Related Party Transactions under Companies Act

Related Party Transactions form a crucial aspect of corporate governance in India. The Companies Act, 2013 introduced a structured and transparent framework to regulate such transactions, recognising that dealings between related parties often carry inherent risks of conflict of interest, misuse of corporate resources, and lack of transparency. The law seeks to balance commercial flexibility with accountability, ensuring that companies function in a fair and ethical manner.

This article explains the concept, scope, approval mechanisms, compliance requirements, and consequences associated with Related Party Transactions under the Companies Act, 2013.

What is a Related Party?

The term “related party” is defined under Section 2(76) of the Companies Act, 2013. It covers a wide range of individuals and entities that have a close connection with the company and may influence its decisions.

The following categories are treated as related parties:

• Directors and Key Managerial Personnel (KMP) and their relatives: This includes directors, managing directors, company secretaries, and other key officers. Their relatives—such as spouse, parents, children, siblings, and members of a Hindu Undivided Family—are also covered, as such relationships may affect decision-making within the company.
• Firms and companies with managerial or ownership links: A firm in which a director, manager, or their relative is a partner is considered a related party. Similarly, a private company in which a director or manager is a member or director also falls within this definition.
• Public companies with significant shareholding influence: A public company becomes a related party if a director or manager, along with relatives, holds more than 2% of its paid-up share capital. This reflects the law’s intention to capture situations where even a relatively small stake can create influence.
• Entities acting on directions or advice: Any body corporate whose board or management acts on the instructions of a director or manager of the company is treated as a related party. Likewise, any person whose directions are followed by a director or manager is also included, unless such advice is given in a professional capacity.
• Group companies and structural relationships: Holding companies, subsidiary companies, associate companies, and fellow subsidiaries are all recognised as related parties. These relationships often involve overlapping control or influence, making regulation necessary.

The definition is intentionally broad to ensure that all possible channels of influence are captured.

Meaning of Related Party Transactions

Section 188 of the Companies Act, 2013 governs Related Party Transactions. It specifies the types of transactions that fall within its scope.

The following transactions are treated as Related Party Transactions:

• Sale, purchase, or supply of goods or materials: Transactions involving the exchange of goods, whether directly or through an agent, are covered as they may be used to transfer value between related parties.
• Sale, purchase, or leasing of property: Property transactions, including leasing arrangements, are included because they often involve substantial financial implications.
• Availing or rendering of services: Service agreements between related parties are common and require scrutiny to ensure fairness and transparency.
• Appointment of agents: Appointing a related party as an agent for buying, selling, or dealing with goods or property is regulated to prevent undue advantage.
• Appointment to an office or place of profit: When a related party is appointed to a position where remuneration is received beyond standard entitlements, such arrangements are treated as Related Party Transactions.
• Underwriting of securities or derivatives: Agreements involving underwriting of securities with related parties are also covered due to the financial risks involved.

These categories reflect the wide scope of transactions that may lead to potential conflicts of interest.

Approval Mechanism for Related Party Transactions

The Companies Act, 2013 prescribes a multi-layered approval framework to regulate Related Party Transactions. The level of approval depends on the nature and value of the transaction.

Board Approval

All Related Party Transactions covered under Section 188 require approval of the Board of Directors through a resolution passed at a duly convened meeting.

The concerned director who is interested in the transaction must disclose the nature of interest and abstain from participating in the discussion and voting. This ensures that decisions are taken independently and without bias.

Shareholder Approval

In certain cases, shareholder approval becomes mandatory when transactions cross prescribed thresholds under the Companies (Meetings of Board and its Powers) Rules, 2014.

Key thresholds include:

• Goods and materials transactions: Transactions exceeding 10% of turnover or ₹100 crore (whichever is lower) require shareholder approval.
• Property transactions: Sale or purchase of property exceeding 10% of net worth or ₹100 crore (whichever is lower), and leasing arrangements exceeding 10% of turnover or ₹100 crore, require approval.
• Services transactions: Transactions involving services exceeding 10% of turnover or ₹50 crore (whichever is lower) require approval.
• Office or place of profit: Appointment of a related party where remuneration exceeds ₹2.5 lakh per month requires approval.
• Underwriting transactions: Underwriting arrangements exceeding 1% of net worth require shareholder approval.

