Related Party Transaction Under Companies Act, 2013

Related Party Transaction Under the Companies Act, 2013:

INTRODUCTION:

Meaning of related party:

Section 2(76) of the Companies Act, 2013 (“the Act”) defines the word “related party”:

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 per cent. 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:

Provided that nothing in sub-clauses (vi) and (vii) shall apply to the advice, directions or instructions given in a professional capacity;

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;

ix. such other person as may be prescribed;

For the purposes of sub-clause (ix) a 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 – Rule 3 of Companies (Specification of definitions details) Rules, 2014.

Ministry of Corporate Affairs issued the Companies (Removal of Difficulties) Fifth Order, 2014 dated 9^th July, 2014 and clarified that the word “OR” in sub-clause (v) has appeared inadvertently and therefore defeating the intention of this clause. The word “AND shall be substituted for the word “OR”.

MCA issued Companies (Removal of Difficulties) Sixth Order, 2014 dated 24^th July, 2014 and clarified that in sub-clause (iv)after the word “manager” the word “OR HIS RELATIVE” shall be inserted.

MCA vide exemption Notification dated 5^th July, 2015 exempted private companies from clause (viii) of Section 2(76) for the purpose of Section 188 of the Act.

After this exemption notification in case of private companies holding, subsidiary or associate companies will not be related parties for the purpose of Section 188 unless they fall any other category as specified in Section 2(276).

Nature of transaction:

The Companies Act, 2013 widened the scope of related party transaction. The Companies Act, 1956 covered only purchase or sale of goods or supply of services and subscription of any shares or debentures of the company under the related party transaction. However, Companies Act, 2013 has brought immovable properties and leasing of property also under the ambit of related party transaction.

Approval of Board of directors:

Section 188(1) of the Act provides that 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.

The agenda of the Board meeting at which the resolution is proposed to be moved shall disclose-

a. the name of the related party and nature of relationship;

b. the nature, duration of the contract and particulars of the contract or arrangement;

c. the material terms of the contract or arrangement including the value, if any;

d. any advance paid or received for the contract or arrangement, if any;

e. the manner of determining the pricing and other commercial terms, both included as part of contract and not considered as part of the contract;

f. whether all factors relevant to the contract have been considered, if not, the details of factors not considered with the rationale for not considering those factors; and

g. any other information relevant or important for the Board to take a decision on the proposed transaction.

Where any director is interested in any contract or arrangement with a related party, such director shall not be present at the meeting during discussions on the subject matter of the resolution relating to such contract or arrangement.

Approval of the company by Ordinary resolution:[1]

MCA has amended the Companies (Meetings of Board and its Powers) Rules, 2014 vide Companies (Meetings of Board and its Powers) Second Amendment Rules, 2014 on 14^th August, 2014 and changed the criteria for passing of special resolution for related party transaction.

(a) As contracts or arrangements with respect to clauses (a) to (e) of sub-section (1) of section 188, with criteria as mentioned below –

i. Sale, purchase or supply of any goods or materials, directly or through appointment of agent, exceeding ten per cent. of the turnover of the company or rupees one hundred crore, whichever is lower, as mentioned in clause (a) and clause (e) respectively of sub-section (1) of section 188;

ii. Selling or otherwise disposing of or buying property of any kind, directly or through appointment of agent, exceeding ten per cent of net worth of the company or rupees one hundred crore, whichever is lower, as mentioned in clause (b) and clause (e) respectively of sub-section (1) of section 188;

iii. Leasing of property of any kind exceeding ten per cent of the net worth of the company or ten per cent. of turnover of the company or rupees one hundred crore, whichever is lower, as mentioned in clause (c) of sub-section (1) of section 188;

iv. Availing or rendering of any services, directly or through appointment of agent, exceeding ten per cent. of the turnover of the company or rupees fifty crore, whichever is lower, as mentioned in clause (d) and clause (e) respectively of sub-section (1) of section 188:

Explanation.—It is hereby clarified that the limits specified in sub-clauses (i) to (iv) shall apply for transaction or transactions to be entered into either individually or taken together with the previous transactions during a financial year.

(b) For appointment to any office or place of profit in the company, its subsidiary company or associate company at a monthly remuneration exceeding two and half lakh rupees as mentioned in clause (f) of subsection (1) of section 188; or

(c)  For remuneration for underwriting the subscription of any securities or derivatives thereof, of the company exceeding one per cent. of the net worth as mentioned in clause (g) of sub-section (1) of section 188.

Explanation.- (1) The Turnover or Net Worth referred in the above sub-rules shall be computed on the basis of the Audited Financial Statement of the preceding Financial year.

No member of the company shall vote on such resolution, if he is a related party, to approve any contract or arrangement which may be entered into by the company. However, MCA has exempted to private companies from this requirement vide notification dated 5th July, 2015.

MCA vide circular no 30/2014 dated 17^th July, 2014 clarified that word “related party” referred to in the second proviso has to be construed with reference only to the contract or arrangement for which the said special resolution is being passed.

