Related Party Transactions under Company Act – What is allowed and what is not?

Related Party transactions holds special place under the Companies Act 2013, as these transactions needs to be assessed separately in order to check their genuineness. Moreover these transactions require separate disclosure in the financial statements of the companies.

In order to check whether the transaction is allowed under the purview of Company Act, 2013, we first need to oversee who is defined as related party under the definition of Company Act, 2013.

A related party is…?

Lets take the example of Company LMN Ltd with Mr. L, Mr. M and Mr. N as directors and shareholders of the company.

The following are the company’s general related parties:

S.No	Related Parties	Examples
1.	A director or relative of director. A relative can be any of the following: a brother, stepbrother, sister, step-sister, husband, wife, father, stepfather, mother, stepmother, son, stepson, son’s wife, daughter, daughter’s husband, brother, stepbrother, sister, or father’s wife.	The relatives of directors of  Mr. L, Mr. M, and Mr. N are regarded as related parties.
2.	Key Managerial Person of the company or their relatives.	If Mr. O works as CFO, his relatives will be regarded as related parties.
3.	Any business firm where a key managerial person , director, or their family member is a partner	Mr. L works as a partner at another company, RST LLP This firm will be regarded as a related party as well.
4.	Any company key managerial person , director, or their family member is a beneficial member or director.	In this instance, M Pvt. Ltd. becomes a related party as Mr. M is a director of M Pvt Ltd. This company will be regarded as a relative party even if Mr. M’s relative is a director or member of M Pvt Ltd.
5.	A publicly traded corporation where a management or director is a director and owns more than 2% of the company’s paid-up capital with his family	More than 2% of N Ltd.’s paid-up capital is owned by Mr. N and his family. N Ltd shall be regarded as a related party in this instance.
6.	Any corporate entity whose manager, MD, or board of directors is mandated to operate in line with the recommendations, guidance, or instructions of a manager or director (NA in situations where these instructions are followed in a professional capacity)	P Ltd. shall be considered a related party since P Ltd. follows Mr. L’s instructions.
7.	Any individual whose counsel, orders, or directives a management or director must follow (NA if acting in their official role)	Mr. A, the 51% owner of LMN Ltd. will be regarded as a related party as it is on his recommendation that Mr. L act.
8.	Holding, a subsidiary, or a partner of that business	All of these will be regarded as connected parties:   LMN Ltd (Holding Company) is owned 51% by ABC Ltd.   LMN Ltd owns a 51 percent stake in XYZ Ltd, a subsidiary company.   DEF Ltd owns thirty percent of LMN Ltd (Associate Company).
9.	Any business that both operates as a subsidiary and is a holding company	ABC Ltd. has two subsidiaries: PQR and LMN. PQR thus becomes a related party.

Meaning of Related Party Transactions

In India, related party transactions are covered by Section 188 of the Companies Act 2013. It lays out the rules and legal foundation for carrying out these kinds of transactions in businesses that are registered under Indian law.

Any related party transaction must first have the board’s approval. An ordinary resolution by the shareholders is also required if the transaction amounts is over the prescribed criteria shown below. The transaction’s specifics, including its terms, value, and any other pertinent information, must be revealed in the company’s financial statements.

S.No.	Transactions subject to the Companies Act that need board approval	Limits of Transactions exceeding which approval from the shareholders is required
1.	selling, buying, or supplying any materials or goods, either directly or through an agent’s appointment	equivalent to at least 10% of the company’s turnover
2.	selling, giving away, or purchasing any form of property, either directly or by using an agent	representing at least 10% of the company’s net worth
3.	leasing of any form of property	equivalent to at least 10% of the company’s turnover
4.	receiving or providing any services, either directly or through an agent’s appointment	equivalent to at least 10% of the company’s turnover
5.	is for payment for underwriting the subscription of any company securities or derivatives.	more than 1% of the total net worth
6.	Such related party’s appointment  to any office or place of profit in the Company, its subsidiary or associate  Company	At a monthly remuneration exceeding Rs 250000/-

Important points to remember:

• The audited financial statement of the previous financial year will serve as the foundation for calculating the turnover, or net worth, mentioned above.

