Before jumping directly onto the section one must know Who is RELATED PARTY?
Section 2(76)- “Related party”, with reference to a company,means – (the phrase “with reference to a company” here means the following persons are related party to a company ,the reason I am saying this is because most of the students gets confused while identifying who is related to whom)
(i) & (ii) a director, key managerial personnel or his relative is a related party to the company;
(iii) a firm,in which a director,manager or his relative is partner then that firmis a related party to the company;
iv) a private company in which a director or manager or his relative is a member or director then that private company is a related party to the company;
v) a public company in which a director or manager is a director and holds along with his relative, more than 2% of its paid up share capital then such public company is a related party to the company; (It may be noted that mere common directorship with a public company would not mean that such public company is a related party, director shall also hold more than 2% of paid up share capital of that public company)
vi) any body corporate whose BOD,MD or manager is accustomed to act in accordance with the advice,directions or instructions of a director or manager then such body corporate is a related party of the company; (In simple words director or manager of a company gives advice and instructions to BOD,MD, or manager of other body corporate and such advice and instructions is followed by them then that body corporate is a related party to the company)
vii)any person on whose advice,directions,instructions a director or manager is accustomed to act then such person is a related party to the company:
Provided that nothing in sub-clauses(vi) and (vii) shall apply to the advice,directions or instructions given in professional capacity; (i.e let say if any CS or CA is giving advice or directions in his professional capacity to the director or manager of a company and director or manager is following such directions or advice then such CS or CA is not a related party)
Difference between sub-clause (vi) & (vii)- In sub-clause (vi) companies director is giving advice to other body corporate and that body corporate is a related party whereas In sub-clause (vii) any person is giving advice to the director or manager of a company and such any person is a related party.
(viii) any company which is –
A) a holding,subsidiary or an associate company of such company; or
B) a subsidiary of a holding company to which it is also a subsidiary (i.e let say H Ltd is a holding company of S1 Ltd then they are related to one another as provided in point A but if H Ltd also has one more subsidiary S2 Ltd then S2 Ltd and S1 Ltd are also related to one another as stated in point B )
(ix) such other person as may be prescribed in Rules given below.
Rule 3 of –Related party. A director(other than independent director) or KMP of the holding company or his relative is a related party to a company.
It may be noted from Section 2(76)(i) and Rule 3 that the independent director of a company is a related party but independent director of holding company is not a related party.
Clause 49 of listing agreement provides wider definition of related party. It follows like this – an entity shall be considered as related to the company if:
(i) such entity is a related party under Section 2(76) of the Companies Act, 2013; or
(ii) such entity is a related party under the applicable accounting standards.
What is RELATED PARTY TRANSACTIONS?
Section 188- RELATED PARTY TRANSACTIONS (1)No company shall enter into any contract or arrangement with a related party u/s 2(76) except with consent of BOD in the Board Meeting and subject to the conditions as may be prescribed, in 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;
The word ‘leasing’ is used and not ‘licensing ‘ by which a question arises that, if a company enter into transaction with related party for providing let say trademark license than whether such transactions falls under the ambit of related party or not ?
(d) availing or rendering of any services;
(e) appointment of any agent for purchase or sale of goods, materials, services or property;
In above point agent is not a related party ,but the party with which company is dealing through an agent is a related party.Now companies cannot escape by saying that an agent is not a related party hence Section 188 is not attracted.In simple words a company cannot even indirectly enter into (through an agent) related party transaction
(f) such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company;
In above clause if related party of a company is appointed to any office or place of profit in its subsidiary then also consent of Board and approval of Shareholders is required in the company and not in its subsidiary company.
The expression “office or place of profit” means any office or place of profit-
(i)where a director is holding such office or place of profit and if he receives remuneration from the company 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 an individual other than director or by any firm,private company orother body corporate is holding such office or place of profit and receives anything by way of remuneration, salary,fee,commission ,perquisites,any rent free accommodation,or otherwise;
(g) underwriting the subscription of any securities or derivatives thereof, of the company.
Provided that no contract or arrangement shall be entered into except with the prior approval of the company by a special resolution if the transactions exceeds such sums, as may be prescribed in Rule 15.(Above requirement of special resolution is to be replaced by ordinary resolution in Companies Amendment Bill 2014 which is yet to be approved by Rajya Sabha )
As per Clause 49 -All material Related Party Transactions shall require approval of the shareholders through special resolution and the related parties shall abstain from voting on such resolutions.
Provided that a transaction with a related party shall be considered material if the transaction / transactions to be entered into individually or taken together with previous transactions during a financial year, exceeds ten percent of the annual consolidated turnover of the company as per the last audited financial statements of the company.
