Related Party Transactions -For Unlisted Companies

1. Introduction to Related Party Transactions

Till 2013, Related Party Transactions (RPTs) were governed through provisions of Companies Act, 1956 (Section 297,314) which warranted approval of Central Government for entering into RPT by Large Cap Companies.

Whereas, under Companies Act, 2013 this requirement has been done away with and substantial focus is towards disclosure regime. The ambit of provisions governing Related Party Transactions has been increased phenomenally. After concerns of stakeholders several rounds of amendments has been made in the provisions.

In this article unless otherwise expressly provided all rules referred to are of Companies (Meeting of Board & its Powers), 2014 as amended from time to time.

Related Party Definition – 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; or

(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.

(ix) such other person as may be prescribed;

2. Transactions Covered under Related Party Transactions (section 188(1))

Following transactions if entered into with Related Party would attract RPT Compliances:-

1. Sale, purchase or supply of goods or materials.

2. Sell, buy or otherwise dispose property of any kind.

3. Lease Property of any Kind.

4. Avail or render any Service.

5. Sell, purchase of goods, materials, services or property through Agent.

6. Appointment of Related Party to office or Place of profit in Company, it’s Subsidiary or Associate.

7. Underwriting the subscription of any securities or derivatives of Company.

Meaning of Office/place of profit:-

i) Where such office/place held by a Director and he receives anything over and above the remuneration to which he is entitled as director.

ii) Where such office/place held by individual other than Director/firm/Pvt. Co./Body Corporate and person holding it receives anything by way of remuneration.

3. Approvals Required for Related Party Transactions

Omnibus Approval Of Audit Committee

Audit Committee may grant Omnibus approval

As audit committee approval is mandatory for every RPT but in cases where RPTs are entered too frequently its not feasible for the committee to meet every time.

• Basis / criteria for granting omnibus approval to include:-
  • Maximum value, per transaction & in aggregate
  • Disclosure required for obtaining approval
  • Periodical review criteria for approved transactions
  • Specifying transactions which cannot be approved by omnibus approval
• Information required for granting omnibus approval: Particulars which need to be mentioned in Omnibus Approval Resolution :-
  • Name of Related Parties, Nature & Duration of Transaction
  • Maximum Amount of Transaction
  • Indicative base price and formula for variation

However, in cases where the above information is not available & need for obtaining approval cannot be foreseen then approval may be given subject to value not exceeding Rs. 1 crore.

• Validity of omnibus approvals:- Maximum 1 financial year and will require fresh approval thereafter.
• Bar on Omnibus approval:- No omnibus approval for selling or disposing of the undertaking.

Shareholder’s Approval

If value of transaction (including previous transactions in the financial year) exceeds lower of the following limits then Ordinary Resolution is mandatory to be passed:-

4. Restriction at Meetings

At Board Meeting

If a Director is interested in any Contract/Arrangement with a related party he shall not be present at the meeting during discussions on such resolution. (Rule 15(2))

Moreover if RPT is such that Director is interested as per section 184(2) then he shall neither discuss nor vote and also not be counted for quorum in respect of such transaction. (Section 184(2) read with 174(3)) (**)(#)

At General Meeting (**) ($) (!)

Related party cannot exercise voting right on shares held by him if RPT is being entered into with such related party. (2ndproviso to Section 188(1))

(**) Does not apply to a PRIVATE COMPANY & IFSC Public Company.

(#) Does not apply to a Section 8 (Not for profit Company) if value of transaction is upto Rs. 1,00,000/- (Rupees One Lakh).

($) Does not apply to transactions between 2 Govt. companies or if the Govt. companies obtains approval of ministry in charge.

(!) Does not apply where atleast 90% of number of members are relatives of promoters or are related parties.

5. Arm’s Length Transaction

As per Section 188(1) 3rdproviso, RPTs entered into in ordinary course of business and at arm’s length need not require to comply with the following:-

1. Board/Shareholder’s Approval.

2. Restrictions on presence in Board meeting/voting in General meeting.

3. Specific disclosures required in agenda of Board meeting & explanatory statement of General meeting

♦ Meaning of ordinary course of business:- It is not defined under the act or rules.

The general meaning of the same can be taken as all the usual transactions of a Company.

ICAI has vide standrad on auditing 550 provided guidance to determine whether a transaction is at ordinary course of business or not, through examples. Following shall be considered to be outside ordinary course of business:-

1. Corporate Restructurings

2. Sale transactions with unusual large discounts or returns

3. Circular transactions such as sale with commitment to repurchase

♦ Meaning of Arm’s length:- It means a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest (explanation to Section 188(1)).

