An Analysis on the “Law related to Related Party Transactions” UNDER Section 188 of the Companies Act, 2013 BY CS YASH PAREEK (www.csyashpareek.in)

 

||Om Shri Ganeshay Namah||

 

 

An Analysis

on the

“Law related to Related Party Transactions”

 

 

Prepared by

 

TEAM YPA

CS Yash Pareek (ICSI Silver Medalist)

Valuable inputs by CS Neha Jain & CS Gajab Maheshwari (Practicing Company Secretaries)

WWW.CSYASHPAREEK.IN

 

YASH PAREEK & ASSOCIATES

Company Secretaries

BHOPAL | INDORE | NAGPUR | AHMEDABAD

 

Reach us at:

Address: T-3, 3rd Floor, 207, M.P Nagar, Zone-II, Bhopal-462011, M.P

Mobile No: 9111575222

Email id: pcsyashpareek@gmail.com

Website: www.csyashpareek.in

                                                                   

                                                                 An Analysis

on the

“Law related to Related Party Transactions”

 

1.      Statutory Sections and Rules of the Law:

 

·        Section 2 (76) of the Companies Act, 2013 (‘The Act’).

 

·        Section 188 of the Companies Act, 2013 (Effective from April 01, 2014).

 

·        Rule 6A & Rule 15 of Companies (Meetings of Board and its Powers) Rules, 2014 (Effective from April 01, 2014).

 

·        Secretarial Standards issued by the Institute of Company Secretaries of India.

 

·        Accounting standards 18 (AS-18) Related Party Disclosures issued by Institute of Chartered Accountants of India.

 

·        Companies (Specification of definitions details) Amendment Rule, 2014 Dated 17th July, 2014.

 

 

 

2.      Definitions:

 

2.1     Related Party:

 

2.1.1        Related Party under the Companies Act, 2013:

 

Pursuant to section 2 (76) of the Act, "related party", with reference to a company, means

·        Director or KMP or relative thereof

 

·        Director (excl. IDs) or KMPs of the holding co. or his relative

 

·        Firm, in which a director, manager or his relative is a partner

 

·        Holding Company

 

·        Subsidiary Co. (including sister subsidiary)

 

·        Associate Company

 

·        Investor Company

 

·        Venturer Company

 

·        Private co. in which a director or manager or his relative is a member or director

 

·        Public co. in which a director or manager is a director AND holds along with his relatives, more than 2% of its paid-up share capital

 

·        any body corporate whose BoD, MD 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

 

‘Explanation.—For the purpose of this clause, “the investing company or the venturer of a company” means a body corporate whose investment in the company would result in the company becoming an associate company of the body corporate.’

 

 

               2.1.2.     Related party as per Accounting Standard 18 (AS-18)

As per Accounting Standard 18-’Related Party Disclosures’ issued by the ICAI,

·        Related party means “Parties are considered to be related if at any time during the reporting period one party has the ability to control the other party or exercise significant influence over the other party in making financial and/or operating decisions”

 

·        Related Party transaction means “a transfer of resources or obligations between related parties, regardless of whether or not a price is charged”

 

 

 

 

2.2     Relative:

 

Pursuant to Section 2(77) of the Act,

 

A person shall be deemed to be the relative of another, if he or she is related to another in the following manner, namely:-

 

·        Father: Provided that the term “Father” includes step-father.

 

·        Mother: Provided that the term “Mother” includes the step-mother.

 

·         Son: Provided that the term “Son” includes the step-son.

 

·        Son’s wife.

 

·        Daughter.

 

·        Daughter’s husband.

 

·        Brother: Provided that the term “Brother” includes the step-brother;

 

·        Sister: Provided that the term “Sister” includes the step-sister.

 

 

2.3     Office or Place of Profit

 

Pursuant to explanations to Section 188 (1) of the Act,

 

Office or Place of Profit means any office or place—

 

·        if the director 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;

 

·        if any individual other than a director or 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;

 

 

 

3.      Restriction under Section 188 of the Companies Act, 2013:

 

Section 188 (1) of the Act provides some restrictions prior to entering into related party transactions which are stated as under:

 

·        Section 188 of the Companies Act 2013 provides that 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 transactions mentioned under Section 188 of the Companies Act, 2013.