• The board’s or the company’s approval is not necessary if the transaction is carried out in the regular course of business and at arm’s length.

• If the transaction is between the holding company and its wholly owned subsidiary, a resolution need not be passed.

• If a member is connected, they are not permitted to vote on the resolution. But this clause won’t apply if ninety percent of the members show interest.

• Every contract that is entered into will have a mention in the board’s report, along with a rationale for it.

Related parties and related party transactions are regulated by SEBI.

Certain regulatory criteria for related party transactions are also stated in SEBI Clause 49. A related party transaction is defined as one in which resources, services, or obligations are transferred.

Its purview is more expansive than that of the 2013 Companies Act. It includes a private corporation where directors or key managerial staff, along with their relatives, have control or a considerable amount of influence, as well as members of their immediate families.

All related parties are prohibited from voting on special resolutions approving related party transactions unless they are deemed relevant by the shareholders.

A Checklist for Businesses Engaging in Related Party Transactions Where Shareholder Approval Is Needed First

• Calling a board meeting to approve a resolution authorising the notice of an extraordinary general meeting and to obtain prior board approval for transactions involving related parties. With the caveat that the Board of Directors’ consent cannot be acquired in any other way (as specified in Section 175 of the Act) or by passing a circular resolution. The Companies (Meetings of Board and its Powers) Rules, 2014, Rule 15, stipulate that the Board of Directors must be provided with the necessary disclosures in the agenda of the meeting where the proposed resolution will be discussed. When the resolution pertaining to a contract or arrangement is being discussed at the meeting, the director who has an interest in the contract or arrangement is not permitted to attend.

• Calling of EGM: If the company is entering into a contract or arrangement with a related party and the transaction(s) exceed the prescribed limits [i.e., as prescribed in Rule 15(3) of the Companies (Meetings of Board and its Powers) Rules, 2014], the shareholders’ prior approval by ordinary resolution shall be required.

• Submission of e-form MGT-14: Within 30 days after the date on which the corresponding resolutions were passed, the Board of Directors and the shareholders’ consent to the related party transactions must be submitted in e-form MGT-14 to the ROC.

Consequences of noncompliant behavior:

• Within three months, either the Board or the shareholders may approve the deal. The Board may choose to void the contract if the same is not completed. Transactions may become null and void if the Companies Act’s conditions are not met.

• Any director who approves the contract is required to reimburse the firm for any damages.

• The business may take legal action against the director or the worker to recoup any losses incurred as a result of RPTs.

• A fine of five lakh rupees will be imposed on any director or other company employee who entered into or approved a contract or agreement that violated the terms of this section in the case of a private firm.

Disclosure Requirement

Every contract or arrangement entered into under section 188(1) shall be referred to in the Board’s report in Form AOC-2 to the shareholders along with the justification for entering into such contract or arrangement. [Section 188(2), Section 134(3)(h) read with Rule 8 of Companies (Accounts) Rules, 2014] Section 189(1) of the Act read with rule 16 of the Companies (Meetings of Board and its Powers) Rules, 2014 provides that:

Every company shall maintain one or more registers in Form MBP-4 and enter therein particulars of all contracts or arrangements to which section 184(2) or 188 applies and after entering the particulars, such register or registers shall be placed before the next meeting of the Board and need to be signed by all the directors present at the meeting.

Final Thought

Companies must comprehend related-party transactions in order to maintain transparency and avoid conflicts of interest. Maintaining excellent corporate governance is facilitated by adhering to the Companies Act, 2013, and the IND AS 24 principles for related party transactions. Companies are able to appropriately report these transactions in their financial accounts by supplying the needed data and gaining the required approvals.