♦ Justification of arm’s length:- Justifications can be classified into 3 categories namely entity oriented, price oriented & documentation oriented. Certain indicators may include:-

6. Disclosures Required For Related Party Transactions

Audit Committee

No specific disclosures are mandated under law, but as per section 177(6) the committee shall have full access to information contained in the reccords of the company and power to obtain professional advice from external sources, therefore adequate disclosure should also be given to the committee so as to ensure fair decision making by it, whether for specific approval or omnibus approval.

Board

Following information should be given in the agenda (Rule 15):-

√ Name of the related party and nature of relationship

√ Nature, duration of contract/arrangement & its particulars

√ Material terms of the contract/arrangement including value, if any

√ Any advance paid or received for contract/arrangement

√ Manner of determining pricing and other commercial terms

Shareholders

Following Information should be given in Explanatory statement:-

A. General (Section 102):-

√ Concern or interest, financial/otherwise of any Director/KMP or their relatives.

√ Any other information/fact that may enable members to understand meaning, scope and implication of resolution.

√ In case resolution relates to another company then shareholding in that company of every promoter, Director and KMP if it exceeds 2% of paid up share capital.

B. Specific (Rule 15):-

√ Name of related party

√ Name of Director/KMP who is related, if any

√ Nature of relationship

√ Nature,material terms, monetary value and particulars of contract/arrangement

√ Any information relevant/important to take decision by members

Board Report

As per section 188(2) & 134(3)(h) read with rule 8 of Companies (Accounts) rules, 2014 disclosure required in Board report by way of annexing form AOC-2, can be summed up as under:-

* Materiality has not been defined in act/rules. Therefore, Company should define a materiality threshold and transactions falling beyond which will be disclosed in Board’s Report.

Particulars to be Entered In RPT Register

As per Section 189 read with rule 16 a register shall be maintained and kept at the registered office for recording particulars of the following:-

A. Entities in which any Director is having concern/interest u/s 184(1)

B. Contracts or agreements with related party u/s 188 OR in which any director is concerned / interested u/s 184(2)

Particulars Exempt From Being Recorded In Register

√ Particulars of body Corporate required to be entered in table A above, if directors together do not hold more than 2% of paid-up share capital of such body corporate.

√ Particulars of contract/arrangement for sale/purchare/supply of goods/material/ sevices, if value of such contract/arrangement is less than Rs. 5 lakh in aggregate in any year.

√ Particulars of contract/ arrangement by a banking company for the collection of bills in the ordinary course of business

Other Requirement Pertaining To Register

√ Disclosure of info. as required u/s 184(1) to be given by Director/KMP within 30 days of appointment, failure would attract penalty of Rs. 25,000/-.

√ Register shall be placed at Board meeting & be signed by all Directors present thereat.

√ Register shall be produced at and shall remain open and accessible during AGM.

√ Register shall be open for inspection and extracts may be given on payment of amount prescribed in AOA (max. Rs. 10) within max. 7 days of request.

Financial Statements

A. Under Companies Act, 2013:- Schedule III deals with presentation of financial statements. Following disclosures need to be made:-

1. Details of loans & advances from related parties (under long-term & short-term borrowings)

2. Details of loans & advances to related parties(under long-term & short-term loans & advances)

B. Under AS-18:- Provisions of AS-18 are mandatory on every company as per Companies (Accounting Standard) rules, 2006.

7. Duties of Director with respect to Related Party Transactions

A. Duty of Director:- As per section 166, a director of company shall not

• Involve in a situation in which he may have a direct/indirect interest that conflicts or may conflict with interest of the Company.
• Not achieve/ attempt to achieve any undue gain either to himself or to any of his relatives, partners or associates and if found guilty then liable to pay equal amount.

B. Duty of Independent Director:- Independent Director shall pay sufficient attention and ensure that adequate deliberations are held before approving related party transactions and assure themselves that the same are in the interest of Company (schedule IV, para III-point 9)

8. Consequences of Non-Compliance

Ratification:- If Board/Shareholder’s approval not taken before entering into RPT, then same can be ratified by Board/ Shareholders within 3 months. If ratification not done then Contract/arrangement voidable at the option of Board.

Indemnification:- If transaction was with related party of Director/ authorized by any director then he shall indemnify the company against loss incurred.

Recovery of loss:- Company may proceed against a Director/ employee who has entered into such contract/arrangement in contravention of section 188 for recovery of loss.

Penalty:-

9. Compendium of Changes To Related Party Transaction Provisions