 

·        Section 188 is applicable to both Private and Public Companies.

 

 

4.      Transactions covered under Section 188 of the Act:

 

Section 188 of the Act requires the consent of the board at the meeting of the board subject to conditions as specified in Rule 15 of Companies (Meetings of Board and its Powers) Rules, 2014 for entering into following transactions with a related party with respect to-

 

·        Sale, purchase or supply of any goods or materials

 

·        Selling or otherwise disposing of, or buying, property of any kind

 

·        Leasing of property of any kind

 

·        Such RP's appointment to any office or place of profit in the company, its subsidiary company or associate company

 

·        Underwriting the subscription of any securities or derivatives thereof, of the company

 

·        Appointment of any agent for purchase or sale of goods, materials, services or property

 

·        Availing or rendering of any services

Note-“goods” means every kind of movable property other than actionable claims and money; and includes stock and shares, growing crops, grass, and things attached to or forming part of the land which are agreed to be severed before sale or under the contract of sale. (Sec 2 (7) of the Sale of Goods Act,1930).

 

5.      Stages of Approval

 

Section 188 of the Act and Rule 15 of Companies (Meetings of Board and its Powers) Rules, 2014 requires various approvals and recommendations for entering into related party transactions which are subject to various conditions, threshold and substance of transactions.

 

The various approvals determined under the Act have been expressed as follows:

 

·        Audit Committee Approval

 

·        Board of Directors Approval

 

·        Shareholders Approval

 

Stage of Approval	Particulars and Relevant Pointers
Audit Committee Approval	All transactions with related parties though not covered by Section 188, shall require approval of Audit Committee in terms of Section 177.   1.      Contract in Ordinary Course of business and on Arm’s Length Basis   ·        Need not be prior approval. However, prior omnibus approval may be granted.   ·        In case the company does not have any Audit Committee, this provision will not apply.   ·        None of the provisions u/s 188 will apply to such transactions. However, approval by Audit Committee, if any would still be applicable.       ·        Further, all RPTs entered in to by a company along with any modifications to the same will require approval of the Audit Committee of the company, if any.       2.      Contracts not in the ordinary course of business   ·        May be approved by Audit Committee and will be recommended to Board for approval.     3.      Contracts in Ordinary Course of business not on Arm’s Length basis   ·        Audit Committee cannot approve   ·        Accordingly, any transaction which takes place in the ordinary course of business, but is not on an arms’ length basis will be covered under the provisions of Section 188 (1) of the Act, 2013.   ·        Considering provisions under Sec 166 (duties of directors), Board to take necessary action subject to the approval of the shareholders
Board of Directors Approval	Most transactions that a company may have with “related parties” require approval of Board   Every company needs to seek the approval of its board of directors for entering into a related party transaction mentioned under Section 188, irrespective of the capital of the company or the value of transaction.   1.      Once approved by the Audit Committee, if any, the Board of Directors of the Company will need to pass the resolution at a meeting of the Board.   2.      Such resolutions cannot be passed by a resolution by circulation.   3.      The third proviso to Section 188 (1) of the Act, 2013 provides that the company will not require the approval of the Board and / or shareholders provided the transactions are entered into by the company with the related party   IN THE ORDINARY COURSE OF BUSINESS;   AND          SUCH TRANSACTIONS ARE ON AN ARMS’ LENGTH BASIS   4.      Agenda of Board Meeting (Rule 15(1)):   ·        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 including the value   ·        Any advance paid or received for the contract   ·        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;   ·        Any other information relevant or important for the  Board to take a decision on proposed transaction
Approval of Shareholders	a.      The RPT will additionally need to be passed by the shareholders of the company.   b.      Members who are also related party to the particular contract cannot vote to approve such resolutions.   c.      This is not required for transactions between holding company and wholly owned subsidiary companies whose accounts are consolidated with such holding company and placed before the shareholders at the general meeting for approval. Hence, approval of Board and Audit Committee shall still be required     In case of wholly owned subsidiary, the resolution passed by the holding company shall be sufficient for the purpose of entering into the transaction between the wholly owned subsidiary and the holding company.   However, no exemption has been given to holding subsidiary transactions which are not on an arms’ length basis.   d.      Prior approval of shareholders is required by way of an Ordinary Resolution* , if Value exceeds the limits under Rule 15 of MBP Rules, 2014 and the transaction is not in ordinary course of business and not at arm's length.   The word special resolution was substituted by ordinary resolution by Companies (Amendment) Act, 2015 and is effective from 29th May, 2015.   e.      Explanatory Statement of GM  (Expln 3 to Rule 15(3)):     ·        Name of the related party   ·        Name of the Director/KMP who is related   ·        Nature of relationship   ·        Nature, material terms, monetary value and  particulars of contract   ·        Any other information relevant or important  for members to take a decision
If approval of Board or prior approval of S/H not obtained	1.      Needs to be ratified within 3 months from date   Otherwise The RPT shall become voidable at the instance of the Board or, as the case may be, of the shareholders; and   If the same is with any director, or is authorized by any other director, the director(s) concerned shall be required to indemnify the company against any loss incurred by it.   2.      The company has power to initiate any proceeding against director or employee who has entered in to such contract or arrangement.   3.      In terms of section 164, he shall be disqualified for appointment as a director of any other company for 5 years.

