Related Party transactions in the previous Act i.e in Companies Act, 1956 was in different sections wheres as now it is provided in only one section to make it easily understood.
Let us see first all the legal sources applicability, only, to Related Party Transaction as prescribed as follows:
Let see first the definition of Related Party as stated in Companies (Specification of definitions details) Rules, 2014:
Section 2 (76) Related party-
“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 is a member or director; (v) a public company in which a director or manager is a director or 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 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;
(ix) such other person as may be prescribed;
In above definition there is a minor difference which needs to remember….see this picture:-
Section 2 (77) – ‘‘Relative’’ with reference to any person, means any one who is related to another, if—
(i) they are members of a Hindu Undivided Family;
(ii) they are husband and wife; or
(iii) one person is related to the other in such manner as may be prescribed;
Definition of Relative u/s. 2(77) read with Rule Companies (Specification of Definitions Details) Rules, 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.
SEE FOLLOWING PICTURE TO REMEMBER IT EASILY:-
Section 188 Related Party Transactions
(1) 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 no contract or arrangement, in the case of a company having a paid-up share capital of not less than such amount, or transactions not exceeding such sums, as may be prescribed, shall be entered into except with the prior approval of the company by a special resolution:
Provided further that no member of the company shall vote on such special resolution, to approve any contract or arrangement which may be entered into by the company, if such member is a related party:
Provided also 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.
Explanation.—
In this sub-section,—
(a) the expression “office or place of profit” means any office or place—
(i) where such office or place is held by a director, 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, or otherwise;
(ii) where such 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, or otherwise;
(b) the expression “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.
(2) Every contract or arrangement entered into under sub-section (1) shall be referred to in the Board’s report to the shareholders along with the justification for entering into such contract or arrangement.
(3) 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 special resolution in the general meeting under sub-section (1) and if it is not ratified by the Board or, as the case may be, by the shareholders at a meeting within three months from the date on which such contract or arrangement was entered into, 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 authorized by any other director, the directors concerned shall indemnify the company against any loss incurred by it.
(4) Without prejudice to anything contained in sub-section (3), 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.
(5) 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,—
(i) 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
(ii) 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.
Companies (Meetings of Boards and its Powers) Rules, 2014
Rule 15 Contract or arrangement with a related party
A company shall enter into any contract or arrangement with a related party subject to the following conditions, namely:-
(1) 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.
(2) 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-
(3) For the purposes of first proviso to sub-section (1) of section 188, except with the prior approval of the company by a special resolution
(i) a company having a paid-up share capital of ten crore rupees or more shall not enter into a contract or arrangement with any related party; or
(ii) a company shall not enter into a transaction or transactions, where the transaction or transactions to be entered into—
(a) as contracts or arrangements with respect to clauses (a) to (e) of sub-section (1) of section 188 with criteria, as mentioned below—
(i) sale, purchase or supply of any goods or materials directly or through appointment of agents exceeding twenty five percent of the annual turnover as mentioned in clause (a) and clause (e) respectively of sub-section (1) of section 188;
(ii) selling or otherwise disposing of, or buying, property of any kind directly or through appointment of agents exceeding ten percent of net worth as mentioned in clause (b) and clause (e) respectively of sub-section (1) of section 188;
(iii) leasing of property of any kind exceeding ten percent of the net worth or exceeding ten percent of turnover as mentioned in clause (c) of sub-section (1) of section 188;
(iv) availing or rendering of any services directly or through appointment of agents exceeding ten percent of the net worth as mentioned in clause (d) and clause (e) of sub-section (1) of section 188;
(b) 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 sub-section (1) of section 188; or
(c) remuneration for underwriting the subscription of any securities or derivatives thereof of the company exceeding one percent 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 on the basis of the Audited Financial Statement of the preceding Financial year.
(2) In case of wholly owned subsidiary, the special resolution passed by the holding company shall be sufficient for the purpose of entering into the transactions between wholly owned subsidiary and holding company.
(3) 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.
Related Party Transactions under the Listing Agreement
The provisions with regard to related party transactions under the recently amended Clause 49 of the Listing Agreement are as under:
- A related party transaction is a transfer of resources, services or obligations between a company and a related party, regardless of whether a price is charged.
