Summary: Related Party Transactions (RPTs) are transactions between an entity and its related parties, governed under Section 188 of the Companies Act, 2013, SEBI’s LODR Regulations, and associated rules. A “related party” includes directors, key managerial personnel (KMP), their relatives, and entities with specific relationships to them. RPTs include contracts for goods, property, services, leasing, or appointments in profitable positions. These transactions must be disclosed, approved by the Board, and ratified by shareholders when applicable. Section 188 outlines strict conditions, including approvals and penalties for non-compliance, ensuring transparency and accountability. Exceptions apply for transactions conducted at arm’s length or between wholly-owned subsidiaries. Additionally, SEBI’s Regulation 23 emphasizes independent director oversight, enhanced disclosures, and materiality policies for listed entities. Recent updates have introduced stricter enforcement mechanisms and increased protection for minority shareholders. Key changes include mandatory independent director approvals, disclosure of detailed RPT information in annual reports, and regular policy reviews to address evolving market standards. SEBI also requires adherence to materiality thresholds and global standards like IFRS, fostering alignment with international best practices. These measures aim to ensure fairness, reduce conflicts of interest, and promote sustainable corporate governance. Companies must adapt to evolving regulatory frameworks to maintain compliance, protect stakeholders, and mitigate risks.
Related Party Transactions
Before understanding what a related party transaction is and the laws and regulations that govern it, let’s first define what a related party is.
Related Party
The definition of the related Party is given u/s 2(76) of the Companies Act to be read with Regulation 2(zb) of SEBI (LODR) Regulations as–
- “Director and KMP or their relatives, relatives are defined under Sec. 2(77) of the Companies Act which says that relatives are members of HUF, husband and wife or one person is related to another in such manner as may be prescribed.
- The firm where a director, manager, or their relatives are partners.
- a private company in which a director or manager is a member or director
- a public company in which a director or manager is a director or holds along with his relatives, more than two percent. of its paid-up share capital
- any body corporate whose Board of Directors, managing director, or manager is accustomed to acting in accordance with the advice, directions, or instructions of a director or manager
- The above given 2 points will not cover a company that is a holding, subsidiary, or an associate company of that company or a subsidiary of a holding company to which it is also a subsidiary.”
Legislations Monitoring the Related Party Transactions
A related party transaction is a transaction entered into by an entity with its related party. These transactions are subject to monitoring and regulation under various legislations, rules, and regulations. They are : –
i. The COMPANIES ACT 2013
ii. The COMPANIES (MEETINGS OF BOARD AND IT’S POWER) RULES, 2014
iii. The SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015
iv. OTHER RELEVANT PROVISIONS DEALING WITH RELATED PARTY TRANSACTIONS
The Companies act, 2013
Section 188 of the Companies Act deals with Related Party Transactions.
Section188(1) of the Act provides for the approval of the board for the following contract or arrangements with a related party:
a. sale, purchase, or supply of any goods or materials;
b. selling or otherwise disposing of, or buying, property of any kind;
c. leasing of property of any kind;
d. availing or rendering of any services;
e. appointment of any agent for the purchase or sale of goods, materials, services, or property;
f. such related party’s appointment to any office or place of profit in the company, its subsidiary company, or associate company; and
g. underwriting the subscription of any securities or derivatives thereof, of the company.
Section 188(2) states that, every Contract or arrangement as mentioned in the above sub section shall be referred in the board’s report. The report is to be sent to the Shareholders along with the reason/ justification for entering into such contract or arrangement.
Section 188(3) states that if a contract or arrangement is entered into without the approval of the Board or the shareholders, and if it is not ratified by the Board or the shareholders within a period of three months from the date of entering into such contract or arrangement, the transaction shall be voidable at the option of the directors or shareholders. if such an agreement is entered into with a party who is a related party to any director or is ratified by any director, that director shall be liable to indemnify the company for any loss incurred due to such agreement.
Section 188(4) states that the company may take action against any director or employee to recover any loss incurred due to an agreement entered into by them in contravention of the provisions of this section.
Section 188(5) provides that a penalty will be imposed on the employee or director in the event of a violation of the provisions outlined. The penalty will amount to Rs. 25 lakhs for a listed company and Rs. 5 lakhs for any other company.
The provisions mentioned above will not apply in the following cases:
i. Transactions done on an arm’s length basis.
ii. Transactions done between a holding company and its wholly owned subsidiary, whose accounts are consolidated with those of the holding company.
