This article is written by Pratibha Bansal, a student of Banasthali Vidhyapith, Rajasthan. The author has discussed section 188 of the Companies Act, 2013 which enumerates related party transactions.

Under the Companies Act, 2013, the extent to which the related party transactions are covered is more complex, but provisions of the act are explaining complexities of transactions in a more better manner than the earlier act. Along with its strict procedural compliances has been foisted. Section 188 is still more open to changes and consist of more different opinions as compared to previous Section 297 of the Companies Act, 1956.

Who all are related parties?

Section 2(76) of the companies act, 2013 defines the term related parties.

Related parties with reference to a company(consider this company a base company) are:-

1. Director of Base company- Director or relatives of such director of the base company can be a related party to the company.
2. Key managerial personnel and Base company- If the company has appointed Key Managerial Personnel then such Key managerial personnel(section 2(51) including the CEO, Managing Director, CFO etc. of the base company) or relatives of such key managerial personnel can also be a related party of the base company.
3. Firm and Base company- Where the directors and the manager of the base company or relative of such director and manager are partners of any firm, then that firm would become a related party of the base company. Illustration- suppose the director of company A is a partner in a firm C, then firm C will be a related party of company A.
4. Private company and Base company- When the director or manager of our base company or relative of such director or manager are also the director and manager of any private company, then that private company would become a related party of our base company. Illustration- person Z is a director of company A and also the director of company D(a private company), Company D will be a related party of company A.
5. Whereas the hidden interpretation of this clause is that public companies are excluded from this purview, i.e. if the director or manager of the base company or relatives of such director or manager is also a director or manager of any public company, then such public company won’t become a related party to our base company.
6. Public company and Base company- A public company could become a related party of our base company only when two conditions are satisfied:-

• The Director and manager of our base company or relatives of such director or manager are also a director or manager of a public company.
• The director or manager or relatives of such director or manager should hold two per cent of the paid-up share capital.

Then once both the conditions are satisfied, a public company would become a related party to our base company.

7. Body corporate and Base company- Any Body corporate(defined under section 2(11) of the act) whose board of directors, managing Directors or Manager, accustomed to act in accordance with advice, direction and instruction of the director or manager of the base company, then such body corporate will become a related party of our base company.

Illustration- M is a body corporate(larger ambit than that of a company)  and its board of directors are working on the advice of a director of a company O then, body corporate  M become the related party of company O.

8. Any other person and base company- Any other person on whose advice, direction or instruction directors or manager of our base company is accustomed to act then, such a person would be a related party of our base company.

So, there is an exception in respect of point no. 6&7 that if such a piece of advice is given in its professional capacity then the person giving such advice will not become a related party.

9. Holding, subsidiary and associate company of base company-

(a) Holdings, subsidiary and associate companies of our base company also become its related parties.

(b) If the holding company of our base company has any other subsidiary company then such subsidiary company would inter-se become its related party.

Illustration- The Base company “A” is a subsidiary of company “Z” that means company Z is a holding company and company “M” is also a subsidiary of company Z then, company M would inter-se become a related party of our base company A.

10. Any other person as may be prescribed by law

Now for understanding who all will be considered as relative under section 2(76), we need to go through section 2(77).

Relative is the one who is related to the director or manager referred.

1. Either the member of Hindu Undivided Family.
2. Both are related to husband and wife.
3. Related to each other in such a manner as may be prescribed.

Which transactions are called related party transaction?

Transactions specified under section 188(1) done with a related party includes:-

1. Sale, purchase or supply of any goods(movable goods) or materials by a company to its related party.
2. Selling and otherwise disposing of any kind of property(immovable goods) to a related party or any purchase or buying of any property from a related party.
3. Lease of the property of any kind to a related party.
4. Consultancy services or any other kinds of services which a company is providing or the company is receiving.
5. Appointment of agent for making sale or purchase of any good, material, service or property.
6. Appointment of such related parties to any office of place of profit(if the director is occupying such position then whatever he is receiving apart from the remuneration which he was entitled to receive being a director every remuneration which he is receiving either by salary or by any other perk will be covered?) in the company, in it’s subsidiary or associate company; and
7. If there is any underwriting agreement is done, for the subscription of securities between the company and related parties.

Approvals required by the company

1. Board of directors approval

Without approval from the Board of directors, no company shall enter into any of the transaction mentioned in section 188(1) with a related party. Except when such a transaction is being done during the ordinary course of business other than transactions of arm’s length price.

Arm’s length price– If a company is entering into any transaction with its related party then that price which the company would have taken or given if such transaction would have taken place with any unrelated party i.e. the actual market price of that good, property or service.

