Related Party Transaction

Discuss what these sources say about Related Party Transactions (RPT) - Companies Act, 2013.

The Companies Act, 2013, significantly strengthened the regulatory framework for Related Party
Transactions (RPTs), moving towards a more complex system based on disclosure and shareholder
approval compared to the simpler approval mechanism of the 1956 Act 1. The intent behind these
stricter provisions is to address higher chances of abuse, conflicts of interest, transactions not
conducted on an arm's length basis, and the siphoning of funds2. The Companies Act, 2013, along with
SEBI LODR Regulations, 2015, and Accounting Standards (AS 18 and Ind AS 24), governs RPTs2. It is
crucial for company secretaries (CS) to understand the nuances, as definitions and compliance
requirements can differ across these frameworks3.

The Companies Act, 2013, significantly strengthened the regulatory framework for Related Party
Transactions (RPTs), moving towards a more complex system based on disclosure and shareholder
approval compared to the simpler approval mechanism of the 1956 Act. The intent behind these
stricter provisions is to address higher chances of abuse, conflicts of interest, transactions not
conducted on an arm's length basis, and the siphoning of funds. The Companies Act, 2013, along with
SEBI LODR Regulations, 2015, and Accounting Standards (AS 18 and Ind AS 24), governs RPTs. It is
crucial for company secretaries (CS) to understand the nuances, as definitions and compliance
requirements can differ across these frameworks.3

Definition of "Related Party" (Section 2(76)) Under Section 2(76) of the Companies Act, a "related
party" with reference to a company includes:3

 A director or their relative.3

 A Key Managerial Personnel (KMP) or their relative.3

 A firm in which a director, manager, or their relative is a partner.3

 A private company in which a director, manager, or their relative is a member or director.3

 A public company in which a director or manager holds, or holds along with their relative,
more than 2% of its paid-up share capital.4

 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.4

 Any person who is acting in relation to a relative under Section 2(77) read with the Companies
(Specification of Definitions Details) Rules, 2014.4

Relatives, as defined by Section 2(77) and relevant rules, include immediate family members like father
(including stepfather), mother (including stepmother), son (including stepson), son's wife, daughter,
daughter's husband, brother (including stepbrother), and sister (including stepsister). A "relative" is a
narrower term focusing on family members, while "related party" has a broader scope, encompassing
individuals and entities that can influence or be influenced by the company.4

Identification of Related Parties and RPTs.The primary responsibility for identifying related parties lies
with the secretarial department, as they possess the data concerning promoters, management,
directors, and director disclosures of interest. Once identified, this list should be shared with other
departments, especially finance and accounts, for verification. The finance 5 and accounts department
is primarily responsible for identifying RPTs themselves, as they manage transactions.6 It is advised to
have inbuilt checks and balances in accounting systems (like SAP or ERP) to flag RPTs. The company
secretary's role is pivotal in ensuring overall compliance and awareness across the organization.7

Transactions Covered (Section 188) Section 188 of the Companies Act specifically covers the following
types of transactions with a related party:

 Sale, purchase, or supply of any goods or materials.8

 Availing or rendering of any services.8

 Selling or otherwise disposing of, or buying, property of any kind8.

 Appointment to any office or place of profit in the company or its subsidiary or associate
company.8

 Leasing of property of any kind.8

 Appointment of any agent for purchase or sale of goods, materials, services, or property.8

 Underwriting the subscription of any securities or derivatives of the company.8

It's important to note that not every transaction with a related party is an RPT under Section 188. For
example, financial transactions like lending or borrowing money, or providing guarantees/securities,
are not covered by Section 188, but they still require Audit Committee approval under Section 177.9

Approval Mechanisms

Audit Committee (Section 177)

 Section 177's coverage of RPTs is broader than Section 188, including financial transactions
like loans and guarantees.10

 All companies required to constitute an Audit Committee, or those that have done so
voluntarily, must obtain prior approval, not just recommendation, from the Audit Committee
for all related party transactions.10 9

 This approval is required irrespective of whether the transactions are in the ordinary course
of business or on an arm's length basis.10

 If an Audit Committee is not required (e.g., in some private companies) or not constituted, the
Board of Directors must discharge these responsibilities. However, if an Audit Committee is
voluntarily constituted, its provisions must be complied with.11

Board Approval

 Board approval by a resolution is generally required for RPTs, unless specific exemptions apply
or shareholder approval is mandated.12

 Board resolutions for RPTs must be passed at a physical board meeting, not by circular
resolution.13
  The board agenda must include specific details of the transaction, such as the related party's
name, nature of relationship, duration, value, pricing method, and rationale.14 15

Shareholders' Approval

 Shareholders' approval by a resolution is required for companies with a paid-up share capital
not less than the prescribed amount, or for transactions exceeding prescribed sums.16

 Specific thresholds for shareholder approval include: 17

o Availing or rendering services: more than 10% of turnover.

o Goods or material transactions: more than 10% of turnover.

o Appointment to a place of profit: remuneration exceeding INR 2.5 lakhs.

o Property transactions: more than 10% of net worth.

o Underwriting contracts: fees exceeding 1% of net worth.

o Leasing: 10% of turnover.

Omnibus Approval

 Omnibus approval is a prerogative solely of the Audit Committee, not the Board.13

 It can be taken for transactions of a repetitive nature, in the interest of the company.18

 The approval must specify the nature, period, amount, and indicative price. 19

 Omnibus approval for unforeseen RPTs is limited to INR 1 crore.19

 It requires quarterly review by the Audit Committee and is valid for a period not exceeding one
financial year, requiring fresh approval thereafter.19

 Omnibus approval is not permitted for transactions involving the selling or disposing of the
company's undertaking.19

Voting Restrictions

 Under the Companies Act, related parties generally cannot vote on resolutions to approve any
contract or arrangement under Section 188.

 An exception exists if 90% or more of the members in the company are relatives of a promoter
or related parties.

 For listed companies, SEBI LODR Regulation 23 states that related parties can vote against, but
not in favor of, an RPT. However, the Companies Act's stricter provision still applies to listed
companies, meaning related parties cannot vote either positively or negatively.

Ratification

 If a contract or arrangement is entered into by a director or employee without the board's

consent or shareholder approval, it must be ratified by the board or shareholders within three
months.
  If not ratified, the contract is voidable at the option of the board or shareholders.

 Ratification should be an exception, not a default practice, as habitual reliance on it may be

viewed as non-compliance by regulatory authorities. Ratification is generally allowed up to a
transaction value of INR 1 crore by the Audit Committee.

Exemptions

Ordinary Course of Business and Arm's Length Transaction

 Section 188 does not apply to transactions entered into by the company in its ordinary course
of business, provided they are conducted on an arm's length basis.

 Ordinary Course of Business: Not explicitly defined in the Act, it refers to normal routines in
managing trade or business. Factors considered include: 20-24

o Whether the activity is covered in the Memorandum of Association's object clause

and furthers the company's business.

o Whether the activity is routine or repetitive for the particular business or industry.

o Whether income from such activity is treated as business income.

o Historical practice of conducting such activities.

o The determination of whether a transaction falls under the ordinary course of

business is the Audit Committee's responsibility, supported by CS, CFO, and CEO. Legal
opinions are advisable for high-stakes transactions.

 Arm's Length Transaction: A transaction between two related parties conducted as if they are
unrelated, ensuring no conflict of interest. It involves considering the transaction as a whole,
including pricing, delivery, quality, credit period, and reputation. For listed companies, the
ordinary course of business and arm's length exemptions available under the Companies Act
are generally not available under SEBI LODR regulations.25-26

Holding and Wholly Owned Subsidiary Transactions

 The requirement for passing a resolution is not applicable to transactions between a holding
company and its wholly-owned subsidiary, provided the subsidiary's accounts are consolidated
with the holding company and presented at the general meeting for approval. This exemption
applies even if the transactions are not on an arm's length basis or in the ordinary course of
business.

