Related Party Transactions | Companies Act, 2013 | Section 188

Related Party Transactions u/s 188 of the Companies Act, 2013.

As we all very well know that related party transactions require many compliance as per the Companies Act, 2013.  In this Article an attempt is made to understand the provisions of Section 188 of the companies Act, 2013.

Important Definitions 

1. Office or Place of Profit [Explanation to sub-section (1) of section 188]

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;

2. Arms Length Transaction [Explanation to sub-section (1) of section 188]

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.

3. Related Party [Section 2(76)]

“related party”, with reference to a company, 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 and 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 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.]

(ix) such other person as may be prescribed*;

*Rule 3 of Companies (Specification of Definitions Details) Rules, 2014.

For the purposes of sub-clause (ix) of clause (76) of section 2 of the Act, a director ¹[other than an 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.

4. Relative [Section 2(77)]

 (77) “relative”, with reference to any person, means any one who is related to another, if—

(i) they are members of a Hindu Undivided Family;

(ii) they are husband and wife; or

(iii) one person is related to the other in such manner as may be prescribed*;

*Rule 4 of Companies (Specification of Definitions Details) Rules, 2014.

A person shall be deemed to be the relative of another, if he or she is related to another in the following manner, namely:-

(1) Father: Provided that the term “Father” includes step-father.

(2) Mother: Provided that the term “Mother” includes the step-mother.

(3) Son: Provided that the term “Son” includes the step-son.

(4) Son’s wife.

(5) Daughter.

(6) Daughter’s husband.

(7) Brother: Provided that the term “Brother” includes the step-brother;

(8) Sister: Provided that the term “Sister” includes the step-sister.

Transactions covered under section 188

• sale, purchase or supply of any goods or materials
• selling or otherwise disposing of, or buying, property of any kind
• leasing of property of any kind;
• availing or rendering of any services;
• appointment of any agent for purchase or sale of goods, materials, services or property;
• such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company
• underwriting the subscription of any securities or derivatives thereof, of the company

Subject to consent of Board of Directors given by a resolution at a meeting of the Board, no company shall enter into any contract or arrangement with a related party with respect to above mentioned transactions.

(1) 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.

(2) 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.

Prior approval of the company by a resolution shall be required to enter into a transaction or transactions, where the transaction or transactions to be entered into…

A. as contracts or arrangements with respect to

1. sale, purchase or supply of any goods or material, directly or through appointment of agent amounting to ten percent or more of the turnover of the company or rupees one hundred crore, whichever is lower
2. selling or otherwise disposing of or buying property of any kind, directly or through appointment of agent, amounting to ten percent or more of net worth of the company or rupees one hundred crore, whichever is lower
3. leasing of property any kind amounting to ten percent  or more of the net worth of company or ten per cent or more of turnover of the company or rupees one hundred crore, whichever is lower,
4. availing or rendering of any services, directly or through appointment of agent, amounting to ten percent or more of the turnover of the company or rupees fifty crore, whichever is lower

B. is 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 a half lakh rupees

C. is for remuneration for underwriting the subscription of any securities or derivatives thereof, of the company exceeding one percent.of the net worth

• The limits specified above shall apply for transaction or transactions to be entered into either individually or taken together with the previous transactions during a financial year.
• 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 case of wholly owned subsidiary, the resolution]is 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.
• 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 arrangements;

  (e) any other information relevant or important for the members to take a decision on the proposed 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:

Relaxations and Exemptions

A. Provisions relating to passing of special resolution and voting by related party shall not apply to ….

• a Government company in respect of contracts or arrangements entered into by it with any other Government company;
• a Government company, other than a listed company, in respect of contracts or arrangements other than those referred to in clause (a), in case such company obtains 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

B. the provisions restricting voting by a member if such member is a related party shall not apply….

• to a company in which ninety per cent. or more members, in number, are relatives of promoters or are related parties
• a private company
• Specified IFSC Public Company

C. 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.

D. 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

Other requirement

Every contract or arrangement entered into under sub-section (1) of section 188 shall be referred to in the Board’s report to the shareholders along with the justification for entering into such contract or arrangement.

Effect of Non-Compliance:

a) 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 resolution in the general meeting 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)]

b) Without prejudice to anything contained in sub-section (3), 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 provisions of this section for recovery of any loss sustained by it as a result of such contract or arrangement. [Section 188(4)]

c) Any director or any other employee of a company, who had entered into or authorised the contract or arrangement in violation of the provisions of this section shall,—

 (i) in case of listed company, be punishable with imprisonment for a term which may extend to one year or with fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees, or with both; and

(ii) In case of any other company, be punishable with fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees. [Section 188(5)]