This article is written by Yash Bagra, a student of Institute of Law, Nirma University during his internship with iPleaders.
Key changes which have been done in Companies Act, 2013 under related party transactions:
- Central government approval of these transactions has been done away with.
- The ambit of these transactions has been widened up, such as leasing of property of any kind, the appointment of any agent for the purchase and sale of goods, material, services or property.
- ‘Arm’s length transaction’ has substituted cash at prevailing market price and it is also defined in the act.
- Transactions entered into with related parties now to be included in the board’s report along with justification for entering into such contracts and arrangements.
- The penalty for contravention of the provisions of section 297 was covered in general provisions before, but this is now covered specifically in the section itself which also now extends to imprisonment.
- Additional conditions may be prescribed by the Central Government.
Meaning of ‘Related Party’
Under Companies Act, 1956 ‘related party’ to any transaction was not defined. However, the old Companies Act dealt with restrictions on transactions with parties like the director of the company or his relative, firm in which such a director or relative is a partner, any other partner in such a firm and private company of which the director is a member or director. Companies Act, 2013 defines ‘related party’ with reference to a company in multiple entities like a firm, in which a director, manager or his relative is a partner, any corporate body 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, or any company which is a holding, subsidiary or an associate company of such company.
Restrictions on related party transactions
Companies Act, 1956 had section 297 which corresponds to section 188 of Companies Act, 2013 imposing restrictions on contract or arrangement for the sale, purchase or supply of any goods, materials or services and for underwriting the subscription of any shares in, or debentures of, the company with a related party.
On the other hand, section 188 of the Companies Act 2013 has widened the scope of restricted transactions, including various kinds of transactions which require consent of the board of directors given by a resolution in a meeting of the board like sale, purchase or supply of any goods or materials, selling or otherwise disposing of, or buying, property of any kind leasing of property of any kind, availing or rendering of any services, the appointment of any agent for the purchase or sale of goods, materials, services or property, underwriting the subscription of any securities or derivatives of the company and such related party`s appointment to any office or place of profit in the company, its subsidiary company or associate company.
No contract or agreement in the case of a company having a paid up share capital of not less than the prescribed amount or transaction not exceeding prescribed sums will be entered except with the prior approval of the company by a special resolution. No member of the company will be allowed to vote on a special resolution for approving any contract or arrangement entered by the company if such a member is a related party.
Companies Act, 2013 explains the term “office or place of profit” as an office or place which is held by a director and if the director holding it receives from the company 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 and where office or place is held by an individual other than a director or by any firm, private company or other body corporate, if the individual, firm, private company or body corporate holding it receives from the company anything by way of remuneration, salary, fee, commission, perquisites, any rent-free accommodation.
Companies Act, 2013 provides exemption to transactions which are at “arm`s length” i.e., a transaction which leads to no conflict of interest as the relation between the two related parties was like as if they were unrelated parties.
It is required that every contract or arrangement which is a related party transaction will be referred to in the board`s report to the shareholders along with the justification for entering into such contract or arrangement.
Old companies act did not provide any provision related to loss recovery in case of related party transactions. Under Companies Act, 2013 if a director or any other employee has not obtained the consent of the board or approval by a special resolution in the general meeting and has entered into any contract or arrangement with a related party and it is not even ratified by the board or by the shareholders at a meeting within three months from the date on which such contract or arrangement was entered into such contract will be voidable at the option of the board and if the contract or arrangement is with a related party to any director or it is authorized by any director the concerned director will indemnify the company against any loss incurred by it.
It is open to the company to proceed against a director or any other employee who had entered into such contract or arrangement in contravention of the provisions of the act for the recovery of any loss sustained by it as a result of such contract or arrangement.
PENALTY FOR CONTRAVENTIONS
Under the companies act of 2013 any director or any other employee of a company, who had entered into or authorized the contract or arrangement in violation of the provisions of the act in case of a listed company or any other company he/she will be punishable with imprisonment for a term which may extend to one year or with fine which shall not be less than twenty five thousand rupees but which may extend to five lakhs. There was no separate penalty provision in the Companies Act, 1956.
A contrasting change in the Act of 2013 in comparison to Act of 1956 is that in the latter, it was mandatory to get previous approval from the central government to enter into any transaction with “related party” for companies having paid up capital of not less than one crore rupees but in the new act this approval route has been done away with.
Every company has to seek approval from the board of directors to enter into any related party transactions irrespective of the capital of the company and the approval has to be obtained at a meeting of the board and it cannot be obtained by passing a resolution by circulation. Any director who has an interest in any contract entered with a related party, he shall not be present at the meeting during discussion on the subject matter relating to related party transactions.
Companies Act, 2013 also requires the Audit Committee to approve or modify transactions with related parties, scrutinize inter-corporate loans and investments and value undertakings or assets of the company, wherever it is necessary. Further, the Companies Act gives Audit Committee the authority to investigate into any matter falling under its domain and the power to obtain professional advice from external sources and have full access to information contained in the records of the company. Transactions entered into with related parties are required to be included in the board’s report along with justification for entering into such contracts and arrangements.