Consequences of Non-Compliance

 If a contract is entered into without proper disclosure or with the participation of an interested
director, it is voidable at the company's option.

 The concerned director must indemnify the company for any incurred loss, and the company
can recover losses from the director or employee.

 A director can be disqualified for appointment if convicted of an offense related to Section 188
at any time during the preceding five years.
  Penalties for non-compliance are up to INR 5 lakhs for directors/employees of unlisted
companies and up to INR 25 lakhs for directors/employees of listed companies.

 Non-identification of related parties leading to fraud can result in the company secretary being
made a party under Section 447, as demonstrated in a fraud investigation session at an SFIO
conference.27-28

Disclosures

 Board's Report (Section 134(3) read with Rule 8(2)): All companies must disclose particulars of
contracts or arrangements with related parties in their board's report, typically in Form AOC-
2. This includes both material RPTs (whether at arm's length or not) and RPTs not at arm's
length. The AOC-2, being an annexure to the board's report, must be signed by the same
persons who signed the board's report. 30

 Agenda/Notice for Meetings: The board agenda and explanatory statement in the notice for
general meetings must provide relevant information about the proposed RPTs to enable
shareholders to make an informed decision regarding the fairness of the terms.31

 Register of Contracts (Section 189): A register in Form MBP-4 must be maintained for all
contracts or arrangements to which Section 188 applies. Entries must be authenticated by the
CS (or director/authorized person if CS is absent), placed before the next board meeting, and
signed by all directors. This register must be open for inspection at AGMs and copies furnished
upon request. This register must be maintained even for transactions exempted under Section
188 (e.g., ordinary course of business, arm's length).32

 Auditor's Report (CARO 2016/2020): Auditors' reports on financial statements must state
whether all RPTs comply with Sections 177 and 188 of the Act.

Practical Insights

 Proactive Compliance: The secretarial department should act proactively to prevent non-
compliance rather than dealing with it post-mortem.

 Joint Responsibility: While the CS department leads, RPT compliance is a joint responsibility
involving finance and other departments.

 Director Disclosure Verification: CS must cross-check director disclosures of interest (e.g.,

directorships, committee memberships, shareholdings) with MCA/stock exchange websites
instead of blindly accepting them. The CS should not act merely as a "postman".33-34

 Good Governance vs. Strict Compliance: If a company takes approvals for transactions not
legally mandated by the Act (but done for good governance), it should clearly state this in the
explanatory statement to avoid implications of quoting non-applicable sections.35

 Digitization: Companies are increasingly using digital tools to manage RPTs, including making
related party lists accessible to all stakeholders and integrating RPT identification into
ERP/accounting systems.36-37

Case Studies
 SEBI vs. RT Agro Private Limited: SAT ruled that the bar on related parties voting under Section
188 applies only at the time of entering into a contract, not when rescinding a resolution,
highlighting the distinction between the Companies Act and SEBI LODR regulations regarding
voting.

 Solina Gupta vs. RVG Enterprises Private Limited: The tribunal invalidated RPTs conducted
without proper approval, ordered the removal of responsible directors, and directed the
refund of siphoned funds, emphasizing strict adherence to Section 188. 38

 Sanjivani Syntex Mills Private Limited vs. Commissioner of Income Tax: The Supreme Court
ruled against the company for failing to obtain necessary approvals for RPTs and underpricing
goods to related entities, deeming it an unlawful attempt to reduce tax liability.39

 Blue Max Capital Solutions Private Limited vs. ROC: The company and its directors were
penalized for failing to disclose RPTs in their board reports (Form AOC-2) for three consecutive
years, despite the transactions being noted in the balance sheet, underscoring the importance
of mandatory disclosures.