Related Party Transaction- Section 188 of Companies Act, 2013
APPLICABILITY OF THE SECTION
Section 188 is applicable to both private as well as public companies and is applicable with effect from 01.04.2014
Before studying Section 188( Related Party Transaction) we must know Section 2(76) (Definition Related party)
Section 2(76), read with rule 3 of Companies (Specification of definitions details) Rules, 2014, defines a related party as under
“Related party”, with reference to a company, means—
(i) a director or his relative;
a key managerial personnel or his relative;
a firm, in which a director, manager or his relative is a partner;
a private company in which a director or manager is a member or director;
a public company in which a director or manager is a director or holds along with his relatives, more than 2% of its paid-up share capital;
anybody 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;
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 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;
(viii) a director or key managerial personnel of the holding company or his relative
(ix)such other person as may be prescribed
EXEMPTION TO PRIVATE COMPANY: SUB- CLAUSE(VIII) OF CLAUSE 76 OF THE SECTION 2 SHALL NOT APPLY WITH RESPECT TO SECTION 188 DEALING WITH THE RELATED PARTY TRANSACTIONS.
Companies (Specification of definition details) Rules, 2014
For the purpose of clause (ix) a dIrector (other than the independent director) or KMP of the holding company or his relatives with reference to company, shall deemed to be related party.
Company (Removal of difficulties) Order,2014
Amendment in sub clause (v) : A public company in which a director or manger is a director or manager is a director AND holds along with his relatives, more than two percent of its paid up share capital shall be related party.
Amendment in sub clause (iv) : In clause (iv) after the word ‘manager’ the word ‘or his relative ‘ shall be inserted.
Definition of Relative as per section 2 (77)
“relative” with reference to any person, means anyone who is related to another, if-
(i) they are members of a Hindu Undivided Family;
(ii) they are husband or wife ; or
(iii) one person is related to the other in such manner as may be prescribed;
Company shall enter any contract or arrangement with Related Party which are as mentioned below:-
1- Sale, purchases or supply of any goods or materials.
2- Selling or otherwise disposing of , or buying, property of any kind,
3- Leasing of property of any kind
4- Availing or rendering of any services
5- Appointment of any agent for purchases or sale of goods, materials, services or property.
6- Such related party’s appointment to any office or place of profit in the company its subsidiary company or associate company and
7- Underwriting the subscription of any securities or derivatives thereof, of the company
Approval of Board of Directors
- Every company needs to seek the approval of its Board of Directors for entering into any related party transaction, as listed above, irrespective of the capital of the company or the value of the transaction.
- Approval of the Board has to be sought at a duly convened meeting of the Board and same cannot be obtained by passing of a resolution by circulation.
- Where any director is interested in any contract or arrangement with a related party, such director shall participate in the Board Meeting in which the contract or arrangement is discussed. As per Rule 15 of the Companies (Meeting of Board and its powers) Rules, 2014, 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.
Prior approval of Members by means of special resolution
- In the following circumstances, in addition to approval of Board of Directors, prior approval of members by means of a special resolution must also be sought before entering into any related party transaction:
All related party transactions in case of a company having a paid-up share capital of Rs. 10 Crores or more,
Sale, purchase or supply of any goods or materials directly or through appointment of agents exceeding 25% of the annual turnover 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 agents exceeding 10% of net worth as mentioned in clause (b) and clause (e) respectively of sub-section (1) of section 188
Leasing of property of any kind exceeding 10% of the net worth or exceeding 10% of turnover as mentioned in clause (c) of sub-section (1) of section 188
Availing or rendering of any services directly or through appointment of agents exceeding 10% of the net worth as mentioned in clause (d) and clause (e) of sub-section (1) of section 188
Appointment to any office or place of profit in the company, its subsidiary company or associate company at a monthly remuneration exceeding Rs. 2.5 Lakhs as mentioned in clause (f) of sub-section (1) of section 188
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.
- The Turnover or Net Worth shall be on the basis of the Audited Financial Statement of the preceding financial year.
- 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.