 

For unforeseen transaction-

·        Value shall not exceed 1 crore per transaction.

 

·        Validity of omnibus approval is one financial year and Shall require fresh approval after the expiry of such financial year.

 

·        No omnibus approval for transactions in respect of selling or disposing of the undertaking of the company.

 

·        Criteria for omnibus approval is Prescribed in Rule 6A of MBP Rules.

 

 

6.      Material Related Party Transactions:

 

Without Prior approval of shareholders by an Ordinary Resolution, a company cannot transact with related parties where the transaction or transactions to be entered in to are for:

 

Type of transaction	Maximum limit
Sale, Purchase or Supply of any Goods or Materials directly or through appointment of agents	10% of the annual turnover*
Selling or other wise disposing of, or buying , property of any kind directly or through appointment of agents	10% of net worth*
Leasing of property of any kind	10% or more of the turnover*
Availing or rendering of any services directly or through appointment of agents	10% or more of the turnover*
Appointment to any place of profit in the company, its subsidiary or associate company at a monthly remuneration	Rs.2.5 lakhs
Remuneration for underwriting the subscription of any securities or derivatives there of the company	1% of the net worth

 

*The turnover or net worth shall be on the basis of the Audited Financial Statement of the preceding financial year.

 

 

7.      Non-participation of Interested Director in Board meeting:

 

Directors are required to observe compliance u/s 184 (2) with regard to disclosure of interest and non-participation in a particular discussion.

 

Private company directors may participate subject to disclosure.

 

 

8.      Non-Participation of Interested Member in General Meeting:

 

·        In the general meeting the member who is are related party shall not vote to approve the transaction.

 

·        Post Companies (Amendment) Act, 2017, this seems to be redundant as exemption has been provided to companies in which 90% or more members, in number, are relatives of promoters or are related parties. (Inserted by The Companies (Amendment) Act, 2017 effective from 9th February, 2018).

 

·        In case of private company - Second proviso to Sub-section (1) of Section 188 shall not apply - Notification dated 5th june, 2015.

 

 

 

9.      Exemption from Board or Members Approval:

 

·        Any transaction entered into ordinary course of business AND transactions on ‘arm’s length basis’ shall not require any approval of Board or of members of the company.

However the same shall still require the approval of Audit Committee;

 

“Arm’s length transaction would mean a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest.”

 

·        Exemption to Government Companies from the Shareholders Resolution. (Notification dated 02nd March, 2020):

In case of Government company - First and second proviso to Sub- section (1) of Section 188  shall not apply to:-

 

(a)          a Government company in respect of contracts or arrangements entered into by it with any other Government company, or with Central Government or any State Government or any combination thereof;

 

(b)          a Government company, other than a listed company, in respect of contracts or arrangements other than those referred to in clause (a), in case such company obtains approval of the Ministry or Department of the Central Government which is administratively in charge of the company, or, as the case may be, the State Government before entering into such contract or arrangement.

 

·        Transaction arising out of compromise, arrangements and amalgamations dealt with under specific provisions of Companies Act, 1956/2013 will not attract requirement of Section 188 of the Companies Act, 2013.

