Related party transactions

Sections and provisions applicable

· Section 188 of Companies Act, 2013 [Related Party Transactions]

· Rule 15 of the Companies [Meetings of Board and its Powers Rules], 2014

Meaning of Related Party Transaction(s)
Related Party Transaction(s) means transaction(s) between two or more related parties

Meaning of Related Party

As per Section 2(76) of Companies Act, 2013, Related Party in relation to Company A means-

i.

[Director or Relative] Company A

ii.

[Key Managerial Personnel or Relative] Company A

iii.

A firm B if, [Director or Manager or Relative] Company A is [Partner] Firm B

iv.

A Private Company C if, [Director or Manager or Relative] Company A is [Member or Director] Private Company C

v.

A Public Company D if, [Director or Manger] Company A is [Director] Public Company D and holds along with his relatives > 2 % of Paid-up Share Capital of Public Company D

vi.

A Body Corporate E if, [BOD, MD or Manager] Body Corporate E is accustomed to act in accordance with the advice/directors/instructions [not in professional capacity] of [Director or Manager]Company A

vii.

Any person F, on whose advice/directors/instructions [not in professional capacity], [Director or Manger] Company A is accustomed to act

viii.

[Any company being a Holding/ subsidiary/ associate Company G] Company A

ix.

Any company being a Subsidiary H of Holding Company to which Company A is also a subsidiary

x.

[Director (except independent director) or Key Managerial Personnel or Relative of Holding Company] Company A

Meaning of Relative

As per Section 2(77) of Companies Act, 2013, relative with reference to any person means-

i.Members of Hindu Undivided Family

ii.Husband and Wife

iii.Father including Step-Father

iv.Mother including Step-Mother

v.Son including Step-Son and Sons Wife

vi. Daughter and Daughter’s Husband

[Interesting to note, Step-Daughter is not included]

vii.Brother including Step-Brother

viii.Sister including Step-Sister

Applicability of Section

This section applies for transactions between related parties which are in-

· Ordinary Course of business + Not at Arm’s Length
· Not in the ordinary course of business + Not at arm’s length price

Section not applicable if

· This section doesn’t apply to transactions between related parties which are in-Ordinary Course of Business+ At arm’s length price
· Thus, transactions which are both at arm’s length price and in the ordinary course of business do not attract the provisions of this section

Meaning of Ordinary Course of Business

· The term ‘Ordinary course of business’ is not defined in the Act
· Ordinary course of business can be said to cover the usual transactions, customs and practices of a certain business
· Need not necessarily be the objects as stated in the Memorandum of association of the Company

For Example

If a Pharmaceutical Company enters in to transactions which involve construction of buildings, it can still be in the purview of ordinary course of business if the purpose behind the same was building quarters for granting residence facilities to it’s employees and like wise

Meaning of Arm’s Length Transaction

‘Arm’s Length Transaction’ means transaction between two related parties as if they were unrelated so that there is no conflict of interest

Transactions Covered

Sub-section (1) of section 188 covers the following contracts/arrangements which are divided in to seven categories

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 any goods, materials, services or property

f.Such related party’s appointment in the 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

· The section states that the aforesaid transactions can be entered in to by the Company with the Board’s consent vide a Board resolution if falling within the limits prescribed in the section

· Whereas, when these transactions exceed the limits specified in the section, members consent vide an ordinary resolution* [previously special resolution] will be required

[*Prior to the Companies (Amendment) Act, 2015 which was effective from 29.05.2015, special resolution was required (and not ordinary)]

Thus if, prescribed limits not exceeded

The above mentioned contracts or arrangements with related party can be passed with a Board resolution

If prescribed limits exceeded

The above mentioned contracts or arrangements with related party can be passed with an Ordinary resolution

Exception – Holding – Subsidiary Relationship

Requirement of passing an ordinary resolution shall not be applicable for transaction between holding company and it’s WOS even when the prescribed limits are exceeded if the WOS’s accounts are consolidated with that of the Holding Company and placed before the shareholders at the general meeting for approval

Limits specified

Sr No.

Contracts/arrangement

Prescribed Limits

i.

Sales, purchase or supply of any goods or materials and

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

(i.e. directly or indirectly)

10% (Turnover of the Company) or INR 100 Crores whichever is lower

ii.

Selling or otherwise disposing of or buying property of any kind and

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

(i.e. directly or indirectly)

10% (Net worth of the Company) or INR 100 Crores whichever is lower

iii.

Leasing of property of any kind

10% (Net worth of the Company) or 10% (Turnover of the Company) or INR 100 Crores whichever is lower

iv.

Availing or rendering of any services, directly or through appointment of agent

10% (Turnover of the Company) or INR 50 Crores whichever is lower

v.

Such related party’s appointment in the office or place of profit in the company, its subsidiary company or associate company

Monthly remuneration of INR 2,50,000

vi.

Remuneration for underwriting the subscription of any securities or derivatives thereof of the company

1% (Net worth of the Company)

Note

· Transaction with related parties up to the limits specified in the above table can be entered in to by Board Resolution

· When the above limits are exceeded, ordinary resolution will be required

· Limits specified for transaction (i) to (iv) shall apply for present transactions individually or with previous transactions entered in to during the financial year

· Turnover/ Net worth mentioned above shall be computed on the basis of Audited Financial Statement of preceding financial year

For Example

For a transaction to be entered in financial year 2015-16, audited financial statement of 2014-15 to be taken in to account for considering the prescribed limits

Office/ place of profit means an office or place if-

i.

