Related Party Transaction (overall Understanding) Section 188 of the Companies Act 2013

CS Keshav Sarda

First, we need to understand the meaning of the term Relative:

With reference to the Section 2(77):

i. They are member of a Hindu Undivided family;

ii. They are husband and wife;

iii. One person is related to the other in such manner as may be prescribed;

Explanation:

1) Father include step-father;

2) Mother include step-mother;

3) Son;

4) Son’s Wife;

5) Daughter;

6) Daughter’s husband;

7) Brother include step brother;

8) Sister includes step sister.

Now we required to understand the meaning of the Related Party:

Section 2(76), read with Rule 3 of Companies (Specification of definition details) Rule 2014, define the related party with reference to a Body Corporate means-

(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 relative more than 2 percent of its paid up share capital,

(vi) any body corporate whose Board of directors, managing director, manager is accustomed to act in accordance with the advice directions or instructions a director or manager,

(vii) any person under whose advice, direction or instruction a director or manager is accustomed to act,

(viii) any company which is –

(A) a holding, subsidiary, or an associated company of such company

         or

(B) a subsidiary of a holding company to which it is also a subsidiary.

In addition to the above a director or Key Managerial Personnel of holding the company or his relative also covered under the definition of related parties.

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

Exemption to a private company: Sub – clause (viii)  shall not apply with respect to section 188 dealing with related party transaction [Notification dated 5^th June 2015].

Related Party Transaction- Subsection (1) to Section 188

Except with the consent of the Board of Directors given by a resolution at a meeting of the Board and subject to such condition as may be prescribed, no company shall enter into any contract or arrangement with related party with respect to—

Clause

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 or property;

e) Appointment of any agent for purchase or sale of goods material, 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;

First Proviso:  Provided that no contract arrangement, in the case of a company having 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 special resolution.

Second Proviso: Provided further that no member of the company shall vote on such resolution to approve any contract arrangement which may be entered into by the company if such member is a related party.

The Second proviso to Section 188(1) shall not apply to a private company, vide Notification No. GSR 464(E) dated 5^th June 2015.

Third Proviso: Provided also that nothing in this sub-section shall apply to any transaction 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 the first proviso shall not be applicable for transaction 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

The first and second proviso to section 188(1) shall not apply to-

(a) a Government company in respect of contract or arrangement entered into by it with any other Government company.

(b) a Government company, other than listed company, in respect of contracts or arrangements other than those referred to in above clause(a), in case such company obtain approval of the ministry or department of the \Central Government which is administratively in charge of the company or as the case may be, the state Government before entering into such contract or arrangement; vide Notification No. GSR 463(E) dated 5^th June 2015.

Office or place of profit-

> 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;

> Where such office or place is held by an individual other than a director or by any firm, private company or other bodies 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;

Arm’s length transaction-

> Arm’s length transaction mean a transaction between two related parties that is conducted as if they were unrelated so that there is no conflict of interest.

Requirement to pass Special Resolution

With reference to the Companies (Meeting of Board and its Powers) Rules 2014

Special Resolution for the purpose of the first proviso to sub-section(1) of section 188, except with the prior approval of the company by a special resolution, a company shall not enter into a transaction or transactions, where the transaction or transactions to be entered into:

> for clause (a) to subsection (1) of section 188, where the contract or arrangement value exceeding ten percent (10%) of the turnover of the company or rupees one hundred crores, whichever is lower;

> for clause (b) to subsection (1) of section 188, where the contract or arrangement value exceeding ten percent (10%) of the net worth of the company or rupees one hundred crores, whichever is lower;

> for clause (c) of subsection (1) of section 188, where the contract or arrangement value exceeding ten percent (10%) of the net worth or ten percent (10%) of the turnover of the company or rupees one hundred crores, whichever is lower;

> for clause (d) and (e) to subsection (1) of section 188, where the contract or arrangement value exceeding ten percent (10%) of the turnover of the company or rupees fifty crores, whichever is lower;

The above-specified limit for the transaction or transactions to be entered into either individually or taken together with the previous transaction during a financial year.

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

> for clause (f) to subsection (1) of section 188, where the remuneration for underwriting the subscription of any security derivatives thereof, of the company exceeding one percent (1%) of the net worth.

Explanation:

> 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.

> In the case of a wholly owned subsidiary, the special resolution passed by the holding company shall be sufficient for the purpose of the entering into the transaction between wholly owned subsidiary and the holding Company.

Contract voidable if approval of Board/Members is not taken:

Where any contract or arrangement entered into by a director or any other employee, without obtaining the consent of the Board or approval by a resolution and if it is not ratified by the Board/Shareholder 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. If the contract or arrangement is with a Party related to any director or is authorised by any other director, the director concerned shall indemnify the company against any loss incurred by it.

Further, it shall be 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 provision of the section for recovery of any loss sustained by it as a result of such contract or arrangement.

Offence & Penalty:

Any director or other employee of a company, who had entered into or authorized the contract or arrangement in violation of the provision of this section shall, in case of listed company, be punishable with imprisonment for a term which may extended to one year or fine which shall not be less than twenty-five thousand but which may be extended to five lakh rupees or with both; and in case of any other company, be punishable with fine which shall not be less than twenty-five thousand but which may be extended to five lakh rupees.

Disclosure Requirement;

> Disclosure to be made in Board’s report.

> Disclosure to be made in the Register of contracts or arrangements in which director are interested, every company shall maintain a register in Form MBP 4.

Omnibus approval for related party transactions on annual basis;

a) All related party shall require prior approval of the audit committee and the Audit Committee may make omnibus approval for related party transaction proposed to be entered into by the company.

b) Omnibus approval shall be valid for a period not extending one financial year and shall require fresh approval after the expiry of such financial year.

c) Omnibus approval shall not be made for a transaction in respect of selling or disposing of the undertaking of the company.

d) Provided that where the need for related party transaction cannot be foreseen and aforesaid details are mot available, Audit Committee may make approval for such a transaction subject to their value not exceeding rupees one crore per transaction.

However, Audit Committee shall consider different parameter before giving the omnibus approval to any contracts or arrangements-

a) repetitiveness of the transaction

b) justification for the need of omnibus approval.

The omnibus approval shall contain or indicate the following;-

1) name of related parties;

2) nature and duration of the transaction;

3) maximum amount of transaction that can be entered into;

4) any other information relevant or important for Audit Committee to take a decision on the proposed transaction.

For related party contact and arrangements, Form AOC 2 required to be enclosed with the Board Report.