A Brief View of Related Party Transactions Under Section 188 of Companies Act, 2013 By CS Neha Mittal


Introduction:

The enactment of Companies Act, 2013 is leading towards a new era in the Indian corporate sector which places more reliance on disclosure norms rather than on regulatory framework. One such area is related party transaction. The concept of related party transaction was not defined under the earlier act, Companies Act, 1956. However, the old Companies Act, 1956 dealt with restrictions imposed on various transactions with parties like the 
director of the companies 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 director is a member or director.

Under the Companies Act, 2013 the whole concept of related party transaction has been encapsulated in single section namely section 188 which is a combination of section 314 and section 297 of the Companies Act, 1956.

Related Party Transactions not in the Ordinary Course of Business or/and not at Arm’s Length.

Without related party (‘RP’) disclosures, there is a general presumption that transactions reflected in financial statements (‘FS’) are consummated on an arm’s length basis between independent parties. However, that presumption may not be valid when RP relationships exist because RP may enter into transactions which unrelated parties would not enter into OR such transactions between RP may not be effected at the same T&C’s as between unrelated parties.

Applicability of Section 188 of Companies Act, 2013

Section 188 is applicable to both private as well as public companies and is applicable with effect from 1.4.2014.

Meaning of Related Party:

Section 2(76) of the Companies Act, 2013 (“the Act”) defines the word “related party”:

  1. Director or his relative;
  2. Key managerial personnel or his relative;
  3. Firm, in which a director, manager or his relative is a partner;
  4. Private company in which a director or manager or his relative is a member or director;
  5. Public company in which a director or manager is a director and holds along with his relatives, more than two percent 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 (vi) and (vii) shall apply to the advice, directions or instructions given in a professional capacity;

Any Body Corporate (before company amendment bill 2017 it was “company”) which is—
(A) a holding, subsidiary or an associate company of such company; or

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

(C) an investment company or the venture of the company (New point as per company amendment bill 2017)

such other person as may be prescribed;
 
Proposed Amendments of Definition of related Party (as per company amendment bill 2017):

An investment company or venturer will now be considered a related party if such investment in the company would result in becoming an associate company of the Body Corporate.
 
RELATIVES AS PER COMPANIES ACT, 2013

Sec 2(77) of the Companies Act 2013 define Relative as:
Relative with reference to any person means anyone who is related to another, if—

  1. they are members of a Hindu Undivided Family;
  2. they are husband and wife; or
  3. One person is related to the other in such manner as may be prescribed.
  4. Chapter 1 of Rule 4 of Companies (Specification of Definitions details), 2014 a person shall be deemed to be the relative of another, if he or she is related to another in the following manner, namely:-
(1) Father:

Provided that the term “Father” includes step-father.

(2) Mother:

Provided that the term “Mother” includes the step-mother.

(3) Son:

Provided that the term “Son” includes the step-son.

(4) Son’s wife.

(5) Daughter.

(6) Daughter’s husband.

(7) Brother:

Provided that the term “Brother” includes the step-brother;

(8) Sister:

Provided that the term “Sister” includes the step-sister.
                          
                           Disclosure Requirement
  • Board Meeting
  • Disclosure by interested directors
  • Board Disclosures
  • Disclosures to be made in the Register
Approval of the company by Ordinary resolution:

Prior approval of Shareholders by Ordinary Resolution is required for entering into transactions exceeding the prescribed threshold limits:

 

Nature of Related Party Transactions

Threshold Limit

      i.          

Sale, purchase or supply of any goods or materials directly or through the appointment of agents (or)

Exceeding 10% if Turnover of Company or Rupees 100 Crore Whichever is Lower

     ii.          

Selling or otherwise disposing of, or buying, the property of any kind directly or through the appointment of agents (or)

Exceeding 10% of Net worth or Rupees 100 Crore Whichever is Lower

   iii.          

Leasing of property of any kind (or)

Exceeding 10% of the Net worth of a company or 10% of Turnover of Company of Rupees 100 Crore, Whichever is lower

   iv.          

Availing or rendering of any services directly or through appointment of agents (or)

Exceeding 10 % of Turnover of company or Rupees 50 Crore, Whichever is lower.

    v.          

Appointment to any office or place of profit in the company, its subsidiary company or associate company (or)

Monthly Remuneration Exceeding Rs. 2.5 lakhs

   vi.          

Remuneration for underwriting the subscription of any securities or derivative

Exceeding 1% of Net worth


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.

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 to private companies from this requirement vide notification dated 5th June, 2015.

The word “related party” referred above has to be construed with reference only to the contract or arrangement for which the said resolution is being passed.

MCA also clarified that contracts entered into by companies, after making necessary compliances under Section 297 of the Companies Act, 1956, which already came into effect before the commencement of Section 188 of the Companies Act, 2013, will not require fresh approval under the said section 188 till the expiry of the original term of such contracts. Thus, if any modification in such contract is made on or after 1st April, 2014, the requirements under section 188 will have to be complied with.

The explanatory statement to be annexed to the notice of a general meeting convened pursuant to section 101 shall contain the following particulars namely:-

(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.

  • No company shall enter into any contract or arrangement with a related party with respect to matters prescribed in 188(1) except with the consent of the Board and the requisite proviso. 
  • Proposed Amendments of related Party transaction (as per company amendment bill 2017): Apart from the existing provisions, the requirement related to restriction on voting by relatives in the general meeting shall not apply to a company in which 90% or more members in numbers are relatives of promoters or related parties Non-ratification of transaction shall be voidable at the option of the Board or shareholders, as the case may be.
Conclusion:

Related Party Transactions are regulated by certain conditions as provided in Section 188 of the Act, by the means of which they can be disclosed to the Board and shareholders for them to ratify. A prior approval from the Audit Committee is to be obtained. If the transactions fall within the meaning of Section 188, then these need to be disclosed in the Board Report for prior approval. A justification is required to be given in support of the transactions. If the transactions are beyond the threshold limits given above, then they need to be disclosed in the General Meeting for approval by special resolution.

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