Section 188: Related Party Transactions – An Analysis

♦ Sec – 188(1): A company shall not enter into any contract or arrangement with a related party without the consent of Board of Directors through board resolution at a meeting and subject to conditions as prescribed 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:

> Provided that no contract or arrangement, in the case of a company having a 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 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:

> Provided that second proviso shall not apply to a company in which 90% or more members, in number, are relatives of promoters or are related parties:

> Provided also that this section 188(1) shall not 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.

> Provided also that 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:

√ Explanation: In this section 188(1):

• “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;
• “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.

♦ Sec – 188(2): Every contract or arrangement entered into u/s. 188(1) shall be referred to:

• in the Board’s report to the shareholders
• along with the justification for entering into such contract or arrangement.

Sec – 188(3): 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 a resolution in the general meeting u/s. 188(1) and
• if it is not ratified by the Board or,
• by the shareholders at a meeting

within 3 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
• 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.

♦ Sec – 188(4): Without prejudice to anything contained in section 188(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
• incontravention of the provisions of this section
• for recovery of any loss sustained by it as a result of such contract or arrangement.

♦ Sec – 188(5): 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:

Punishable with Imprisonment: Maximum – 1year or

Fine: Minimum: Rs. 25,000/-, Maximum: Rs. 5,00,000/- or

with both;

and

(ii) In case of any other company:

Punishable with Fine: Minimum: Rs. 25,000/-, Maximum: Rs. 5,00,000/- 

Note:

1. In case of private company – Second proviso to Sub-section (1) of Section 188(1) shall not apply [Notification dated 5th June, 2015]

2. In case of Government company – First and second proviso to Section 188 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. [Notification dated 5th June, 2015]

3. In case of Specified IFSC Public Company – Second proviso to section 188(1) shall not apply. [Notification Date 4th January, 2017]

4. In case of Government company – First and second proviso to Section 188(1) shall not apply to:

• a Government company in respect of contracts or arrangements entered into by it with any other Government company, or with Central Government or any State Government or any combination thereof;
• 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. [Company Law Notification dated 02nd March, 2020]

Practical Questions:

Que-1: The second proviso to section 188(1) of the Companies Act, 2013 states 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. Are there any exceptions?

Answer: The Companies (Amendment) Bill, 2016 intends to insert a proviso which states that nothing contained in the second proviso shall apply to a company in which ninety per cent or more members, in number, are relatives of promoters or are related parties.

Que-2: Whether it is necessary to pass Board Resolution if a transaction is transacted at arm’s length basis with a related party?

Answer: Section 188(1) enlists the various transactions which when undertaken with a related party shall require the consent of the Board of Directors by way of a resolution at a meeting of the Board. However, third proviso to section 188(1) states that nothing stated therein 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.

Hence, it may be concluded that the passing of a Board resolution is not necessary in case of related party transactions occurring at arm’s length basis. However, as a good practice the board may note and approve such a related party transaction. Further, there are additional compliances (beyond the Act) for listed companies, and the same must be complied with as applicable.

Que-3: A public company intends to take loan from its directors (whole-time directors) and this transaction is not covered under section 188 of the Companies Act, 2013. But since a director is a related party, the acceptance of loan will be taken as related party transaction.  How much interest the company can pay to the director for the said loan?

Answer: Where a company takes a loan from a director, the same falls under the purview of Acceptance of Deposits under section 73 of the Companies Act, 2013 read with relevant rules. However, the Director from whom the money is received has to furnish a declaration that the amount given by him is not out of borrowed funds. Though no rate of interest has been prescribed in the Act, a maximum cap has been set out in the Companies (Acceptance of deposits) Rules, 2014; i.e., the maximum rate of interest prescribed by the RBI for acceptance of deposits by NBFCs. The same may be complied with in the said case.

Que-4: As per the Sale of Goods Act, 1930, the definition of ‘goods’ includes ‘shares’, Whether selling of shares to related party will fall under the purview of section 188?

Answer: Yes. In both situations, viz., if a company is engaged in the business of buying and selling of shares and such other securities then the sale of shares and such other securities shall be covered under clause (a) of subsection (1) of section 188 of Companies Act, 2013, and also in any other case, the sale of shares held by a company in the normal course as investments shall be covered under section 188 as related party transactions. However, issue of shares of the company itself shall not be covered by section 188 nor will issue or sale of shares pursuant to an employee stock option scheme be covered as the Act provides specifically for compliances in that regard. The special provisions relating to employee stock option scheme and issue of shares will therefore override the general provisions of section 188.

Que-5: Whether remuneration and unsecured loans to directors are covered under related party transactions as per section 188?

Answer: Remuneration and unsecured loans to directors are not covered under the related party transactions as per section 188 of the Companies Act, 2013. There are specific sections for both of them:

• Remuneration to directors (section 197 of the Act); and
• Unsecured loans to directors (section 185 of the Act).

Que-6: A non-executive director of a private limited company holds expertise in a certain area. Can the said director render services as a consultant to the same company? Can he render his services to a company in some other group as well?

Answer: A non-executive director of a private limited company is eligible to act as a consultant of the private company in which he is a director. However, any such appointment shall be done in compliance of sections 184 and 188 of the Companies Act, 2013 and Rules framed thereunder. Unless the Articles of Association of the company prohibit appointment in group companies, he can also be appointed as consultant of any other company.

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