In this blog post, Bharat Rajvanshi, a student at Institute of Law, Nirma University and pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, describes how the Companies Act identifies related parties and related party transactions.
Related Party Transactions
By a general definition of related party transactions, it means any transaction, deal or arrangement between two and more parties who have a special relationship before the transaction or deal. Related party transactions under company law mean a business transaction of a company with related parties to the company or the transfer of resources, services or obligations between a company and a related party. The term related party is defined under Section 2(76), read with Rule 3 of Companies (Specification of definitions details) Rules, 2014.[1]
This concept got strength under Companies Act 2013; the new act brings many changes and improvements in the corporate sector. Section 188 of the Act provides a mechanism to improve the business transactions and reduce the risk in transactions by improving the process of selecting the parties. Although this is not entirely a new concept, Companies Act 1956 also has provisions related to this. Section 297 of the Act of 1956 deal with this.[2]
As per the Companies Act 2013 if any company wants to do their transaction with any party given in Section 2(76), read with Rule 3 of Companies (specification of definitions details) Rules, 2014, they have to comply with provision given under Section 188 of the Act and other law time being in force.
Related party under Companies Acts 2013 and Rules
Related party is defined under Section 2(76) of the Companies as[3]:-
(1) director of company and relative of the director; director includes all the directors including the nominated and independent director.
(2) key managerial persons and their relatives; key managerial persons are:- (i) the Chief Executive Officer or the managing director or the manager; (ii) the company secretary; (iii) the whole-time director; (iv) the Chief Financial Officer; and (v) such other officer as may be prescribed.
(3) Any firm in which director and manager of the company and their relatives are partners.
(4) Any private company in which director or manager of the company is the director or having a membership.
(5) A public company in which a director or manager is a director or holds along with his relatives, more than two per cent of its paid-up share capital.
(6) Any corporate which acts by aid and advice of the director or manager of the company.
(7) Any person on who’s direction or advice director and manager of company works, except the case when advice is given on profession capacity.
(8) Any company which is a subsidiary or holding company of company and subsidiary of holding company of that company.
These are expressly defined under company act; there can be other than these under any other prescribed Rule. Like as per Rule 3 of Companies (specification of definitions details) Rules, 2014, the related party also includes [4]:-
A director or key managerial personnel of the holding company or his relative with reference to a company.
In above case the term relative is used, relative is also defined under Companies Act, 2013 and Rules of 2014. Section 2 (77) read with Rule 4 of Companies (specification of definitions details) Rules, 2014 define the term relative.[5]
As per the Companies Act: – relative includes:-
(1) member of HUF (Hindu undivided family)
(2) husband and wife
(3) other person prescribed in any Rules.
As per Companies (specification of definition details) Rules, 2014 –
(1) father and mother including step- father and step- mother.
(2) son and son’s wife including step- son.
(3) daughter and daughter’s husband.
(4) Brother and sister including step- brother and step- sister.
The term related party and provision related to this is also defined under revised clause 49 of listing agreement by SEBI in very broad manner.[6]
Related Party Transaction under Companies Act, 2013
Section 188 of Companies Act provides the provision related to Related Party Transaction as[7]:-
(1) Sub-section (1) identify the transactions which cannot be done with related parties except in certain conditions prescribed, such transactions includes:-
- Transactions related to goods and materials including supply, sale, and purchase;
- any property transactions;
- any service contracts;
- Appointment of any agent for purchase or sale of goods, materials, services or property
- Such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company, and
- Underwriting the subscription of any securities or derivatives thereof, of the company
(2) as per Sub-section (2) and (3) to entered into any transactions company need special resolutions, and any members who are a related party to such transaction are not allowed to give their vote in such resolutions.
(3) The company can enter into any transactions with a related party in transactions related to its ordinary court of business, but such transaction must be of arm length.
(4) Details of every contract/arrangement with justification to be given in the Board’s report;
(5) If a company has entered into any such transaction without the approval of shareholder through a special resolution, they need to rectify it in their shareholder meeting within three months or in the lack of these compliances such contracts or agreements become voidable on the option of the board.
(6) In case where any director did not take approval before entering into such transaction, company is free to proceed against them, and they will be punished as per Sub-section (5) of 188;
- In the case of listed company: – Imprisonment which may extend to one year and fine of 25,000 to 5,00,000 rupees.
- In the case of an unlisted company: – Fine of 25,000 to 5,00,00 rupees.
Office or Place of Profit
It would be a place held by a director and receives remuneration after receiving the remuneration as a director. Also, if such place or office is held by any other individual, not a director or by a firm or a company in any form over and above the salary and perquisites he receives as a director. Where the transactions are carried out in the ordinary course of business on arm’s length transaction base, then there is no need of taking consent of the board of directors.
Arms Length Transaction
Arm’s length transaction can be described as the transaction between two related parties that is conducted as if they were not related to each other. This is to ensure that the two parties carry out a fair transaction and act in their interest rather than benefiting the other, and there exists no biases.
Recovery of Loss in Related Party Transaction
Despite any further approvals, the company and the board of directors can bring about the proceedings against a director or an employee who might have been engaged in a related party transaction and loss has been sustained by the company.
Shareholder’s approval in cases of Related Party Transactions is somewhere not sought and vary from company to company. Related Party Transactions in the case of listed companies is not exempted even if executed at arm’s length and in the ordinary course of business. This is a critical difference.
References:
[1] http://taxguru.in/company-law/related-party-transactions-companies-act-2013.html
[2] http://www.caclubindia.com/articles/related-party-transaction-companies-act-2013-18681.asp
[3] http://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf
[4] http://taxguru.in/company-law/companies-act-2013-companies-specification-definitions-details-Rules-2014.html
[5] http://www.caclubindia.com/articles/relative-section-2-77-of-the-companies-act-2013-25503.asp
[6] http://www.ey.com/IN/en/Issues/Governance-and-reporting/EY-Compass-on-Companies-Act-2013/EY-cfo-companies-act-2013-related-party-transactions
[7] http://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf
