Related Party Transactions (Section 188 of the Companies Act, 2013) :
Section 188 of the Companies Act, 2013 came into force from 1st April, 2014 which provides for related party transactions. According to this section:
(i) Contracts with related parties which are covered under section 188 [Section 188(1)]: Except with the consent of the Board of Directors given by a resolution at a meeting of the Board and subject to such conditions11 as may be prescribed, no company shall enter into any contract or arrangement with a related party with respect to—
(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 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:
However, 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. [First proviso to section 188(1)]
According to the Companies (Meetings of Board and its Powers) Rules, 2014 except with the prior approval of the company by a resolution, a company shall not enter into a transaction or transactions, where the transaction or transactions to be entered into,—
(1) as contracts or arrangements with respect to clauses (a) to (e) of sub-section (1) of section 188, with criteria as mentioned below –
(A) sale, purchase or supply of any goods or materials, directly or through appointment of agent, exceeding 10% of the turnover of the company or rupees 100 crore, whichever is lower, as mentioned in clause (a) and clause
(e) respectively of sub-section (1) of section 188;
(B) selling or otherwise disposing of or buying property of any kind, directly or through appointment of agent, exceeding 10% of net worth of the company or rupees 100 crore, whichever is lower, as mentioned in clause (b) and clause
(e) respectively of sub-section (1) of section 188;
(C) leasing of property of any kind exceeding ten per cent. of the net worth of the company or 10%. of turnover of the company or rupees 100 crore, whichever is lower, as mentioned in clause (c) of sub-section (1) of section 188;
(D) availing or rendering of any services, directly or through appointment of agent, exceeding 10% of the turnover of the company or rupees 50 crore, whichever is lower, as mentioned in clause (d) and clause (e) respectively of sub-section (1) of section 188:
Explanation.—It is hereby clarified that the limits specified in sub-clauses (i) to (iv) shall apply for transaction or transactions to be entered into either individually or taken together with the previous transactions during a financial year.
(2) is for appointment to any office or place of profit in the company, its subsidiary company or associate company at a monthly remuneration exceeding 2.5 lakh rupees as mentioned in clause (f) of subsection (1) of section 188; or
(3) is for remuneration for underwriting the subscription of any securities or derivatives thereof, of the company exceeding 1% of the net worth as mentioned in clause (g) of sub-section (1) of section 188.
Explanation –
- The Turnover or Net Worth referred in the above sub-rules shall be computed on the basis of the Audited Financial Statement of the preceding financial year.
- In case of a wholly owned subsidiary, the special resolution passed by the holding company shall be sufficient for the purpose of entering into the transactions between the wholly owned subsidiary and the holding company.
(4) The explanatory statement to be annexed to the notice of a general meeting convened pursuant to section 101 shall contain the following particulars, namely:—
(a) name of the related party ;
(b) name of the director or key managerial personnel who is related, if any;
(c) nature of relationship;
(d) nature, material terms, monetary value and particulars of the contract or arrangement;
(e) any other information relevant or important for the members to take a decision on the proposed resolution.‖
No voting by related member: Further 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. [Second proviso to section 188(1)]
The MCA vide General Circular No. 30/2014 dated 17th July, 2014 has clarified the scope of second proviso to section 188(1). 1The second proviso to subsection (1) of section 188 requires that no member of the company shall vote on a resolution to approve the contract or arrangement (referred to in the first proviso), if such a member is a related party. It is clarified that ‘related party’ referred to in the second proviso has to be construed with reference only to the contract or arrangement for which the said resolution is being passed. Thus, the term ‘related party’ in the above context refers only to such related party as may be a related party in the context of the contract or arrangement for which the said resolution is being passed.
According to the Companies (Meetings of Board and its Powers) Rules, 2014, where any director is interested in any contract or arrangement with a related party, such director shall not be present at the meeting during discussions on the subject matter of the resolution relating to such contract or arrangement.
Vide Notification G.S.R. 463(E) dated 5th June 2015, first and second proviso to section 188(1) shall not apply to -(a) a government company in respect of contracts or arrangements entered into by it with any other government company; (b) 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.
(ii) Transaction to be at arm’s length prices: Nothing as provided above 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.
(iii) Provided also that the requirement of passing 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.—
(a) the expression “office or place of profit” means any office or place—
(1) 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;
(2) 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;
(b) the expression “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.
(iv) Related party transaction to be mentioned in Board’s report [Section 188 (2)]: Every contract or arrangement entered into under sub section (1) as mentioned above, shall be referred to in the Board‘s report to the shareholders along with the justification for entering into such contract or arrangement.
(v) Related party transaction can be voidable at the option at the Board [Section 188 (3)]: A contract or arrangement shall be voidable at the option of the Board:
(a) 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 as required under section 186(1), and
(b) if it is not ratified by the Board or, as the case may be, by the shareholders at a meeting within 3 months from the date on which such contract or arrangement was entered into.
Further, 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.
(vi) Section 188 (4) provides that without prejudice to anything contained in sub-section (3) of section 188, it shall be open to the company to proceed against a director or any other employee who had entered into such contract 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.
(vii) Penalty for contravention [Section 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,—
(a) in case of listed company, be punishable with imprisonment for a term which may extend to 1 year or with fine which shall not be less than 25,000 rupees but which may extend to 5 lakh rupees, or with both; and
(b) in case of any other company, be punishable with fine which shall not be less than 25,000 rupees but which may extend to 5 lakh rupees.
(viii) ‘Related Party’ 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 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 2% of its paid-up share capital;
The Companies 1st (Removal of Difficulties) Order, 2014 clarifies that a Public Company in which a director or manager is a director and holds along with his relatives, more than 2% of its paid-up share capital shall be a related party.
(vi) any body corporate of which a director or manager of the company is a shadow director;
(vii) any shadow director of the company (i.e., any person on whose advice, directions or instructions a director or manager of the company is accustomed to act) ;
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.
Rule 3 of the Companies (Specification of Definitions Details) Rules, 2014 provides that for the purposes sub-clause(ix) of Clause (76) of section 2 of the Act, 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.
The persons covered in items (f) and (g) above shall not be related parties if advice, directions or instructions are given by them in a professional capacity.
Applicability of Section 188 to corporate restructuring, amalgamations etc. : The MCA vide General Circular No. 30/2014 dated 17th July, 2014 has clarified that transactions arising out of Compromises, Arrangements and Amalgamations dealt with under specific provisions of the Companies Act, 1956/Companies Act, 2013, will not attract the requirements of section 188 of the Companies Act, 2013.
Requirement of fresh approvals for past contracts under Section 188: The MCA vide General Circular No. 30/2014 dated 17th July, 2014 has 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.