Related Party Transactions: Legal Provisions & Compliance

Related Party Transactions: Legal Provisions & Compliance

Applicable Provisions: Section 2(76) & 188 of the Companies Act, 2013 read with Rule 6A, 15 and 16 of Companies (Meeting of Board and its Power) Rules, 2014 and Regulation 23 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.

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

 Definition of Related party

The word “related party” is defined under Section 2(76) of the Companies Act, 2013 as follows:

“Related party”, with reference to a company, means—

(i) a director or his relative;

(ii) a key managerial personnel or his relative;

(iii) a firm, in which a director, manager or his relative is a partner;

(iv) a private company in which a director or manager [or his relative] is a member or director;

(v) 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;

(vi) 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;

(vii) any person on whose advice, directions or instructions a director or manager is accustomed to act:

Provided that nothing in sub-clauses (vi) and (vii) shall apply to the advice, directions or instructions given in a professional capacity;

*[(viii) any body corporate which is—

(A) a holding, subsidiary or an associate company of such company;

(B) a subsidiary of a holding company to which it is also a subsidiary; or

(C) an investing company or the venturer of the company;”;

Explanation.—For the purpose of this clause, “the investing company or the venturer of a company” means a body corporate whose investment in the company would result in the company becoming an associate company of the body corporate.]

MCA vide exemption Notification dated 5th June, 2015 exempted private companies from clause (viii) of Section 2(76) for the purpose of Section 188 of the Act.
After this exemption and *pursuant to amendment in clause (viii) of Section 2(76) substituted by the Companies (Amendment) Act,2017, in case of private body corporates holding, subsidiary, associate, venturer or investing companies will not be related parties for the purpose of Section 188 unless they fall in any other category as specified in Section 2(76).

(ix) 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 [other than an independent director] or key managerial personnel 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 Regulation 2(1)(zb) of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015

A Listed entity shall be considered as related party to the company if:

  • Such entity is a related party as defined under Section 2(76) of the Companies Act, 2013; or

  • Such entity is a related party under the applicable accounting standards.

Provided that any person or entity belonging to the promoter or promoter group of the listed entity and holding 20% or more of shareholding in the listed entity shall be deemed to be a related party.

Provided further that this definition shall not be applicable for the units issued by mutual funds which are listed on a recognized stock exchange(s).

Applicability:

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

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

  • The notification does not provide 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 in a private company is case of related party transaction.

Pursuant to Regulation 15 of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, the compliance with the corporate governance provisions as specified in regulations 23 shall not apply in respect of-

  • the listed entity having paid up equity share capital not exceeding rupees ten crore and net worth not exceeding rupees twenty five crore, as on the last day of the previous financial year.

Provided that where the provisions of the regulations specified in this regulation becomes applicable to a listed entity at a later date, such listed entity shall comply with the requirements those regulations within six months from the date on which the provisions became applicable to the listed entity.

  • the listed entity which has listed its specified securities on the SME Exchange. 

Requirement for Approval of Board of directors

Section 188(1) of the Companies Act, 2013 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.

Provided that nothing in this sub-section shall apply to any transactions entered into by the company in its ordinary course of business other than transactions which are not on an arm’s length basis.

Pursuant to Rule 15 of the Companies (Meeting of Board and its Powers) Rules, 2014, 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

Pursuant to Rule 15 of the Companies (Meeting of Board and its Powers) Rules, 2014, Company shall not enter into contracts or arrangements with respect to clauses (a) to (g) of sub-section (1) of section 188, except with the prior approval of the company by way of passing an ordinary resolution, with criteria as mentioned below –

  • Sale, purchase or supply of any goods or materials, directly or through appointment of agent, amounting to10% or more of the turnover of the company, as mentioned in clause (a) and clause (e) respectively of sub-section (1) of section 188;

  • Selling or otherwise disposing of or buying property of any kind, directly or through appointment of agent, amounting to 10% or more of net worth of the company, as mentioned in clause (b) and clause (e) respectively of sub-section (1) of section 188;

  • Leasing of property of any kind amounting to 10% or more of the turnover of the company, as mentioned in clause (c) of sub-section (1) of section 188

  • Availing or rendering of any services, directly or through appointment of agent, amounting to 10% or more of the turnover of the company, 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 abovementioned 4 points shall apply for transaction or transactions to be entered into either individually or taken together with the previous transactions during a financial year.

