Related Party Transactions Under the Companies Act, 2013

Related party transactions under the Companies Act, 2013, must follow applicable approval, disclosure, and compliance requirements. Section 188 regulates specified transactions with related parties, while Sections 184 and 189 address directors’ interests and statutory records. Companies must assess each transaction carefully to manage conflicts of interest and reduce legal and financial risks.

Related party transactions are common in corporate groups and family-owned businesses. They may involve the sale of goods, provision of services, leasing of property, or other commercial arrangements with directors, relatives, or associated entities. Although such transactions are not prohibited in general, companies must ensure that they meet the applicable legal requirements. Businesses seeking guidance from a corporate law firm in Bangalore can benefit from a structured approach to approvals, disclosures, and ongoing compliance.

1. What Is a Related Party Transaction?

A related party transaction (RPT) is a business arrangement between a company and an individual or entity that has a specified relationship with it. Such relationships may arise through ownership, management, family connections, or control.

Under Section 2(76) of the Companies Act, 2013, related parties include specified directors, key managerial personnel (KMP), their relatives, certain firms and companies, and holding, subsidiary or associate companies, subject to the statutory conditions.

Common examples include:

• A company purchasing raw materials from a firm owned by a director.
• A company leasing office space from a director’s relative.
• A business providing services to its holding company.
• A company appointing a related individual to an office or place of profit.

These arrangements can support business operations. However, they require proper scrutiny to ensure that the interests of the company and its shareholders are protected.

2. Key Provisions Governing Related Party Transactions

Several provisions of the Companies Act, 2013, govern related party transactions and their compliance requirements.

Section 188 covers the sale, purchase or supply of goods and materials; buying or selling property; leasing property; availing or rendering services; appointing agents; appointments to offices or places of profit; and underwriting securities or derivatives.

The applicability of these provisions depends on the company’s structure, the nature of the transaction and the relevant statutory conditions. Listed companies must also consider applicable SEBI regulations, including the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015.

3. Approval Requirements for Related Party Transactions

Companies must identify the required approvals before entering into a related party transaction. The approval process depends on the applicable provisions, transaction value and company category.

Board approval under Section 188

For transactions covered by Section 188, the company generally requires the consent of its Board of Directors through a resolution passed at a Board meeting, subject to the statutory exemptions.

The Board should receive sufficient information to assess the commercial purpose and terms of the proposed arrangement. This includes the related party’s identity, the nature of the relationship, transaction value, duration, pricing method and other material conditions.

An interested director must not participate in the discussion where Section 184 and the applicable rules require their abstention.

Shareholder approval

Prior shareholder approval by resolution is required when the applicable thresholds under Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014, are met.

The prescribed thresholds include:

• Goods and materials: 10% or more of the company’s turnover.
• Buying or selling property: 10% or more of the company’s net worth.
• Leasing property: 10% or more of the company’s turnover.
• Services: 10% or more of the company’s turnover.
• Office or place of profit: Monthly remuneration exceeding ₹2.5 lakh.
• Underwriting securities: Remuneration exceeding 1% of the company’s net worth.

The relevant turnover and net worth are generally determined using the audited financial statements of the preceding financial year. Applicable rules must be checked for the precise calculation and any relevant exemptions.

A related-party member is generally restricted from voting on the applicable shareholder resolution, subject to statutory exceptions. Certain transactions between a holding company and its wholly owned subsidiary may qualify for an exemption from the separate shareholder resolution requirement under Section 188, subject to the prescribed conditions.

Audit Committee approval

Companies required to constitute an Audit Committee under Section 177 must comply with its applicable approval requirements for related party transactions. The Audit Committee may also grant omnibus approval for eligible recurring transactions, subject to prescribed conditions.

For listed entities, additional requirements under SEBI regulations may apply, including prior Audit Committee approval and specific shareholder approval rules. Companies should assess these requirements separately rather than relying only on Section 188.

4. Ordinary Course of Business and Arm’s-Length Transactions

Section 188 provides an important exemption for transactions entered into in the ordinary course of business and on an arm’s-length basis.

Both conditions must be satisfied for the exemption to apply. A transaction does not qualify merely because it is common in the company’s industry or has been undertaken previously.

An ordinary course of business transaction is one that falls within the company’s normal business activities. An arm’s-length transaction is conducted as though the parties were unrelated, without a conflict of interest affecting the terms.