Therefore any transaction done at arm’s length price called arm’s length transaction and such transaction didn’t require board approval for its completion.

• Audit committee approval

Only those companies which are required to form an audit committee will first take the approval of the audit committee then enter into the transaction with its related party.

So it is stated that with addition to the boards’ approval there are the following class of the companies which are required to take the approval of the audit committee.

The purpose for such approval is for entering into or subsequent modifications to be made in the transaction of the company with the related parties.

What all companies require audit committee approval:-

1. Every listed company.
2. The public companies having paid up share capital of 10 crore rupees or more.
3. The public companies having a turnover of 100 crore rupees or more.
4. The public companies which have in aggregate outstanding loans, debentures and deposits exceeding 50 crore rupees.

So we can analyse that only listed companies and certain public companies are required to take audit committee approval.

Audit Committee approval Is to be taken in audit committee meeting whereas according to 2015 amendment audit committee may make omnibus approval that is may provide approvals in combination, no per transaction approval is required.so liberty of omnibus approval is to be given to the audit committee.

So for audit committee approval board of directors, approval is mandatory. After that, if the committee is making omnibus approval then, it must specify why such approval is given and certain things which are required to be considered before giving omnibus approval are:-

1. The maximum value of the transactions, in the aggregate which can be allowed under omnibus transaction route in a year i.e. the sum of all the transactions entered by a company.
2. The maximum value of per transaction which can be allowed.
3. The extent and manner of disclosures to be made to the audit committee at the time of seeking omnibus approval.
4. The audit committee has to review such approvals at such intervals as it may deem fit.
5. The audit committee must satisfy itself on the need for omnibus approval for transactions of repetitive nature and also must satisfy that such an approval is in the interest of the company.

These omnibus approvals are valid for a period of one year and at the expiry of each financial year, fresh approval is required.

• Approval of shareholders

Such approval is required if exceeds the following threshold limits:-

1. Any transaction mentioned under point “a to e” of section 188(1) is of 100 crores or 10% or more of turnover whichever is lower then such a transaction with a related party can be done without the approval of shareholders.
2. If a transaction exceeds the given threshold limit, then prior shareholder approval is required.
3. Appointment of such related party’s to any office of profit in the company, in its subsidiary or associate company and if the appointment is for more than 2.5 lakhs monthly remuneration then in such case shareholder approval is required.
4. Underwriting, so if the value of the transaction exceeds 1% of Net Worth(computed based on audited financial statements of the preceding year), then shareholder approval is required.

Before companies amendment 29. 05. 2015 shareholder approval was required in special resolution whereas after the amendment approval can be given in the ordinary form.

No member of the company shall vote on such resolution for shareholder approval of any contract which may be entered into by the company if such member is a related party.  

Shareholder approval is a special kind of business and for passing an ordinary resolution for the same explanatory statement is required which shall contain the following particulars namely:-

1. Name of related parties.
2. Name of directors or key managerial personnel.
3. Their relationship.
4. Nature, material term, monetary value and particulars of contract or arrangement.
5. Any other relevant information.

Consequences of non-compliance of section 188

If there is any contract or arrangement which is not approved by the board of directors or ordinary resolution and the company has entered into any such transactions with its related parties then in that case-

1. If such transactions are not ratified by the board or the shareholders in its meeting within 3 months from the date of entering into such contract or arrangement then such contract or arrangement shall become voidable at the option of the board. So, if the board want it can declare such contract or arrangement void.
2. Any director entering into any contract or arrangement in contravention to section 188 can also be disqualified to be a director for a period of 5 years.
3. The company can also proceed against such director or manager who had entered into such contract or arrangements in contravention to the provision of the section.

• If the company is listed company then the director or manager acted in such contravention shall be punished with imprisonment which may extend to 1 year or with a fine of Rs. 25,000/- which may extend to Rs. 5,00,000/-, or both.
• If there is any other company then, such manger or directed acted in contravention to the provision of a section shall be punishable with fine of Rs. 25,000/- that may extend to Rs. 5,00,000/-.

Conclusion

It may be seen that under Section 297 of the Companies Act, 1956, in case of having paid up share capital of Rs. 1 Crore or more, shareholders approval had no role to play for any related party transaction referred under section 188(1) of Companies Act, 2013 , it is the approval from central government which is required for such transactions except when the transaction has been done in cash and at arm’s length price.

However, in regards to services in excess of Rs.5,000/- per year, the approval of the Central Government necessarily required.

Section 188 applies to both public and private companies. It is strongly felt that there is no reason for interpreting as to why the provisions of Section 188 be only applied to purely private companies where neither public is interested, nor any public funds are infused.