Related Party Transaction Under the Companies Act, 2013:
Meaning of related party:
Section 2(76) of the Companies Act, 2013 (“the Act”) defines the word“related party”:
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 is a member or director;
v. a public company in which a director or manager is a director OR 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 company 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;
ix. such other person as may be prescribed;
For the purposes of sub-clause (ix) a director or key managerial personnel of the holding company or his relative with reference to a company, shall be deemed to be a related party – Rule 3 of Companies (Specification of definitions details) Rules, 2014.
Ministry of Corporate Affairs issued the Companies (Removal of Difficulties) Fifth Order, 2014 dated 9th July, 2014 and clarified that the word “OR” in sub-clause (v) has appeared inadvertently and therefore defeating the intention of this clause. The word “AND shall be substituted for the word “OR”.
Now, MCA issued Companies (Removal of Difficulties) Sixth Order, 2014 dated 24th July, 2014 and clarified that in sub-clause (iv)after the word “manager” the word “or his relative” shall be inserted.
Nature of transaction:
The Companies Act, 2013 widened the scope of related party transaction. Companies Act, 1956 covered only purchase or sale of goods or supply of services and subscription of any shares or debentures of thecompany under the related party transaction. However, Companies Act, 2013 has brought immovable properties and leasing of property also under the ambit of related party transaction.
Approval of Board of directors:
Section 188(1) of the Actprovides that except with the consent of the Board of Directors given by a resolution at a Meeting of the Board and subject to such conditions as may be prescribed, no company shall enter into 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.
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.
Where any director is interested in any contract or arrangement with a related party, such director shall not bepresent at the meeting during discussions on the subject matter of the resolution relating to such contract or arrangement.
Approval of the company by a special resolution:
i. A company having a paid-up share capital of rupees one crore or more shall not enter into a contract or arrangement withany related party except with the prior approval of the company by aspecial resolution.
ii. A company shall not enter into a transaction or transactions, where the transaction or transactions to be entered into—
a. as contracts or arrangements with respect to clauses (a) to (e) of sub-section (1) of section 188 with criteria, as mentioned below—
(i) sale, purchase or supply of any goods or materials exceeding twenty five percent of the annual turnover;
(ii) selling or otherwise disposing of, or buying, property of any kind exceeding ten percent of net worth;
(iii) leasing of property of any kind exceeding ten percent of the net worth or exceeding ten percent of turnover;
(iv) availing or rendering of any services exceeding ten percent of the net worth.
(b) appointment to any office or place of profit in the company, its subsidiary company or associate company at amonthly remuneration exceeding two and half lakh rupees or
(c) remuneration for underwriting the subscription of any securities or derivatives thereof of the company exceeding one percent of the net worth.
In case of wholly owned subsidiary, the special resolution passed by the holding company shall be sufficient for the purpose of entering into the transactions between wholly owned subsidiary and holding company.
No member of the company shall vote on such special resolution, if he is a related party, to approve any contract or arrangement which may be entered into by the company.
MCA vide circular no 30/2014 dated 17th July, 2014 clarified that word “related party” referred to in the second proviso has to be construed with reference only to the contract or arrangement for which the said special resolution is being passed.
MCA also clarified that contracts entered into by companies, after making necessary compliances under Section 297 of the Companies Act, 1956, which already came into effect before the commencement of Section 188 of the Companies Act, 2013, will not require fresh approval under the said section 188 till the expiry of the original term of such contracts. Thus, if any modification in such contract is made
on or after 1st April, 2014, the requirements under section 188 will have to be complied with.
Transactions entered into by the company in its ordinary course of business andundertakenat an arm’s length basis do not need any prior approval.
The word “ordinary course of business” is not defined in the Companies Act, 2013 or Rules made thereunder.
No specific criteria have been provided in the Act whether the transaction is in ordinary course or not. Whether the transaction entered is ordinary course of business or not will depend on the particular business activity of the company. Transaction in ordinary course of business will cover the usual transactions of a business and of a company.
One should consider variety of factors to determine whether the transaction is in ordinary course or not like size, volume, frequency, purpose of transaction etc.
Arm’s length transaction meaning:
Arm’s length transaction means a transaction between two related parties which is conducted as if they are unrelated, so that there is no conflict of interest.
If a transaction fulfills both the criteria no approval will be required under section 188 of the Act.
Disclosures:
Every contract or arrangement entered into under sub-section (1) of the Act shall be referredto in the Board’s report to the shareholders along with the justification for entering into such contract or arrangement.
Applicability:
Section 188 of the Act is applicable to all kinds of companies whether private or public.
MCA issued a draft letter for public comments on 24th June, 2014 to give certain exemptions to private limited companies. Ministry proposed to give exemption to private companies under section 188 of the Act.
The notification placed on parliament does not five full exemptions to private companies but it gives exemption to private companies with some riders.
Consequences of contravention:
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 special resolution inthe general meeting-
– and if it is not ratified by the Board; or
– by the shareholders at a meeting within three months from the date on which such contract or arrangement was entered:
such contract or arrangement shall be voidable atthe option of the Board 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 thecompany against any loss incurred by it – Section 188(3).
Recovery of loss:
It shall be open to the company to proceed against a director or any other employee who had entered into suchcontract or arrangement in contravention of the provisions of this section for recovery of any loss sustained by it as a result of such contract or arrangement – Section 188(4).
Penal Provisions:
Any director or any other employee of a company, who had entered into or authorized the contract or arrangement in violation of the provisions of this section shall,—
(i) in case of listed company, be punishable with imprisonment upto one year or with fine not less than twenty-five thousand rupees but which may extend to five lakh rupees, or with both; and
(ii) in case of any other company, be punishable with fine not less than twenty-five thousand rupees but which may extend to five lakh rupees.
Central Government approval:
The Companies Act, 2013 has removed central government approvals for related party transaction which was mandatory under the 1956 Act for companies having paid-up share capital of rupees one crore or more.
Related Party Transaction Under the Listing Agreement:
Clause 49 of the listing agreement defines the word related party in wider term than the Companies Act, 2013.
Clause 49 defines related party as –
A ‘related party’ is a person or entity that is related to the company. Parties are considered to be related if one party has the ability to control the other party or exercise significant influence over the other party, directly or indirectly, in making financial and/or operating decisions and includes the following:
1. A person or a close member of that person’s family is related to a company if that person:
a. is a related party under Section 2(76) of the Companies Act, 2013;or
b. has control or joint control or significant influence over the company; or
c. is a key management personnel of the company or of a parent of the company; or
2. An entity is related to a company if any of the following conditions applies:
a. The entity is a related party under Section 2(76) of the Companies Act, 2013; or
b. The entity and the company are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others); or
c. One entity is an associate or joint venture of the other entity (or an associate or joint venture of a member of a group of which the other entity is a member); or
d. Both entities are joint ventures of the same third party; or
e. One entity is a joint venture of a third entity and the other entity is an associate of the third entity; or
f. The entity is a post-employment benefit plan for the benefit of employees of either the company or an entity related to the company. If the company is itself such a plan, the sponsoring employers are also related to the company; or
g. The entity is controlled or jointly controlled by a person identified in (1).
h. A person identified in (1) (b) has significant influence over the entity (or of a parent of the entity); or
The company shall formulate a policy on materiality of related party transactions and also on dealing with Related Party Transactions.
All Related Party Transactions shall require PRIOR approval of the Audit Committee.
All material Related Party Transactions shall require approval of the shareholders through special resolution and the related parties shall abstain from voting on such resolutions.
A transaction with a related party shall be considered material if the transaction / transactions to be entered into individually or taken together with previous transactions during a financial year, exceeds five percent of the annual turnover or twenty percent of the net worth of the company as per the last audited financial statements of the company, whichever is higher.
Disclosures:
Details of all material transactions with related parties shall be disclosed quarterly along with the compliance report on corporate governance.
The company shall disclose the policy on dealing with Related Party Transactions on its website and also in the Annual Report.
Penal Provisions:
T
he Companies Act, 2013 provides penalty for violation in case of listed companies imprisonment upto one year or with fine not less than twenty-five thousand rupees but which may extend to five lakh rupees, or with both.
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