MCA also clarified that contracts entered into by companies, after making necessary compliances under Section 297 of the Companies Act, 1956, which already came into effect before the commencement of Section 188 of the Companies Act, 2013, will not require fresh approval under the said section 188 till the expiry of the original term of such contracts. Thus, if any modification in such contract is made on or after 1st April, 2014, the requirements under section 188 will have to be complied with.

The explanatory statement to be annexed to the notice of a general meeting convened pursuant to section 101 shall contain the following particulars namely:-

(a) Name of the related party ;

(b) Name of the director or key managerial personnel who is related, if any;

(c) Nature of relationship;

(d) Nature, material terms, monetary value and particulars of the contract or arrangement;

(e) Any other information relevant or important for the members to take a decision on the proposed resolution.

After the amendment of Companies (Meetings of Board and its Powers) Rules, 2014 on 14^th August, 2014 essence of related party is changed entirely. Now every company whether small or big, private or public will be required to pass ordinary resolution for related party transaction. MCA has removed paid-up capital criteria for ordinary resolution.

The Companies (Amendment) Act, 2015 passed by Parliament and made following changes for related party transaction:

• Empowering Audit Committee to give omnibus approvals for related party transactions proposed to be entered into by the company subject to such conditions as may be prescribed.

• The amendments include replacing “special resolution” with “ordinary resolution” for approval of related-party transactions.

• Exempt related party transactions between holding companies and wholly owned subsidiaries from the requirement of approval.

Transactions entered into by the company in its ordinary course of business and undertaken at an arm’s length basis do not need any prior approval: 

The word “ordinary course of business” is not defined in the Companies Act, 2013 or in Rules made thereunder.

No specific criteria have been provided in the Act whether the transaction is in ordinary course or not. Whether the transaction entered is ordinary course of business or not will depend on the particular business activity of the company. Transaction in ordinary course of business will cover the usual transactions of a business and of a company.

One should consider variety of factors to determine whether the transaction is in ordinary course or not like size, volume, frequency, purpose of transaction etc.

Arm’s length transaction meaning:

Arm’s length transaction means a transaction between two related parties which is conducted as if they are unrelated, so that there is no conflict of interest.

If a transaction fulfills both the criteria no approval will be required under section 188 of the Act.

To minimise confusion and litigation, the government will bring fresh guidelines to clearly explain the meaning of terms “arm’s length basis” and “ordinary course of business”, used in the Companies Act, 2013.[2]

Disclosures:

Every contract or arrangement entered into under sub-section (1) of the Act shall be referred to in the Board’s report to the shareholders along with the justification for entering into such contract or arrangement. 

Applicability:

Section 188 of the Act is applicable to all kinds of companies whether private or public.

MCA issued exemption notification dated 5^th July, 2015 to give certain exemptions to private limited companies for related party transaction.

The notification does not five full exemptions to private companies but it gives exemption to private companies with some riders.

It has exempted private companies from Section 2(76)(viii) for the purpose of Section 188.

A related party can vote for ordinary resolution is case of related party transaction.

Consequences of contravention:

Where any contract or arrangement is entered into by a director or any other employee, without obtaining the consent of the Board or approval by a ordinary resolution in the general meeting-

• and if it is not ratified by the Board; or
• by the shareholders at a meeting within three months from the date on which such contract or arrangement was entered:

such contract or arrangement shall be voidable at the option of the Board 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(3).

Recovery of loss:

It shall be open to the company to proceed against a director or any other employee who had entered into suchcontract 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(4).

Penal Provisions:

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 this section shall,—

• in case of listed company, be punishable with imprisonment upto one year or with fine not less than twenty-five thousand rupees but which may extend to five lakh rupees, or with both; and
• in case of any other company, be punishable with fine not less than twenty-five thousand rupees but which may extend to five lakh rupees.

Central Government approval:

The Companies Act, 2013 has removed central government approvals for related party transaction which was mandatory under the 1956 Act for companies having paid-up share capital of rupees one crore or more.

Conclusion:

The Companies Act, 2013 extended the compliance required in case of related party transaction. The amended provisions issued by the Ministry in the name of Companies (Meeting of Board and its Powers) Second Amendment Rule, 2014 made harder for private and small companies to comply with related party transaction and as well increased the practical difficulties to larger companies.

The parliament has passed the Companies (Amendment) Act, 2015 which replace “special resolution” with “ordinary resolution” for approval of related-party transactions by minority shareholders and also exempt related party transactions between holding companies and wholly owned subsidiaries from the requirement of approval of non-related shareholders. These amendments will provide a big relief to corporate for related party transaction.

Disclaimer : Kindly note that the entire content of this Article have been developed on the basis of relevant statutory provisions and as per the information existing at the time of preparation of i.e Act, Rules, notification, clarification, circulars, issued by MCA, SEBI or any other statutory authority. Though I have made upmost efforts to provide authentic information, however, I do not undertake any liability in any way whatsoever, to any person in respect of anything arising by reliance upon the content of this article. It shall not be used as a legal opinion and not to be used for rendering any professional advice.

[1] Amended under the Companies (Amendment) Act, 2015 from Special resolution to Ordinary resolution.

[2] http://www.business-standard.com/article/companies/govt-to-bring-guidelines-for-arm-s-length-basis-and-ordinary-course-of-business-114120400196_1.html

(Author may be contacted at [email protected])