For example, a company regularly purchasing goods from a related supplier may need to establish that the purchase is part of its normal operations and that the pricing and other commercial terms are comparable to those available between independent parties.

Companies should retain supporting documents such as quotations, market comparisons, valuation reports and pricing analyses. These records can help demonstrate why the transaction qualifies for the exemption. Other applicable requirements, including Audit Committee obligations and disclosure rules, must still be considered.

5. Disclosure and Documentation Requirements

Proper documentation is essential for demonstrating compliance with the Companies Act, 2013. Companies should maintain accurate records of related party transactions and the approvals obtained.

Key compliance requirements include:

• Director disclosures: Directors must disclose their interests in the manner required under Section 184, including at the prescribed Board meetings and when relevant changes occur.
• Board meeting records: The agenda and supporting papers should contain the prescribed transaction details. The minutes should accurately record the decision and applicable abstentions.
• Statutory registers: Section 189 requires companies to maintain registers of specified contracts and arrangements. Entries must be made and presented for Board review as prescribed.
• Board’s report: Contracts or arrangements covered by Section 188 must be reported to shareholders in the Board’s report, along with the required justification.
• Financial statement disclosures: Applicable accounting standards, including Ind AS 24 where relevant, require disclosures about related party relationships and transactions.
• Regulatory filings: Companies must complete applicable annual returns, financial statement disclosures and other statutory filings. Listed entities must also meet relevant stock exchange disclosure requirements.

The company should ensure that its records are consistent across Board minutes, contracts, statutory registers and financial statements.

6. Consequences of Non-Compliance

Failure to comply with related party transaction requirements can expose a company and its directors or employees to legal and financial consequences.

1. Transaction may become voidable

Under Section 188(3), a transaction entered into without the required approval may become voidable at the option of the Board or shareholders, as applicable, if it is not ratified within three months of being entered into.

2. Financial penalties

Section 188(5) provides for a penalty of ₹25 lakh for a director or employee of a listed company and ₹5 lakh for a director or employee of another company who enters into or authorises a transaction in violation of the section. The precise application depends on the statutory provision and circumstances.

3. Recovery of losses

Under Section 188(4), the company may pursue recovery of losses caused by a non-compliant transaction. Directors concerned may also be required to indemnify the company in the circumstances specified under Section 188(3).

4. Consequences of improper director disclosures

Failure to comply with Section 184 can attract the prescribed penalty. A transaction entered into without the required disclosure or with the participation of an interested director may also become voidable at the company’s option.

5. Governance and reputational risks

Non-compliance may lead to regulatory scrutiny, disputes among shareholders, audit observations and concerns about the company’s internal controls. Listed entities may face additional consequences under applicable SEBI requirements.

Companies should assess the nature of each default before determining the available corrective measures. Ratification, where legally available, should not be treated as a substitute for obtaining prior approval when required.

7. A Practical Compliance Checklist for Companies

Companies can reduce compliance risks by following a structured process before approving a related party transaction.

1. Identify related parties: Review director disclosures, shareholding records, group structures and relevant relationships.
2. Classify the transaction: Determine whether the proposed arrangement falls within Section 188 or another applicable provision.
3. Assess commercial terms: Document the business purpose, pricing method and basis for concluding that the transaction is fair.
4. Determine approval requirements: Check Board, Audit Committee and shareholder approval requirements, including applicable thresholds and exemptions.
5. Complete disclosures: Prepare the required notices, explanatory statements, Board papers and statutory entries.
6. Execute and monitor: Ensure the final contract matches the approved terms and track changes in value, scope or duration.
7. Review reporting obligations: Reconcile transaction records with financial statements, statutory registers and applicable regulatory filings.

For complex group structures or high-value arrangements, companies should seek professional guidance before committing to the transaction. Businesses can explore corporate law services in Bangalore for assistance with transaction structuring, governance and regulatory compliance.

Conclusion

Related party transactions are a regular part of business operations, particularly in corporate groups and family-owned enterprises. However, they require careful attention to approvals, disclosures, documentation and statutory reporting.

Sections 177, 184, 188 and 189 of the Companies Act, 2013, establish important safeguards against conflicts of interest and improper use of company resources. Companies should identify related parties early, evaluate transaction terms objectively and obtain the required approvals before proceeding.

A consistent compliance process helps protect shareholder interests, improve corporate governance and reduce the risk of disputes or penalties. Legal review can also help companies determine which provisions and exemptions apply to a particular transaction.