- 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
Non Applicability of Section 188 (1) of the Companies Act, 2013
When any transaction has been made on the basis of Arm Length basis, this sub section shall not apply for any transaction related to ordinary course of business.
Personal onion:- it means if any company transacts any transaction which is covered under sub section 188 (1) of the Act, but the company transacts its business by way of Arm Length basis, in that case the requirement of this section shall not apply.
What is meaning of Arm Length transactions?
According to the Companies Act, 2013, any transactions, which are entered between related parties, shall like as contract made with unrelated. In that type of situation if transactions shall be happened with unrelated parties, it should not be interest there.
The ultimate scope of this section is “interest”, if any interest is there by anyway the Section shall be effective, if there is no interest is there, the section shall be in neutral.
Hence, the simple meaning of Arm Length Transaction is that where there is any transaction which is entering with party, the entering like un-related party and other there is no need to put any interest by any party in such contract by any way.
In short, there is no interest in any contract; such contract automatics cover the meaning of Arm Length Transactions.
Disclosure Requirement (Section 188 (2))
It is mandatory to disclose every contract with proper justification of therein in the Directors Report.
Voidable Contract (Section 188 (3))
According to the aforesaid sub section (1), any contact or arrangement must be passed through Board Meeting or Shareholders Meeting, as case may be,
Suppose, the Contact has been made but the approval has not taken either in the Board Meeting or Shareholders Meeting within 3 months from the date of Contract, In that case the Contract shall be voidable at the option of the Board.
In case of Loss in result of Contract (Section 188(4))
Where any contract has been entered, and any loss has been occurred due to such contract, the company has power to initiate any proceeding against director or employee who has entered into such contract or arrangement.
Disclosures to be made in notice of Board Meeting
The agenda of the Board meeting at which the resolution is proposed to be moved shall disclose:
name of the related party and nature of relationship;
nature, duration of the contract and particulars of the contract or arrangement;
material terms of the contract or arrangement including the value, if any;
any advance paid or received for the contract or arrangement, if any; and
the manner of determining the pricing and other commercial terms, both included as part of contract and not considered as part of the contract;
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
any other information relevant or important for the Board to take a decision on the proposed transaction.
Disclosure by interested directors
Every director of a company who is in any way, whether directly or indirectly, concerned or interested in a contract or arrangement or proposed contract or arrangement entered into or to be entered into
with a body corporate in which such director or such director in association with any other director, holds more than 2% shareholding of that body corporate, or
with a body corporate in which such director is a promoter, manager, Chief Executive Officer of that body corporate; or
with a firm or other entity in which, such director is a partner, owner or member, as the case may be
shall disclose the nature of his concern or interest at the meeting of the Board in which the contract or arrangement is discussed.
Where any director who is not so concerned or interested at the time of entering into such contract or arrangement, he shall, if he becomes concerned or interested after the contract or arrangement is entered into, disclose his concern or interest forthwith when he becomes concerned or interested or at the first meeting of the Board held after he becomes so concerned or interested.
Disclosures to be made in the explanatory statement to be annexed to notice of general meeting:
name of the related party ;
name of the director or key managerial personnel who is related, if any;
nature of relationship;
nature, material terms, monetary value and particulars of the contract or arrangement;
any other information relevant or important for the members to take a decision on the proposed resolution.
Disclosures to be made in Board’s Report:
Every related party transaction or contract shall be disclosed in the Board’s report along with the justification for entering into such contract or arrangement.
Disclosures to be made in Register of contracts or arrangements in which directors are interested
Every company shall maintain one or more registers in Form MBP 4, and shall enter therein the particulars of contracts or arrangements with a related party with respect to transactions to which section 188 applies.
Consequences of non-compliance
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, as the case may be, 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 authorised by any other director, the directors concerned shall indemnify the company against any loss incurred by it.
Additionally, the company can also proceed against a director or 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.
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 –
(i) in case of listed company, be punishable with imprisonment for a term which may extend to 1 year or with fine which shall not be less than Rs. 25,000/- but which may extend to Rs. 5,00,000/-, or with both; and
(ii) in case of any other company, be punishable with fine which shall not be less than Rs. 25,000/- but which may extend to Rs. 5,00,000/-