The Companies (meetings of board and it’s power) rules, 2014
Rule 15 – Contract or Arrangement with a Related Party
- Rule 15(1): The agenda for the Board meeting, where a resolution related to a contract or arrangement with a related party is to be passed, must include all relevant information regarding the relationship with the related party, the duration of the contract, and the particulars of the arrangement to be entered into.
- Rule 15(2): If any director is interested in a contract or arrangement with a related party, that director shall not be present at the meeting where the resolution concerning such contract or arrangement is being discussed.
- Rule 15(3): Shareholder approval is required for the following transactions: a. Transactions with related parties, if they exceed a specified threshold limit. b. Appointment to any office or place of profit in the company, its subsidiary, or associate company, where the monthly remuneration exceeds Rs. 250,000. c. Remuneration for underwriting the subscription of any securities or derivatives of the company, if the amount exceeds 1% of the company’s net worth.
The SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015
Regulation 23 of the SEBI LODR Regulations – Related Party Transactions:
1. The listed entity shall formulate a policy regarding the materiality of related party transactions and the process for dealing with such transactions. This policy shall include the threshold limits as determined by the Board of Directors and must be reviewed at least once every three years.
2. Approval from the independent directors, who are members of the audit committee, is required for all related party transactions.
Recent Development
In recent years, there has been a growing emphasis on transparency and accountability in related party transactions (RPTs) to ensure robust corporate governance. Key regulatory developments have aimed at strengthening oversight and compliance with respect to RPTs, particularly in the context of the Securities and Exchange Board of India (SEBI) and global standards. Here are some key updates:
1. Enhanced Disclosure Requirements: SEBI has strengthened disclosure norms, requiring listed entities to provide detailed disclosures of related party transactions in their annual reports. This includes not only financial details but also the nature of the relationship, terms of the transactions, and their approval process, fostering greater transparency.
2. Independent Director Oversight: A significant development in corporate governance is the requirement for independent directors to approve related party transactions. As per SEBI’s Listing Obligations and Disclosure Requirements (LODR) regulations, approval from the independent members of the audit committee is mandatory for RPTs. This ensures that such transactions are not biased and align with the best interests of minority shareholders.
3. Materiality Thresholds and Policy Formulation: SEBI has also mandated that listed companies formulate a policy on the materiality of related party transactions, which must define clear threshold limits as decided by the Board of Directors. This policy must be reviewed periodically (at least once every three years) to ensure that the thresholds remain aligned with the evolving regulatory and market landscape.
4. Stricter Enforcement and Penalties: Recent amendments to the SEBI regulations have introduced stricter enforcement mechanisms and penalties for non-compliance with related party transaction norms. Companies failing to adhere to these requirements face potential fines and reputational risks, incentivizing better governance practices.
5. Focus on Minority Shareholder Protection: There has been an increasing focus on ensuring that related party transactions do not harm the interests of minority shareholders. Regulations now require that such transactions be at arm’s length, ensuring fairness in pricing and terms, and that they are not prejudicial to the interests of the company or its minority stakeholders.
6. Global Standards and Harmonization: Companies are also adapting to international standards for related party transactions, such as the IFRS (International Financial Reporting Standards), to ensure cross-border compliance. This harmonization helps in improving transparency and aligning with global best practices in corporate governance.
Conclusion
Related party transactions (RPTs) are a critical aspect of corporate governance, requiring stringent oversight to ensure transparency, fairness, and protection of minority shareholders’ interests. The Companies Act, 2013, along with SEBI’s Listing Obligations and Disclosure Requirements (LODR) Regulations, have laid down clear guidelines and requirements for the approval, disclosure, and monitoring of RPTs. Key developments, such as the mandatory approval of independent directors on the audit committee and the formulation of materiality policies by listed entities, further strengthen compliance and governance standards.
With the increased focus on enhanced disclosures, stricter penalties for non-compliance, and the global alignment of standards, companies must adopt transparent and fair practices in handling RPTs. These regulations are designed not only to ensure that RPTs are conducted at arm’s length but also to protect the interests of shareholders, particularly minority stakeholders. As regulations continue to evolve, businesses must remain proactive in adapting to these changes and maintain a high standard of corporate governance.
By adhering to these regulatory frameworks and best practices, companies can foster greater trust with their stakeholders, avoid legal risks, and contribute to long-term sustainable growth.
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