Introduction

A company, in the course of conduct of its business, enters into various transactions with different parties, including its related parties. Companies also carry on their activities through subsidiary companies and associate companies. Accordingly, related party relationships are a normal feature of business. Due to this relationship, related parties may enter into transactions that unrelated parties may not. Every transaction with a related party may not be a ‘related party transaction’ although every ‘related party transaction’ is necessarily a transaction with a related party.

Transactions with related parties need not always be disadvantageous to the parties concerned. The concern arises only when the transactions which are at non arm’s length dealings beneficial to a related party but detrimental to the other stakeholders. Transactions with related parties raise important concerns and hence transparency in such transactions is essential. Therefore, law requires certain specific compliances with respect to the related Party transactions.

Applicable Provisions

Section 188, 177 of the Companies Act 2013 (“the Act”) read with The Companies (Meetings of Board and its Powers) Rules, 2014 govern the compliance framework for related party transactions. Listed Companies are additionally required to comply with the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015.

What is a Related Party Transaction (RPT)?

Related Party Transactions are transactions which a Company does with parties that are related to it.

Who is a Related Party?

There is a long list of persons and entities that are considered related parties by the law. These include the company’s directors, key managerial persons, and their relatives. Also, firms or private companies in which such directors, managers, or their relatives are partners or directors fall under the ambit of related parties. So also, are holding companies, subsidiaries, and associate companies — among others that can exercise influence on the company.

Section 2(76) of the Act defines a related party with reference to a company, means:

i. A director or key managerial personnel or their relatives.

ii. a firm, in which a director, manager or his relative is a partner.

iii. a private company in which a director or manager or his relative is a member or director.

iv. 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.

v. anybody 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.

vi. any person on whose advice, directions, or instructions a director or manager is accustomed to act:

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

vii. anybody 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; (c) an investing company or the venturer of the company.

Regulation of RPT

The Act does not prohibit RPT, it lays down safety measures that are needed to follow while dealing with RPT. RPTs are regulated by certain conditions as provided in Section 188 of the Act, by the means of which they are to be disclosed to the Board and shareholders. Section 188 of the Act also states that if the transactions fall within the meaning of Section 188, then these need to be disclosed in the Board Report to the shareholders along with a justification in support of the transactions.

RPT’s for which Board approval is required.

Section 188 of that Act the following matters require prior Board approval which are not in Ordinary course of business other than transactions which are not on an arm’s length basis:

i. sale, purchase or supply of any goods or materials;

ii. selling or otherwise disposing of, or buying, property of any kind;

iii. leasing of property of any kind;

iv. availing or rendering of any services;

v. appointment of any agent for purchase or sale of goods, materials, services, or property;

vi. such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company; and

vii. underwriting the subscription of any securities or derivatives thereof, of the company.

Transactions that are on an arm’s length basis – a transaction when conducted as if the parties are unrelated, so that there is no conflict of interest, do not fall under the ambit of Section 188 and require no Board or shareholder ratifications.

When does a RPT require Shareholder Approval?

Threshold limits have been prescribed and if the RPT attracts the given threshold limits, prior shareholder approval shall also be required.

S. No Nature of Related Party Transactions Threshold Limit1
1 Sale, purchase, or supply of any goods or material (directly or through an agent). Amounting to ten percent (10%) or more of the turnover of the company.
2 Selling or otherwise disposing of, or buying, property of any kind (directly or through an agent). Amounting to ten percent (10%) or more of the net worth of the company.
3 Leasing of property of
any kind.
Amounting to ten percent (10%) or more of the turnover of the company.
4 Availing or rendering of any services (directly or through an agent) Amounting to ten percent (10%) or more of the turnover of the company
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
5 Appointment to any office or place of profit in the company, subsidiary company, or associate company Remuneration exceeding
Rs. 2,50,000 per month
6 Underwriting the subscription of any securities or derivatives of the company Remuneration exceeding
one percent (1%) of net worth

1 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.

Role of Audit Committee in RPT

Section 177 of the Act requires prior approval of Audit Committee for all the RPT including any subsequent modifications therein. The committee may also ascertain whether or not the transaction is an ordinary transaction and also on determine on the arm’s length for taking up the applicable approvals.

The Audit Committee can also give an omnibus approval to certain related party transactions. The Committee shall consider two factors while specifying the criteria for making omnibus approval, namely,

(i) repetitiveness of the transactions (in part or in future); and

(ii) justification for the need of omnibus approval.

Such omnibus approval for the related party transactions shall be obtained on annual basis [Rule 6-A of the Companies (Meetings of Board and its Powers) Rules, 2014]. Such omnibus approval shall be valid for a period not exceeding 1 financial year and shall require fresh approval after expiry of such financial year. Omnibus approval shall not be made for transactions in respect of selling or disposing of the undertaking of the company.

Approval Mechanism

The Audit Committee shall approve the related party transactions or approve any modification to the related party transactions and forward the same for the consideration of the Board.

The Board shall review the transaction at its meeting only. The information that shall be placed before the Board for its consideration is as given below:

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

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

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

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

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

vi. 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

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

If the Transaction attracts any of the threshold limits, shareholder approval will also be required. The Explanatory Statement to be annexed to the notice of a general meeting convened pursuant to section 101 shall contain the following particulars, namely: –

i. name of the related party;

ii. name of the director or key managerial personnel who is related, if any;

iii. nature of relationship;

iv. nature, material terms, monetary value and particulars of the contract or arrangements; and

v. any other information relevant or important for the members to take a decision on the proposed resolution.

Following are some important points relating to approval of shareholders:

i. Member of the company shall not vote on the ordinary resolution approving related party transaction if such member is a related party (this provision is not applicable to private companies. MCA Notification dated 5-6-2015).

ii. Approval of the shareholder is not applicable in the cases where 90% or more members (in number) are the relatives of promoters or are related parties (applicable to private company and public company, both).

iii. In case of wholly owned subsidiary company, the ordinary resolution passed by the holding company shall be sufficient for the purpose of entering into the transactions between the wholly owned subsidiary company and the holding company, subject to the condition that the accounts of the subsidiary company are consolidated with holding company and placed before shareholders at the general meeting for its approval.

Interested Director

A Director interested in a transaction shall inform the Board before the agenda is taken up for consideration. Directors of public limited company shall not be present in the meeting where these contract and arrangements are discussed upon.

Register of Contracts or Arrangements in Which Directors are Interested.

Company shall make entries in the Register of Contract and Arrangement with a related party in statutory register (Form MBP-4) after receiving an approval from the Board which shall be kept in next Board Meeting and signed by all the Directors present in the Meeting.

Consequences for not obtaining prior approval.

Where any RPT is entered into by a director or any other employee, without obtaining the consent of the Board or approval in the general meeting, post facto approval can be obtained from the Board/ Shareholders, as the case may be, within 3 months of entering into the transaction. In case such approval is not obtained within the said time frame such transactions shall be voidable at the option of the Board or, as the case may be, of the shareholders and if such transaction is with a related party to any director, or is authorized by any other director, the directors concerned shall indemnify the company against any loss incurred by it.

Disclosure in Board Report

Every contract or arrangement entered into by the company shall be referred to in the Board’s report to the shareholders along with the justification for entering into such contract or arrangement in prescribed form (Form AOC-2).

Penal Provisions

Any director or any other employee of a company, who had entered into or authorized a RPT in violation of the provisions of this section shall, —

i. in case of listed company, be liable to a penalty of Rs. 25 Lakhs and

ii. In case of any other company, be liable to a penalty of Rs. 5 Lakhs

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