How to Identify whether the proposed transaction is a Related Party Transaction u/s 188 of Companies Act, 2013 or not?

1st Stage (Preliminary test)

1. Is it a transaction (Contract or arrangement) that falls under Section 188(1)(a) to (g) of the Companies Act, 2013 (the Act)?; AND

2. Is it a related Party in terms of Section 2(76) the Act read with Rule 3 of Companies (Specification of Definitions Details) Rules, 2014?

If the answer to both the above questions are YES then only, we need to comply with the provisions of RPT as per the Act. If answer to any of above questions is NO then we don’t need to do the compliance of RPT for such transaction.

For an Example: – A Private Company M/s XYZ (P) Ltd. wants to enter into a lease agreement at an amount of Rs. 700,000/- for a period of 11 months to maintain its registered office with its Director Mr. “X” for the premises owned by him.

Now, the transaction of leasing falls u/s 188(1)(c) of the Act AND Director falls u/s 2(76)(i) of the Act.

Since the answer to both the above questions are “YES”. Therefore, the transaction is a related party transaction in terms of Section 188 of the Act.

In the above example, if Company would have entered into such lease transaction with a private limited company M/s PQR (P) Ltd. in which there is no common director. Then, such situation does not fulfill condition 2. Thus, does not constitute to a related party transaction.

2nd Stage (Check of Compliance Level)

There are following two levels of Compliances u/s 188 of the Act w.r.t RPT:-

1. “PRIOR” approval of the Board in a Meeting (Resolution can’t be passed through Circular, A meeting of the Board needs to be convened to take up the matter).

2. The transactions exceeding the limits prescribed under Rule 15 of Companies (Meetings of Board and its Powers) Rules, 2014 (“the rules”) shall require “PRIOR” approval of members of the company by a resolution. [limits discussed below in this article]

Continuing the above example:- if the amount of lease i.e. Rs. 7,00,000/- is amounting to ten per cent or more of the turnover [as per Rule 15(3)(a)(iii) of the rules] of XYZ (P) Ltd. as per the audited financial statement of the preceding financial year then the Company requires the “PRIOR” approval of the Board and Members before entering into such transaction.

And on the other hand if it falls below such turnover then only Board Resolution would have been required.

    • In both the cases, an entry of such transaction shall be entered into Register in Form MBP-4 (constituting of Part A and Part B) and it shall be placed before the next meeting of the Board and signed by all the directors present at the meeting [Section 189 of the Act].
    • The particulars of contracts or arrangements with related parties referred to in sub-section (1) of section 188 in the Form AOC-2 shall forms part of the Board Report of the Company. [Section 134 of the Act read with Rule 8 of Companies (Accounts of Companies) Rules, 2014]

Exemptions: –

For ease of doing business purposes and to leave out certain kind of transactions, there are several exemptions being provided under the whole concept of Related Party transactions:-

    • If the transaction to be entered into with a related party is in the ordinary course of business and at arm’s length then no compliance under Related Party in terms of Section 188 is required [fourth proviso to Section 188(1) of the Act].
    • For Private Companies [Notification dated 5th June, 2015] and Specified IFSC Public Companies [Notification dated 4th January, 2017]
      Any Body-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) An investing company or the venturer of the 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. are exempted to be related parties: –

3. The requirement of getting the approval from members in a general meeting 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. [fifth proviso to Section 188(1) of the Act].

4. In case of wholly owned subsidiary, the resolution passed by the holding company shall be sufficient for the purpose of entering into the transaction between the wholly owned subsidiary and the holding company. [2nd Explanation Point (2) to Rule 15(3) of the rules].

5. The requirement of making entry in the Register MBP-4 does not arise for the sale, purchase or supply of any goods, materials or services if the value of such goods and materials or the cost of such services does not exceed five lakh rupees in the aggregate in any year. [Section 189(5)(a) of the Act].

6. The requirement of making entry in the Register MBP-4 does not arise for a banking company for the collection of bills in the ordinary course of its business. [Section 189(5)(b) of the Act]

Few Prohibitions/Restrictions to the General Rule: –

1. 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 [second Proviso to Section 188(1) of the Act].

However, if ninety per cent or more members, in number, are relatives of promoters or are related parties then above restriction shall not be applicable. [third Proviso to Section 188(1) of the Act]

2. If 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. [Rule 15(2) of the rules].

3. In case, 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 resolution in the general meeting u/s 188(1) and if it is not ratified by the Board or, as the case may be, by the shareholders at a meeting within three months from the date on which such contract or arrangement was entered into, such contract or arrangement shall be voidable at the option of the Board or, as the case may be, of the shareholders 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) of the Act]

Points to be kept in mind w.r.t Related party transactions: –

1. Register in Form MBP-4 (constituting of Part A and Part B) providing the particulars of all contracts or arrangements to which sub-section (2) of section 184 or section 188 applies shall be maintained by the Company and after entering the particulars, such register or registers shall be placed before the next meeting of the Board and signed by all the directors present at the meeting.

2. A director other than independent 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]

3. The Agenda item for the related party transaction of the Board Meeting shall disclose the following the following information: –

(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 [Rule 15(1) of the rules]

4. Where there is a need to convene an Extra-Ordinary General Meeting

(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 arrangements;

(e) any other information relevant or important for the members to take a decision on the proposed resolution. [2nd Explanation Point (3) to Rule 15(3) of the rules]

5. Not only the Directors, every Key managerial personnel shall also, within a period of thirty days of his appointment, or relinquishment of his office, as the case may be, disclose to the company the particulars specified in sub-section (1) of section 184 relating to his concern or interest in the other associations which are required to be included in the register under that sub-section or such other information relating to himself as prescribed under Rule 16 of rules. [Section 189(2) of the Act].

6. The register in Form MBP-4 shall also be produced at the commencement of every annual general meeting of the company and shall remain open and accessible during the continuance of the meeting to any person having the right to attend the meeting. [Section 189(4) of the Act].

7. A Person who has been convicted of the offence dealing with related party transactions under section 188 at any time during the last preceding five years shall not be eligible for appointment as a director of a company [Section 164(1)(g) of the Act].

Brief of the transactions and limits to be checked upon for the purpose of requirement of prior approval of members: –

Related Party Transaction Limits

Note:-

i. The limits specified in Point 1 to 5 above shall apply for transaction or transactions to be entered into either individually or taken together with the previous transactions during a financial year.

ii. 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

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