2014].Amount received as a loan from a director of the company is not considered as a “deposit” as the same is covered under the list of exempted deposits.
2. Can the Company accept loan from a relative of a director?
The loan from relatives of the director is exempted only in the case of a private company. However, the money given by the relative of a director should not be out of borrowed funds.
3. What are the reporting requirements for loan from Directors?
As per Explanation to Rule 16 of the Companies (Acceptance of Deposits) Rules, 2014, a company shall be required to file e-form DPT-3 for the transactions not considered as deposits i.e. “Exempted Deposits”. Since, loan from Directors is not considered as deposit, same needs to be reported as Exempted Deposits.
4. What are the other disclosures applicable to the company accepting a loan from Directors or relative of Directors?
A company accepting a loan from directors of the company or a relative of the director shall comply with the following:
- The Director of the company or his/her relative, shall furnish in writing a declaration to the effect that the amount is not being given out of borrowed funds; and
- Disclosure of the details of money so accepted by the Company in the Board’s Report.
- Disclosure in its financial statement, by way of notes, about the money received from the directors, or relatives of directors.
5. Is there any limit upto which monies can be borrowed from the Director?
The law has prescribed an overall limit up to which money can be borrowed by a company under Section 180(1) (c) of the Act and not any specific limit for loan from directors. The board would be required to take consent of the members of the company by way of Special resolution if the money to be borrowed, together with the money already borrowed by the company exceeds the aggregate of:
- its paid-up share capital,
- free reserves, and
- securities premium
6. Are the borrowing limits as stated above is applicable to a Private Limited Company?
Pursuant to Notification by the Ministry of Corporate Affairs dated 05th June, 2015, provisions of Section 180 of the Companies Act, 2013 do not apply to a private company. For other companies (public limited), this limit plays out only in terms of additional requirement of shareholders’ approval by way of special resolution.
7. Can the resolution to borrow funds be passed by circulation?
Borrowing Power is to be exercised by the board in the Board meeting only [Section 179(3)].The Board can exercise the power to borrow monies only in a duly convened board meeting. This implies that the resolution according to the consent of directors cannot be passed through circulation.
8. What is the step-by-step procedure to accept a loan from Director or his /her relative?
The step-by-step procedure to accept a loan from Director or his / her relative is as follows:-
- Board meeting to pass the resolution for accepting a loan and approval of limit.
- Get a signed declaration from the Director or his / her relative that the money given is not out of borrowed funds. Get the loan agreement with all terms and conditions signed.
- File e form DPT-3.
- Disclose the details of such amount in the Board’s Report.
- Disclosure of amounts received from relatives of directors out of their own funds, in Financial Statements (in Notes to the Accounts).
9. Is a loan from a director considered as a Related Party Transaction (RPT)?
A Director or a KMP is considered as a related party in terms of Section 2(76) of the Act and hence any transaction with the director or KMP shall be regarded as a related party transaction.
However, only those transactions are considered as related party transactions that are enumerated in Section 188(1) of the Act. The transactions specified in Section 188 are primarily in the nature of sale and purchase of goods, properties and services. Since the borrowing of money is not covered under Section 188 of the Act, the acceptance of a loan from the director shall not be considered as RPT.
SECTION 2(76) OF THE COMPANIES ACT, 2013
“Related Party”, with reference to a company, means—
(i) A director or his relative.
(ii) 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 per cent of its paid-up share capital.
(vi) Anybody 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:
Provided that nothing in sub-clauses (vi) and (vii) shall apply to the advice, directions or instructions given in a professional capacity.
(viii) Anybody 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) A n investing company or the venturer of a company.
Explanation.—For the purpose of this clause, “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.
(ix) Such other person as may be prescribed.
SECTION 188(1) OF THE COMPANIES ACT, 2013
(1) Except with the consent of the Board of Directors given by a resolution at a meeting of the Board and subject to such conditions as may be prescribed, no company shall enter into any contract or arrangement with a related party with respect to—
(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, its subsidiary company or associate company; and
(g) underwriting the subscription of any securities or derivatives thereof, of the company:
Provided that no contract or arrangement, in the case of a company having a paid-up share capital of not less than such amount, or transactions not exceeding such sums, as may be prescribed, shall be entered into except with the prior approval of the company by a resolution:
Provided further that no member of the company shall vote on such resolution, to approve any contract or arrangement which may be entered into by the company, if such member is a related party.
Provided also that nothing contained in the second proviso shall apply to a company in which ninety per cent. or more members, in number, are relatives of promoters or are related parties:
Provided also that nothing in this sub-section shall apply to any transactions entered into by the company in its ordinary course of business other than transactions which are not on an arm’s length basis.
Provided also that the requirement of passing the resolution under first proviso shall not be applicable for transactions entered into 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.
Explanation.— In this sub-section,—
(a) the expression “office or place of profit” means any office or place—
(i) 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;
(ii) 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;
(b) the expression “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
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