The ultimate purpose of commercial transactions and business aspirations is to circulate and re- distribute societal wealth for the betterment of those working for the business. The higher and larger an organization becomes, the more it pervades into the society. Its reach into people’s pockets becomes prominent. The magnificence of a business is directly proportional to its impact on its stakeholder community’s interests. In such circumstances, even the tiniest vested interest would cause adverse repercussions upon the community and stakeholders.

One of the regulatory measures is to regulate ‘related party transactions’, which if left unregulated or un-scrutinized can yield many fraudulent activities in the company’s working.

Below is a brief overview of the provisions related to regulation of related party transactions:

What are related party transaction? 2(76)

A related party is a party related to a body corporate/ company in any other way other than by the companies’ own transactions. It means that a special relationship persists between the parties even before the transaction takes place. Section 2(76) of the Companies Act, 2013 (“the Act”), defines a related party with reference to a company, to mean a

  1. director or a key managerial person or their relatives or
  2. a firm, private company in which the partner, director/ manager or his relative is a partner or
  3. a private company or 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.

The definition also includes a. anybody 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 and b. any person on whose advice, directions or instructions a director or manager is accustomed to act as related party transactions.

The provisions of related party transactions are applicable to private and public companies.

Related Party Transactions: Banned?

Related Party Transactions are not banned per se. They are regulated by certain conditions as provided in Section 188 of the Act, by the means of which they can be disclosed to the Board and shareholders for them to ratify. A prior approval from the Audit Committee is to be obtained. If the transactions fall within the meaning of Section 188, then these need to be disclosed in the Board Report for prior approval. A justification is required to be given in support of the transactions. If the transactions are beyond the threshold limits given below, then they need to be disclosed in the General Meeting for approval by special resolution.

Threshold limits which require special resolution:

The following are transactions and threshold limits, for related party transactions which require approval by special resolution, under Section 188 of the Act:

  1. sale, purchase or supply of any goods or materials; the amount involved exceeds 10% of the turnover of the company or INR 100 crore, whichever is lower;
  2. selling or otherwise disposing of, or buying, property of any kind; where the amount involved exceeds 10% of the net worth of the company or INR 100 crore, whichever is lower;
  3. leasing of property of any kind; the amount involved exceeds ten percent of net worth of the company or ten per cent. of turnover of the company or Rupees One Hundred crore;
  4. availing or rendering of any services involving an amount exceeding 10% of the turnover of the company or INR 50 Crore, whichever is lower;
  5. appointment of any agent for purchase or sale of goods, materials, services or property; its subsidiary or associate company at a monthly remuneration exceeding INR 2.5 lacs;
  6. such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company; and
  7. underwriting the subscription of any securities or derivatives thereof, of the company more than 1% of net worth of the company.

No member of the related party can vote in a special resolution to approve any contract or arrangement which may be entered into by the company.

If these conditions are satisfied, then the transactions can be proceeded with. Companies adopt policies whereby they prepare standard operating procedures to deal with related parties to be in compliance with the regulations. 

Arm’s length transactions:

If the transactions are conducted and carried out in a fair, justiciable manner without any trace of influence of the parties’ relation upon itself it is known as a transaction at arm’s length. It means transactions which are not biased by the relation of the parties and conducted as if with an unrelated party. Such transactions have been exempted from compliance with Section 188 of the Act.

Consequences of Non-Compliance:

  • Agreements voidable: Where any contract or arrangement is entered into by a director or any other employee, without the consent of the Board or approval by a special resolution in the general meeting and if it is not ratified by the Board or by the shareholders within three months from the date on which such contract is made, then such contract or arrangement shall be voidable at the option of the Board.
  • Indemnification: If such a 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.
  • The company can also proceed against such 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.
  • Penalties for a director or any other employee in violation of the provisions of Section 188 of the Act:
  1. Listed company: Punishment of imprisonment for a term upto 1 year or with fine from INR   25,000 (Approx. 388 USD) upto INR 5 lacs (Approx. 7750 USD), or both
  2. Other companies: fine of INR 25,000 (Approx. 388 USD)  upto INR 5 lacs (Approx. 7750 USD).