  • 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;

  • 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, to approve any contract or arrangement which may be entered into by the company, if such member is a related party. However, MCA has exempted private limited companies from this requirement vide notification dated 5th June, 2015.

Provided that nothing contained in the aforesaid paragraph shall apply to a company in which ninety per cent. or more members, in number, are relatives of promoters or are related parties.

Provided also that the requirement of passing the ordinary resolution shall not be applicable for transactions entered into between a holding company and its wholly owned subsidiary whose accounts are consolidated with such holding company and placed before the shareholders at the general meeting for approval.

Further, the 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.

Omnibus Approval

Pursuant to Rule 6A of the Companies (Meeting of Board and its Powers) Rules, 2014, all related party transactions shall require approval of the Audit Committee and the Audit Committee may make omnibus approvals for related party transactions proposed to be entered into by the company subject to such conditions as prescribed in the Rule 6A of the Companies (Meeting of Board and its Powers) Rules, 2014.

Provided that where the need for related party transaction cannot be foreseen and details mentioned in the aforesaid rule are not available, audit committee may make omnibus approval for such transactions subject to their value not exceeding rupees one crore per transaction.

Omnibus approval shall be valid for a period not exceeding one financial year and shall require fresh approval after the expiry of such financial year.

Omnibus approval shall not be made for transactions in respect of selling or disposing of the undertaking of the company.

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

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.

Further, the word special resolution has been replaced with the word resolution in the entire section for promoting ease of doing business with effect from 29th May, 2015.

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 that is conducted as if they were 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.

Additional Compliances for Listed Companies

Pursuant to Regulation 23 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 listed company as per the last audited financial statements of the listed entity.)

Further, NOTWITHSTANDING the above, a transaction involving payments made to a related party with respect to brand usage or royalty shall be considered material if the transaction(s) to be entered into individually or taken together with previous transactions during a financial year, exceed five percent of the annual consolidated turnover of the listed entity as per the last audited financial statements of the listed entity

The audit committee shall review, at least on a quarterly basis, the details of related party transactions entered into by the listed entity pursuant to each of the omnibus approvals given.

All material related party transactions shall require approval of the shareholders through resolution and no related party shall vote to approve such resolutions whether the entity is a related party to the particular transaction or not.

Provided that the requirements specified under this sub-regulation shall not apply in respect of a resolution plan approved under section 31 of the Insolvency Code, subject to the event being disclosed to the recognized stock exchanges within one day of the resolution plan being approved.

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.

Apart from this, certain extra disclosures are required to be given by listed entities such as:

  • Details of all material transactions with related parties shall be disclosed quarterly along with the compliance report on corporate governance.

  • The company shall disclose the policy on dealing with Related Party Transactions on its website and also in the Annual Report.

  • The listed entity shall submit within 30 days from the date of publication of its standalone and consolidated financial results for the half year, disclosures of related party transactions on a consolidated basis, in the format specified in the relevant accounting standards for annual results to the stock exchanges and publish the same on its website.

Register

Pursuant to Rule 16 of the Companies (Meeting of Board and its Powers) Rules, 2014, every company shall maintain one or more registers in Form MBP 4.

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 or, as the case may be, of the shareholders and if the contract or arrangement is with a related party to any director, or is authorized 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 authorised the contract or arrangement in violation of the provisions of this section shall,—

  • in case of listed company, 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 lakh rupees, or with both; and

  • in case of any other company, be punishable with fine which shall not be 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, 2013, 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

Email Id: – [email protected]

 Updated as on 3rd April, 2020

Post Tagged with approval of related party transactions, compliance of related party transaction, related party provisions, related party transactions, related party transactions under companies act,

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