All About Related Party Transactions (Section 188)
Written by Anuranjita Pathak Dt. August 30th, 2022
The companies are majorly regulated by The Companies Act, 2013. All the sections of The Companies Act, 2013 are important and serve essential purposes. The sections in the given Act are also to safeguard the interest of all the stakeholders.
It is a common scenario to think of our acquaintances while looking for anything but this scenario can create conflict of interest in an organization. Section 188 is such a section of the Companies Act which helps in avoiding and managing this conflict of interest. To get a better insight of this section and importance, let’s assume that there is a bank named, ABC Ltd. which has its shares listed. The bank’s CEO is Mr P. Mr P lends a loan to his son G without any collateral to invest in his textile business. After a month, G goes bankrupt and could not repay the loan. The bank’s shares in the market touch the lowest point owing to the setback the bank suffered. Here, the CEO and the loan taker had a relation, i.e., father & son, hence they were related parties. The investors would suffer badly because of the given Related Party Transaction. This is just one example and type of related party transaction’s outcome. There are many more which turn out to be big scams and scandals in the real world.
To avoid the above given situation, there is section 188 in The Companies Act, 2013 which is about Related Party Transactions. For understanding the related party transactions, it is important to understand the related parties first. With reference to Section 2(76) of Companies Act, 2013, the following are regarded as Related Parties:
- Director himself or relative of director
- The Key Managerial Personnel (KMP) or any relative of the KMP
- Firm or Private Company in which the director, manager or relative is a partner or member or director
- Any public company in which the director or manager is director and holds more than 2% of paid up share capital even including that of his relatives
- Any entity whose board of directors (BOD), Managing Director is obliged to act as per directors and instructions of KMPs of such company. It is not applicable in the case of directions being followed in professional capacity.
- The person on whose recommendations or directions the director is obliged to act. It is not applicable in the case of directions being followed in professional capacity.
- Subsidiary or Associate, Holding of such company
- Another subsidiary of the holding company
When the related parties have some transactions between them, it can be in general said to be Related Party Transactions. But are all the transactions happening between the related parties construed as Related Party Transactions under section 188? The answer is NO. All the transactions happening between related parties may not be coming under section 188. An exhaustive list of various transactions is provided in section 188. Hence all the transactions happening between related parties may not be the Related Party Transactions mentioned in section 188 and even the related party transactions can take place if they go by the procedures mentioned in the law.
As per rule 6A of Companies (Meeting of Board and its power) Rules, 2014, all the related party transactions require approval of the Audit Committee and the Audit Committee has the power to make omnibus approval for related party transactions proposed to be entered into by the company subjected to the following conditions:
- After obtaining approval Board of Directors (BOD), the Audit Committee shall specify the criteria for making the omnibus approval which shall include the following:
a) Maximum aggregate value of transactions which can be entered in a year
b) Maximum value allowed per transaction
c) Manner and extent of disclosure to be made to the Audit Committee at the time of seeking omnibus approval
d) Review the related party transactions entered, at intervals as the Audit Committee may deem fit
e) Transactions which cannot be subjected to omnibus approval by Audit Committee
- The Audit Committee shall consider the repetitiveness of transaction and justification for the need for omnibus approval
- The Audit Committee shall ensure itself on the need for omnibus approval for transactions of repetitive nature and that such approval is in the interest of the company
- The omnibus approval must have name of the related parties, nature, duration and maximum amount of transaction, the indicative price or current contracted price and formula for price variation if any and any other relevant information. The Audit Committee can make omnibus approval in absence of above conditions if the value of transactions is not exceeding one crore rupees per transaction.
- Omnibus approval shall require fresh approval after period of one financial year
- Omnibus approval shall not be made for transactions in respect of selling or disposing of undertaking of the company
- Any other condition as the Audit Committee may deem fit
The following are the transactions u/s 188 which require prior approval of the board of
directors when conducted between related parties:
- If any good is sold or purchased or supplied, directly or indirectly
- Directly or indirectly selling, buying or disposing of any kind of property
- Any kind of property leased
- Directly or indirectly rendering or availing any service
- Appointment in office at any profitable position in the company including placement in subsidiary or associate company
- Underwriting the subscription of any securities or derivatives thereof, of the company
In the above related party transactions, the transactions are limited to a quantifiable limit. After crossing those specified limits, shareholders’ approval is also required. The limits are as follows:
- If any good is sold or purchased or supplied, directly or indirectly- 10% or more than company’s turnover
- Directly or indirectly selling, buying or disposing of any kind of property- 10% or more than company’s new worth
- Any kind of property leased- 10% or more than company’s turnover
- Directly or indirectly rendering or availing any service- 10% or more than company’s turnover
- Appointment in office at any profitable position in the company including placement in subsidiary or associate company If monthly remuneration exceeds Rs 2,50,000
- 6. Underwriting the subscription of any securities or derivatives thereof, of the company- 1% of company’s net worth
The following are the consequences of non-compliance under section 188:
- When a contract is entered without compliance as per section 188 and it is not ratified by the Board or shareholders as the case may be, within three months from date on which such contract was entered into, such contract shall be voidable at the option of the Board and if the contract is with a related party related to any director or is authorized 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 contraventions 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 employee of the company who had entered into or authorized contract or engagement in violation of the provisions of section 188 shall:
a) Punishable with imprisonment which may extend to 1 year or with fine not less than Rs 25,000, extending up to Rs 5,00,000, in case of listed company
b) In case of any other company, be punishable with fine not less than Rs 25,000 extending up to Rs 5,00,000