Held by Director

If the Director holding it receives 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.

Held by individual other than director/ firm/private company/ body corporate

If the individual/ firm/private company/ body corporate holding it receives salary, fee, commission, perquisites, any rent-free accommodation or otherwise

Ratification of contract/arrangement

If the related party transaction is not approved by the board resolution/ ordinary resolution, the same can be ratified by the Board/ members within 3 months of entering in to the contract/arrangement

What if not validly approved/ratified the contract or arrangement as aforesaid

· Voidable – The same shall be voidable at the option of the board

· Indemnify – If contract or/arrangement with related party to director/ authorized by any other director, directors concerned shall indemnify the Company against the loss concerned

· Prosecution – Company can proceed against any director/ employee for recovery of loss sustained by the Company in addition to the indemnification of losses by the director

Member when not to vote

No member shall vote on the ordinary resolution for approving the contract/arrangement if such member is a related party

Interested Director

· Interested member not to be present during discussions on the subject matter of resolution to such contract or arrangement

· Can be interpreted that the director can be present during discussions on other resolution(s) in which he is not interested

Disclosure in agenda

The agenda of the Board meeting at which the resolution is proposed to be moved should disclose the following-

a.

Name of the related party, nature of relationship

b.

Nature, duration of contract, particulars of contract or arrangement

c.

The material terms of the contractor arrangement including the value, if any

d.

Advance paid or received for the contract or arrangement, if any

e.

Manner of determining the pricing and other commercial terms [being part of the contract or otherwise]

f.

Factors relevant to the contract whether considered or not and

Details of factors not considered and the rationale behind it [logical basis]

g.

Any other information as may be considered necessary

Explanatory Statement to be annexed to the notice under section 102 of the Act need to contain the following information-

a.

Name of related party

b.

Name of the director or key managerial personnel who is related

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

Contract between Holding Company and its Wholly Owned Subsidiary [WOS]

In case of WOS, the ordinary resolution [previously special resolution] passéd by the Holding Company shall suffice for contract between Holding Company and WOS

For Example

Company B is a WOS of Company A then, ordinary resolution passed by the members of Company A would suffice for a contract between Company B and Company A

Exemption to Private Companies

A member being a related party can also vote on the ordinary resolution for approving a contract/arrangement after disclosing his interest, in case of a private company*

[*Notification No. GSR 464E, dated 05.06.2015]

Exemption to Government Companies

Contracts or arrangements involving Government Company shall not attract the requirement of passing an ordinary resolution even when the prescribed limits are exceeded if**-

1. If the Contracts or arrangements are entered between two Government Companies

2. If the Government Company [other than a listed company] obtains the prior approval of Ministry or Department of the Central Government/ State Government, as the case may be, which is the administrative in charge of the Company

[**Notification No. GSR 463E dated 05.06.2015]

Penalty Provisions

Any director or employee who has contravened the provisions of section 188 and applicable rules shall be punishable with-

In case of listed company-

· Imprisonment up to 1 year Or

· Fine ranging from INR 25000/- to INR 5,00,000/- Or

· Both

In case of any other company-

Fine ranging from INR 25000/- to INR 5,00,000/-

Related Party Transaction – Easy Checklist

1. Check if the transaction is between related parties [refer the definition stated above]

2. Check if the transaction is in ordinary course of business and at arm’s length price. If yes, provisions of section will not apply

3. Check if transaction is not at arm’s length price/not in the ordinary course of business. If yes, provisions of section will apply

4. Check which category covers the transaction entered into

5. If the transaction entered into does not exceed the limits specified in the section, consent of the Board vide Board resolution would suffice

6. If the transaction entered into exceeds the limits specified in the section, consent of the shareholders vide an ordinary resolution [previously special resolution] will be required

7. If consent of the board/ members as the case may be not taken as required, ratification of the transaction within 3 months of entering in to contract

8. Agenda of the Board meeting at which the resolution is proposed to be moved shall disclose the details as specified in rule 15 of Companies [Meetings of Board and its Powers Rules], 2014

9. Explanatory statement to be attached to the notice of general meeting shall disclose the details as specified in rule 15 of Companies [Meetings of Board and its Powers Rules], 2014

10. Member being a related party, not to vote at the meeting [In case of private company he/she can vote after disclosing his/her interest]

11. Interested director not to participate in the discussion [related party transaction]

12. Interested director to disclose his interest

13. Necessary entries be made in the register to be maintained under section 189 [Register of contracts or arrangements in which director is interested] of the Act and rule 16 of the Companies [Meetings of the Board and its powers] Rules, 2013

14. Register to be kept at the registered office of the Company and be open for inspection during business hours

15. Extracts/copies to be provided to the members on payment of fees

16. Board to disclose the related party transactions entered in to by the Company in the Board Report as per the provisions of section 134(1)(h) [particulars of contracts/arrangements with related parties referred to in section 188(1) as per rule 8 and Form AOC-2 of the Companies [Accounts] Rules, 2014

17. E-filing procedures

Note: Above article contains provisions as amended up to 01.01.2016