All limits are calculated based on audited financial statements of the preceding financial year.

Importantly, no related party is permitted to vote on such resolutions. This principle ensures that only disinterested shareholders decide on the transaction.

Exemptions: Ordinary Course of Business and Arm’s Length Transactions

The law provides relief where transactions are conducted:

• In the ordinary course of business, and
• On an arm’s length basis

An arm’s length transaction refers to a transaction conducted as if the parties were unrelated, ensuring fair market value and commercial terms.

Where both conditions are satisfied, shareholder approval is not required. However, such transactions must still be carefully evaluated to ensure that they genuinely meet the criteria.

Disclosure and Reporting Requirements

Transparency is a key pillar of Related Party Transaction regulation.

• Board’s Report Disclosure: Every company must disclose details of Related Party Transactions in its Board’s Report. This includes justification for entering into such transactions, enabling shareholders to assess their fairness.
• Maintenance of Register: Under Section 189, companies are required to maintain a register of contracts or arrangements in which directors are interested. This register must be kept at the registered office and be open for inspection by members.
• Continuous Compliance: Companies must ensure that all Related Party Transactions are properly documented, approved, and recorded. Proper documentation plays a crucial role in demonstrating compliance during audits and regulatory scrutiny.

Ratification of Transactions

In certain situations, a Related Party Transaction may be entered into without prior approval. The law allows such transactions to be ratified by the Board or shareholders within three months.

If ratification is not obtained within this period:

• The transaction becomes voidable at the option of the Board, and
• The concerned director or related party may be required to indemnify the company for any losses.

This provision ensures that non-compliance is addressed promptly and accountability is enforced.

Role of Directors and Accountability

Directors play a central role in ensuring compliance with Related Party Transaction provisions.

• They must disclose their interest in any related party arrangement.
• They must refrain from participating in decisions where a conflict exists.
• They are responsible for ensuring that transactions are fair, transparent, and in the best interest of the company.

Failure to adhere to these responsibilities may lead to personal liability.

Penalties for Non-Compliance

Section 188 provides strict penalties for violations:

• For listed companies: Imprisonment up to one year or fine ranging from ₹25,000 to ₹5,00,000, or both.
• For other companies: Fine ranging from ₹25,000 to ₹5,00,000.

Additionally:

• Transactions may be declared voidable.
• Directors or employees responsible for the violation must compensate the company for any loss.

These penalties underline the seriousness of compliance with Related Party Transaction provisions.

Interface with SEBI Regulations

While the Companies Act provides the foundational framework, listed companies are also governed by SEBI regulations, which impose additional requirements.

SEBI adopts a broader definition of Related Party Transactions, covering any transfer of resources, services, or obligations. It also mandates stricter approval requirements, including compulsory shareholder approval for material transactions and complete prohibition on voting by related parties.

This dual regulatory framework ensures higher standards of governance for listed entities.

Importance of Regulating Related Party Transactions

The regulation of Related Party Transactions serves several important objectives:

• Prevention of conflict of interest
  It ensures that company resources are not misused for personal gain.
• Protection of minority shareholders
  It safeguards the interests of shareholders who are not involved in management.
• Enhancement of transparency
  It promotes open disclosure of transactions, building trust among stakeholders.
• Strengthening corporate governance
  It aligns company operations with ethical and legal standards.

In the absence of proper regulation, related party dealings can undermine the integrity of corporate decision-making.

Conclusion

Related Party Transactions under the Companies Act, 2013 represent a comprehensive legal framework designed to regulate dealings that may involve conflicts of interest. The law combines broad definitions, structured approval mechanisms, disclosure obligations, and strict penalties to ensure accountability.

Companies must adopt a proactive compliance approach by identifying related parties, evaluating transactions carefully, and ensuring adherence to approval and disclosure requirements. Directors and management play a key role in maintaining transparency and safeguarding the company’s interests.