Who can vote?
As per Companies Act ,no member of the company shall vote on such special resolution, to approve any contract or arrangement which may be entered into by the company, if such member is a related party. But as per Clause 49, all entities falling under the definition of related parties shall abstain from voting irrespective of whether the entity is a party to the particular transaction or not.
For instance let say if A ltd and B ltd are related party to C ltd and C ltd is entering into transactions u/s 188 with B ltd then as per Companies Act, B ltd is abstain from voting which is logical as it is interested in that transaction but when we see Clause 49 even A ltd is not eligible to vote which is kind of illogical.
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. 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.
As per clause 49 -A related party transaction is a transfer of resources, servicesor obligati
Section 188(3)- Where any contract or arrangement is entered into by a director or any other employee without obtaining consent of Board or approval by special resolution as the case may be and is not ratified within 3 monthsfrom the date of contract or arrangement(C/A) by the Board or shareholders as the case may be, then such contract or arrangement shall be voidable at the option of Board and if the C/A is with related party to any director,or is authorized by any other director, then the directors concerned shall indemnify the company against any loss incurred by it.
Section 188(4)- Without prejudice to anything contained in subsection (3),it shall be open for company to proceed against a director or any other employee who had entered into such C/A in contravention of the provisions of this section for recovery of any loss sustained by it as a result of such contract or arrangement.
In subsection (3) loss is to be recovered from a director (in case where C/A is with related party to the director) and a director who have authorize such C/A.But in subsection (4) a company can also proceed against a director or other employee who had entered into such C/A in contravention to the provision of this subsection.
Under Section 177(4)(iv) Audit committee approval is also required for all RPT’s.
And Clause 49 also provides almost same provisions that, All Related Party Transactions (irrespective of the fact that they are material or not)shall require prior approval of the Audit Committee However, the Audit Committee may grant omnibus approval (i.e on annual basis) for Related Party Transactions proposed to be entered into by the company.
Companies(Amendment)Bill 2014 also talks about omnibus approval by the Audit committee .The proposed amendment will reduce the practical difficulties of obtaining approval from audit committee again and again.
Rule 15 of Companies (Meetings of board and its Power) Rules,2014 is the corresponding Rule to section 188.
Rule 15(2) where any director is interested in any C/A with a related party, such director shall not be present in the meeting during discussions on the subject matter relating to such C/A.(i.e director have to go outside at the time of discussion on that particular subject matter)
Rule 15(3) Earlier, the Companies having paid-up capital of Rs. 10 Crore or more were required shareholders approval by way of special resolution. This limit has been dispensed with and the new threshold limits have been introduced. The revised provision states that a company shall not enter into transaction(s) or transactions without the previous approval of shareholders, where the transaction(s) to be entered into involves the following:
# Sale, purchase or supply of any goods or materials, whether directly or through any agent and wherein the amount involved exceeds ten per cent. of the turnover of the company or Rupees Hundred crore, whichever is lower;
# Selling or otherwise disposing of or buying property of any kind, directly or through any agent and where the amount involved exceeds ten percent of the net worth of the company or Rupees Hundred crore, whichever is lower;
# Leasing of property of any kind and the amount involved exceeds ten percent of net worth of the company or ten per cent. of turnover of the company or Rupees One Hundred crore;
# Availing and rendering of any kind of services, directly or through appointment of agent and which involves an amount exceeding ten per cent. Of the turnover of the company or Rupees Fifty Crore, whichever is lower;
Explanation – the above mentioned limits that are specified for the transaction(s) shall apply to the transactions to be entered into either individually or taken together with the previous transactions during a financial year.
# Appointment of any person in the office or any place of profit in the company, its subsidiary or associate company at a monthly remuneration exceeding Rupees Two lakh Fifty Thousand;
# Remuneration for underwriting of subscription of any securities or derivatives of the Company exceeding one percent of net worth of the company.
1)the turnover or the net worth referred in the above Sub-rules shall be computed on the basis of the Audited Financial Statements of the preceding financial year.
2)In case of wholly owned subsidiary, the special resolution passed by the holding company for entering into the transactions between the wholly owned subsidiary and the holding company shall suffice.
Because in case of wholly owned subsidiary there is only one member (i.e holding company) and that too is abstained from voting as given under 2nd proviso to section 188 hence special resolution is required to be passed in holding company.
The above requirement of passing Special resolution in holding company is also going to be done away in Companies(Amendment)Bill,2014 if transactions is entered with its wholly owned subsidiary whose accounts are consolidated with such holding company and placed before the shareholders at the general meeting for approval.The proposed amendment will then be aligned with Clause 49 which already provide such exemption.
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