- A ‘related party’ is a person or entity that is related to the company. Parties are considered to be related if one party has the ability to control the other party or exercise significant influence over the other party, directly or indirectly, in making financial and/or operating decisions and includes the following:
- A person or a close member of that person’s family is related to a company if that person:
- is a related party under Section 2(76) of the Companies Act, 2013; or
- has control or joint control or significant influence over the company; or
- is a key management personnel of the company or of a parent of the company; or
- An entity is related to a company if any of the following conditions applies:
(a) The entity is a related party under Section 2(76) of the Companies Act, 2013; or
(b) The entity and the company are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others); or
(c) One entity is an associate or joint venture of the other entity (or an associate or joint venture of a member of a group of which the other entity is a member); or
(d) Both entities are joint ventures of the same third party; or
(e) One entity is a joint venture of a third entity and the other entity is an associate of the third entity; or
(f) The entity is a post-employment benefit plan for the benefit of employees of either the company or an entity related to the company. If the company is itself such a plan, the sponsoring employers are also related to the company; or
(g) The entity is controlled or jointly controlled by a person identified in (1).
(h) A person identified in (1)(b) has significant influence over the entity (or of a parent of the entity); or
Explanation: For the purpose of Clause 49(V) and Clause VII(B), the term “control” shall have the same meaning as defined in SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.
- The company shall formulate a policy on materiality of related party transactions and also on dealing with Related Party Transactions.
Provided that 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 five percent of the annual turnover or twenty percent of the net worth of the company as per the last audited financial statements of the company, whichever is higher.
- All Related Party Transactions shall require prior approval of the Audit Committee.
- All material Related Party Transactions shall require approval of the shareholders through special resolution and the related parties shall abstain from voting on such resolutions.
In terms of the Listing agreement, the following disclosures are envisaged:
- 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.
Now Approval part to understand in easy form see the following table:
I have tried my possible ways to make this section easy to understand and apply. Comapanies Act, 2013 is also a new phase in a Indian Corporate World. In order to mitigate the practical problems and to clarify the ambiguity of law, Ministry of Corporate Affairs have been providing on regular basis amendments, clarifications, notifications, circulars etc. on its site.
It may happen that companies with larger net worth face difficulties for getting approval of shareholders rather than companies with small net worth. By lower limit of net worth Ministry wants to cover major transactions with medium and higher amounts. Also there is no where written about taking approval of audit committee on contracts already entered into or already executed. Further, in a previous Act there can be approval of Board within three months of entering into a contract but in new Act there is no provision of ‘approval’ but ‘ratification by Board’.
Certain Issues:
- As per Clause 49 prior approval of Audit Committee required but while to follow Act there is a question regarding procedure that whose approval to be taken to priority – i.e. either of Audit Committee or Board of Directors. Also what if Audit committee approves the transactions but Board Of Directors not approve or vice-a-versa. Board can make this decision with its discretion.
- Further no where in any Act or Rules meaning of ‘Ordinary Course of Business’ has defined, so there is a matter of judgement. But in this case its better to follow SA – 550 and AS-18 of Related Parties & any decision to make with available reasons in writing with those charged with governance.
- Further no specific explanation of Arms’ Length has given so it is better to follow provisions of Arms Length transaction as specified in Income Tax Act, 1961. Also to have enough evidences to prove certain transaction having regards to Arms’ Length like Bills/Invoices, Agreement Copy, Quotations documents, all details regarding the party with whom the company is making transactions, contra-confirmations etc.
- Also as per Proviso to Section 188(1), no member of the company shall vote on such special resolution, to approve any contract or arrangement which may be entered into by the company, if such member is a related party while per Rule 15 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. So following both Act and Rule, director should not present in the meeting so there will be no matter arises of voting.
Certain Useful Links:
- Download Companies Act, 2013
- Download Companies (Specification of definitions details) Rules, 2014
- Download Companies (Meetings of Board and its Powers) Rules, 2014
- Download Clause 49 of Listing Agreement
Any kind of feedback regarding my blog to make it better and more useful are always welcomed. Thank You.
Dwarkesh K. Diwan 