 

 

10.   Disclosure in Annual Report

 

Pursuant to Section 188 (2) of the Act,

 

·        Details of every contract entered into shall find its reference in the Board’s report along with justification about the same.

 

·        Board’s Report to include Particulars of Contracts or Arrangements with Related Parties referred to in Sec 188(1) in AOC-2.

 

 

 

11.   RPTS UNDER AS 18

 

Considered related if at any time during the reporting period if one party has the ability to control the other party or exercise significant influence over the other party in making financial and/or operating decisions enterprises that directly, or indirectly through one or more intermediaries, control, or are controlled by, or are under common control with, the reporting enterprise including holding companies, subsidiaries and fellow subsidiaries, associates and JVs investing party or venture individuals owning, directly or indirectly, an interest in the voting power that gives the control or significant influence over the enterprise, and relatives of any such individual KMP and relatives; and Enterprises over which any related person as  Mentioned above is able to exercise significant influence- Includes enterprises owned by directors or major shareholders and Enterprises that have a member of key management in common with the reporting enterprise

 

 

12.   Secretarial Standards

 

12.1 Secretarial Standard - 1

 

·        Director shall not be reckoned for quorum in respect of an item in which he is interested and shall not be present during discussions and voting on such item.

 

·        In case of all the directors are interested, then matter to be decided at general meeting.

 

 

12.2Secretarial Standards -2

 

·        Related party not entitled to vote in a resolution in which he is a related party. However, shall be counted for the purpose of quorum.

 

·        In case of a private company, a member who is a related party is entitled to vote on such Resolution.

 

·        In case of public companies chairman is- not entitled to propose a resolution in which he is interested and not entitled to conduct proceeding of the meeting.

 

Required to entrust the conduct of the proceeding of the meeting to un-interested director or to other member and resume only after the matter is transacted.

 

·        This restriction is applicable only if the interest w.r.t only a particular transaction.

 

13     Contravention of Section 188 of the Act

 

Substituted by the Companies (Amendment) Act, 2020, Effective from 21st December 2020:

 

Punishment for violation of provisions of the section 188:

 

13.1 Listed Company

 

Liable to a penalty of twenty-five lakh rupees

 

 

13.2 Any other company

 

Liable to a penalty of five lakh rupees]

 

·        Penalty on any director or employee who enters in to or authorizes the contract in contravention of provisions of the section.

·        Punishment levied even if no loss has been incurred by Company from such RPT.

 

Conclusion:

Section 188 has to be complied by corporate in true letter and spirit. Also Auditors needs to check the compliance of Section 188 while issuing CARO 2020 report to enable the stakeholders to ascertain the intention of management in utilization the funds of the company in such a manner which is not prejudicial to the interest of the company and its stakeholders.

Happy reading.

 

Regards,

CS Yash Pareek   [ICSI Silver Medalist]

Company Secretary  I     Yash Pareek & Associates {www.csyashpareek.in/Professional}

Entrepreneur             I     Manomay Innovations Private Limited {www.manomay.co.in}

Social Worker            I     Rukmani Devi Pareek Charitable Foundation {www.csyashpareek.in/socialwork}

Contact No.:  9111575222       Website: www.csyashpareek.in

Office at T-3/207, Zone-II, M.P Nagar, Bhopal-462011, M.P

 Google         https://goo.gl/maps/iXKVRo6A5FUQzcj5A               

Just Dial    https://www.jdmart.com/GOJ-JUP1652612757?skip

You tube       https://www.youtube.com/channel/UCg5VPXertW0YWoM-sJcQKXA                

 Linked In https://www.linkedin.com/in/cs-yash-pareek-822978114/

Twitter       https://twitter.com/CSYashPareek1                 

Facebook    https://www.facebook.com/csyashpareek

Read and review our blogs on konnectwithyash.blogspot.com

 

Disclaimer: The entire contents of this document have been prepared based on relevant provisions and as per the information existing at the time of the preparation. Although care has been taken to ensure the accuracy, completeness, and reliability of the information provided, I, CS Yash Pareek assume no responsibility, therefore. Users of this information are expected to refer to the relevant existing provisions of applicable Laws. The user of the information agrees that the information is not professional advice and is subject to change without notice. I assume no responsibility for the consequences of the use of such information.