Related Party Transactions of Unlisted Companies | Companies Act 2013

Background:

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

1. A director or a key managerial personnel or their relatives;

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

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

4. 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;

5. 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;

6. 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.

7. 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 venture of the company.

Related Party Transactions (RPT) – transactions that a company does with parties related to it. It’s an arrangement between two entities which share a preexisting business relationship.

Example:

An RPT is an arrangement between two entities which share a preexisting business relationship.

Ex: A company XYZ buys goods or services from its Director ABC, it’s a RPT.

• Section 188 of Companies Act, 2013 regulates certain conditions by the means of which they are to be disclosed to the Board and Shareholders for them to rectify.
• Section also states that if the transactions fall within the meaning of Section 188 of the Act, then these need to be disclosed in the Board Report to the Shareholders along with a justification in support of the Transactions.

Related Party Transactions:

Section 188 includes within its ambit any contract or arrangement with a related party with respect to:

• 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; and
• Underwriting the subscription of any securities or derivatives thereof, of the Company.
• Section 188 further states that if the transactions are beyond certain threshold limits or if the company has a paid-up share capital of not less than the prescribed amount, then details of the RPTs such as name of related party, nature of relationship, nature and term of contract, material terms etc. need to be disclosed in the General Meeting of the company for approval by special resolution.
• Transactions that are on an arm’s length basis – a transaction when conducted as if they were 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.

Threshold Limits of Related Party Transactions:

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.

Important Pointers:

• Related Party are defined under Section 2 (76)
• Arm’s Length Basis Transactions: Any transaction between two related parties that occur as if they are unrelated.
• Any transaction entered into ordinary course of business or on arm’s length basis shall not require any approval or consent of BOD or members.
• Approval of the Audit Committee shall be required for all the transaction with related parties as mentioned in Section 188 and where Audit Committee does not approve the transaction, it shall make its recommendations to the Board.
• Any transaction involving any amount not exceeding one crore is entered into by a director or officer of the company without obtaining the approval of the Audit Committee and it is not ratified by the Audit Committee within three months from the date of the transaction , such transaction shall be voidable at the option of the Audit Committee and if the transaction is with the related party to any director or is authorized by any other director, the director concerned shall indemnify the company against any loss incurred by it.
• Provisions of the section 177(4) (iv) shall not apply to a transaction, other than a transaction referred to in section 188, between a holding company and its wholly owned subsidiary company.

Approval of Board and Shareholders:

• Approval of the Board at the meeting shall be obtained through voting only by disinterested parties for all the transactions covered under Section 188 of the Companies Act, 2013.
• Prior approval of the shareholders through resolution shall be required if the threshold limit as per the rule 15 of the Companies (Meeting of Board and its Powers) Rules, 2014 is triggered for the transaction.

The details of the proposed specified transaction should be given in the explanatory statement attached to the notice.

• A member, if a related party to the transaction, shall not vote on the resolution for such transaction. (Expect in case of private company or a company in which ninety per cent or more members, in number, are relatives of promoters or are related parties).
• If prior approval is not obtained, then ratification should be done within 3 months of the date of entering into contract/arrangement. However, the contract /arrangement are voidable at the option of the board if prior approval/ratification of the board and shareholders, as the case may be has not been obtained.

Approval of members shall not be applicable in following cases:

• Transactions entered into between two government companies.
• 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.
• Approval of the Board/shareholders shall not be required in case of RPTs which are in ordinary course of business and on an arms’ length basis.

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

• the name of the related party and nature of relationship;
• the nature, duration of the contract and particulars of the contract or arrangement;
• the material terms of the contract or arrangement including the value, if any;
• any advance paid or received for the contract or arrangement, if any;
• the manner of determining the pricing and other commercial terms, both included as part of contract and not considered as part of the contract;
• 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
• Any other information relevant or important for the Board to take a decision on the proposed transaction.

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

• name of the related party;
• name of the director or key managerial personnel who is related, if any;
• nature of relationship;
• nature, material terms, monetary value and particulars of the contract or arrangements;
• Any other information relevant or important for the members to take a decision on the proposed resolution.

Disclosure in (Form AOC-2) in Board’s Report as Disclosure which includes:

• Reference of contract or arrangement with related parties;
• Justification for entering into such a contract or arrangement; and
• Additional disclosures as per the Accounts Rules.

Non-Compliance with the Act and Rules could render RPTs void and entail penalties for the violator.

• A RTP which has been entered into without the consent of the Board or approval by a resolution in the general meeting and if not ratified by the board or the shareholders within 3 months from the date on which such contract or arrangement was entered into, can be voidable at the option of board or shareholders, as the case may be.
• The company also has the option to proceed against a director or any other employee who had entered into such contract or arrangement in contravention of the Act for recovery of any loss sustained by its as result of such contract or arrangement. A director or any other employee of a company, who enters into a irregular RPT is liable to:
• Imprisonment for a term which may extend to one year or with fine which shall not less than twenty-five thousand rupees but which may extent to five lakh rupees, or with both in case of listed company; and
• A fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees in case of any other company.

Note: The above mentioned Litigation are for Related Party Transactions under Companies Act, 2013 for Unlisted Companies excluding litigation under SEBI (Listing Obligation and Disclosure Requirement) Regulation 2015.

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