Related Party Transactions: Legal Provisions & Compliance

Applicable Provisions: Section 2(76) & 188 of the Companies Act read with Rule 15 of Companies (Registration Offices and Fees) Rules, 2014 And Clause 49(7) of the Listing Agreement read with Regulation 23(8) of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015

INTRODUCTION

The Act puts some restriction on the related party transactions. With the introduction of The Companies Act, 2013, the scope and ambit of related party transactions has significantly enlarged. The Companies Act, 1956 covered only purchase or sale of goods or supply of services and subscription of any shares or debentures of the company under the related party transaction. However, Companies Act, 2013 has brought immovable properties and leasing of property also under the ambit of related party transaction.

The Companies Act, 2013 has removed central government approvals for related party transaction which was mandatory under the Companies Act, 1956 for companies having paid-up share capital of rupees one crore or more.

We will start from the definition of related party, which has been prescribed under the Act.

 

Definition of Related party

  1. The word “related party” is defined in Section 2(76) of the Companies Act, 2013 as follows:
    a director or his relative;
  2. A key managerial personnel or his relative;
  3. A firm, in which a director, manager or his relative is a partner;
  4. A private company in which a director or manager or his relative is a member or director;
  5. A public company in which a director or manager is a director and holds along with his relatives, more than two per cent. of its paid-up share capital;
  6. Any body 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;
  7. Any person on whose advice, directions or instructions a director or manager is accustomed to act:
    Provided that nothing in sub-clauses (vii) and (viii) shall apply to the professional advice, directions or instructions.
  8. Any company which is—
    • a holding, subsidiary or an associate company of such company; or
    • a subsidiary of a holding company to which it is also a subsidiary;

    MCA vide exemption Notification dated 5th July, 2015 exempted private companies from clause (viii) of Section 2(76) for the purpose of Section 188 of the Act.
    After this exemption notification in case of private companies holding, subsidiary or associate companies will not be related parties for the purpose of Section 188 unless they fall any other category as specified in Section 2(76).

  9. Such other person as may be prescribed;As per Rule 3 of Companies (Specification of definitions details) Rules, 2014} for the purposes of above-mentioned sub-clause (IX) a director or KMP of the holding company or his relative with reference to a company, shall be deemed to be a related party.

(Special Note for Listed Companies: As per Clause 49(7) of the Listing Agreement read with Regulation 23(8) of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015

An entity shall be considered as related to the company if:

  • Such entity is a related party under Section 2(76) of the Companies Act, 2013; or
  • Such entity is a related party under the applicable accounting standards.)

 

Requirement for Approval of Board of directors

Section 188(1) of the Act provides that except with the consent of the Board of Directors given by a resolution at a Meeting of the Board and subject to such conditions as may be prescribed, no company shall enter into any contract or arrangement with a related party with respect to—

a. sale, purchase or supply of any goods or materials;

b. selling or otherwise disposing of, or buying, property of any kind;

c. leasing of property of any kind;

d. availing or rendering of any services;

e. appointment of any agent for purchase or sale of goods, materials, services or property;

f. such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company; and

g. Underwriting the subscription of any securities or derivatives thereof, of the company.

 

The agenda of the Board meeting at which the resolution is proposed to be moved shall disclose-

a. the name of the related party and nature of relationship;

b. the nature, duration of the contract and particulars of the contract or arrangement;

c. the material terms of the contract or arrangement including the value, if any;

d. any advance paid or received for the contract or arrangement, if any;

e. the manner of determining the pricing and other commercial terms, both included as part of contract and not considered as part of the contract;

f. whether all factors relevant to the contract have been considered, if not, the details of factors not considered with the rationale for not considering those factors; and

g. any other information relevant or important for the Board to take a decision on the proposed transaction.

Where any director is interested in any contract or arrangement with a related party, such director shall not be present at the meeting during discussions on the subject matter of the resolution relating to such contract or arrangement.

 

Requirement for Approval of the company by Ordinary resolution

The following type of transactions require the approval of the company by passing an ordinary resolution:

(a) As contracts or arrangements with respect to clauses (a) to (e) of sub-section (1) of section 188, with criteria as mentioned below –

  1. Sale, purchase or supply of any goods or materials, directly or through appointment of agent, exceeding 10% of the turnover of the company or rupees 100 crore, whichever is lower, as mentioned in clause (a) and clause (e) respectively of sub-section (1) of section 188;
  2. Selling or otherwise disposing of or buying property of any kind, directly or through appointment of agent, exceeding 10% of net worth of the company or rupees 100 crore, whichever is lower, as mentioned in clause (b) and clause (e) respectively of sub-section (1) of section 188;
  3. Leasing of property of any kind exceeding 10% of the net worth of the company or 10% of turnover of the company or rupees 100 crore, whichever is lower, as mentioned in clause (c) of sub-section (1) of section
  4. Availing or rendering of any services, directly or through appointment of agent, exceeding 10% of the turnover of the company or rupees 50 crore, whichever is lower, as mentioned in clause (d) and clause (e) respectively of sub-section (1) of section 188:

Explanation. – It is hereby clarified that the limits specified in sub-clauses (i) to (iv) shall apply for transaction or transactions to be entered into either individually or taken together with the previous transactions during a financial year.

(b)  For appointment to any office or place of profit in the company, its subsidiary company or associate company at a monthly remuneration exceeding two and half lakh rupees as mentioned in clause (f) of subsection (1) of section 188; or

(c) For remuneration for underwriting the subscription of any securities or derivatives thereof, of the company exceeding 1% of the net worth as mentioned in clause (g) of sub-section (1) of section 188.

Explanation. – (1) The Turnover or Net Worth referred in the above sub-rules shall be computed on the basis of the Audited Financial Statement of the preceding Financial year.

No member of the company shall vote on such resolution, if he is a related party, to approve any contract or arrangement which may be entered into by the company. However, MCA has exempted private limited companies from this requirement vide notification dated 5th July, 2015.

Audit Committee is empowered to give omnibus approvals for related party transactions proposed to be entered into by the company subject to such conditions as may be prescribed.

And related party transactions between holding companies and wholly owned subsidiaries are exempted from the requirement of approval.

Related Party Transactions

Further, it is important to take note of contents of the Explanatory Statement annexed to the notice of a General Meeting pursuant to Section 101. The following matters should be included in the said explanatory statement:

(a) Name of the related party ;

(b) Name of the director or key managerial personnel who is related, if any;

(c) Nature of relationship;

(d) Nature, material terms, monetary value and particulars of the contract or arrangement;

(e) Any other information relevant or important for the members to take a decision on the proposed resolution.

After the amendment of Companies (Meetings of Board and its Powers) Rules, 2014 on 14th August, 2014 essence of related party is changed entirely. Now every company whether small or big, private or public will be required to pass ordinary resolution for related party transaction. MCA has removed paid-up capital criteria for ordinary resolution.

 

Exempted Transactions: Transactions entered into by the company in its ordinary course of business and undertaken at an arm’s length basis do not need any prior approval:  

The word “ordinary course of business” is not defined in the Companies Act, 2013 or in Rules made there under.

No specific criteria have been provided in the Act whether the transaction is in ordinary course or not. Whether the transaction entered is ordinary course of business or not will depend on the particular business activity of the company. Transaction in ordinary course of business will cover the usual transactions of a business and of a company.

One should consider variety of factors to determine whether the transaction is in ordinary course or not like size, volume, frequency, purpose of transaction etc.

 

Meaning of Arm’s length transaction:

Arm’s length transaction means a transaction between two related parties which is conducted as if they are unrelated, so that there is no conflict of interest.

If a transaction fulfills both the criteria no approval will be required under section 188 of the Companies Act, 2013.

(Special Note for Listed Companies : As per Clause 49(7) of the Listing Agreement read with Regulation 23(8) of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015

A transaction with a related party shall be considered material if the transaction / transactions to be entered into individually or taken together with previous transactions during a financial year, exceeds 10% of the annual consolidated turnover of the company as per the last audited financial statements of the company.)

 

Disclosures:

Every contract or arrangement entered into under sub-section (1) of Section 188 of the Act shall be referred to in the Board’s report to the shareholders along with the justification for entering into such contract or arrangement.

(Special Note for Listed Companies : As per Clause 49(7) of the Listing Agreement read with Regulation 23(8) of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015

  1. Details of all material transactions with related parties shall be disclosed quarterly along with the compliance report on corporate governance.
  2. The company shall disclose the policy on dealing with Related Party Transactions on its website and also in the Annual Report.)

 

Applicability:

Section 188 of the Act is applicable to all kinds of companies whether private or public.

MCA issued exemption notification dated 5th July, 2015 to give certain exemptions to private limited companies for related party transaction.

The notification does not five full exemptions to private companies but it gives exemption to private companies with some riders.

It has exempted private companies from Section 2(76)(viii) for the purpose of Section 188.

A related party can vote for ordinary resolution is case of related party transaction.

(Special Note for Listed Companies : As per Clause 49(7) of the Listing Agreement read with Regulation 23(8) of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015

Applicability is as follows:

  1. All Listed Companies.
  2. Companies having paid up equity share capital exceeding Rs.10 crore and Net Worth exceeding Rs.25 crore.)

 

Consequences of contravention & Penalty:

Where any contract or arrangement is entered into by a director or any other employee, without obtaining the consent of the Board or approval by a ordinary resolution in the general meeting-

  • and if it is not 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:

such contract or arrangement shall be voidable at the option of the Board and if the 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.

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 this section shall,—

  • in case of listed company, be punishable with imprisonment upto one year or with fine not less than twenty-five thousand rupees but which may extend to five lakh rupees, or with both; and
  • in case of any other company, be punishable with fine not less than twenty-five thousand rupees but which may extend to five lakh rupees.

It is also important to mention that as per section 188(4) of the Companies Act, it shall be 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 this section for recovery of any loss sustained by it as a result of such contract or arrangement.

 

For any queries and legal opinions please contact:-

J. K. Gupta & Associates

257, Vardhaman City Center,

Gulabi Bagh, Near Shakti

Nagar Railway Under Bridge

New Delhi-110052

Phone No- 011-23654449/ +919810043622

Email Id:- [email protected]

 

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