Synopsis of Compliance for Related Party Transactions

Any contract or arrangement entered into with a related party is deemed to be a related party transaction under the Companies Act, 2013. The Ministry of Corporate Affairs and SEBI allows related party transactions to enter into the ordinary course of business at a price applicable to other parties. But first of all who is a related party? So let us discuss it and the compliance for related party transactions.

Meaning of related party

To determine whether an individual or legal entity falls within the scope of a related party or not, we need to know all the terms of a related party include.

The term related party is defined in Section 2(76) of the Companies Act, 2013, and under the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015. Under Section 2(76) of the Companies Act, regarding any company, the related party is:

• Director or his relative;
• A key executive or his relative;
• Firm in which a director, relative, or manager is a partner;
• Private Limited company: In which the director or manager or his relative is a member or director
• A limited liability company in which a director or manager:
  • He is the director or
  • Together with his relatives, he holds more than 2% of the company’s paid-up share capital.

• Any company whose board, executive, or manager is accustomed to actingunder the advice, directions, or instructions (other than those given in a professional capacity) of the director or manager;
• Any person on whose advice, directions, or instructions (other than those given in a professional capacity) a director or manager is accustomed to act.
• A holding company, subsidiary, or affiliate; or
• Another subsidiary of the holding company. For example, a limited is the holding company of B Limited and C Limited. In that case, both B Limited and C Limited are considered related parties.
• Any company that has invested in the company, i.e. an investment company or a venture capital company.
• A related person is a prescribed person, i.e. a director other than an independent director or key executives of the holding company or his relative about the company.

Furthermore, according to Section 2(1) (ZB) of the SEBI Act, in addition to the above-mentioned persons, the following persons are also considered to be related persons:

• All members of the founding and founding group of the company regardless of their shareholding with effect from 1 April 2022.
• Persons or entities holding 20% ​​(10% from 1 April 2023) or more of the shares, either directly or by a beneficial interest in the company, at any time during the immediately preceding financial year.

“Relative” means anyone related to another if—

• They are members of the Hindu Undivided Family;
• They are husband and wife; or
• One person is related to another as a father to a stepfather, mother to a stepmother, brother including stepbrother, sister including stepsister, son including a stepson, son’s wife, daughter, and daughter’s husband.

Applicability of Section 188 of the Act

The checklist for identifying the applicability of Section 188 of the Act is enlisted below:

• Transactions with the company-the company must be a party to said transactions. The Company may either provide or use the necessary services or may sell or purchase or supply any goods or materials.
• Identification of prescribed transaction-the company must enter into a prescribed transaction [as defined in sub-section (1) of section 188 of the Act] which includes:
  • the purchase, sale, or supply of any goods;
  • the sale or other disposition of or purchase of property of any kind;
  • rental of property of any kind;
  • using or providing any services;
  • appointing any agent for the sale and purchase of materials, goods, services, or property;
  • the appointment of the such related party to any office or place of profit in the Company, it is Subsidiary or Affiliate; and
  • approve any derivatives or securities thereof of the Company.
• Identification of a prescribed “related person”- It is necessary for the company to enter into a prescribed transaction with a “connected person” [as referred to in section 2(76) of the Act]. Some of the related parties are a director, a relative of a director, key management personnel, a relative of a key management personnel, a firm in which the director or a relative of the director is a partner, a private company, or a public company in which the director or manager has an interest [as prescribed in Sec. 2(76) of the Act], subsidiary, holding company, associated company, investment company, co-owner company (as defined).

If all three conditions are met, it is necessary to proceed with approval, fulfillment, and communication under the provisions of Section 188 of the Act.

Checklist for Identified related party transactions

The checklist is as follows:

• Approval of Audit Committee (under Section 177 of the Act)– The Audit Committee shall approve related party transactions or approve any modification of related party transactions. The Audit Committee may also give summary approval to certain related party transactions. The Committee will consider two factors in specifying the criteria for approval of the summary, namely
  • the repetition of transactions (partial or future); and
  • a justification for the need for summary approval. Such summary approval for related party transactions shall be obtained on an annual basis [Rule 6-A of the Companies (Board Meetings and Powers Rules, 2014)].

  Such summary approval shall be valid for a period not exceeding 1 financial year and after the expiry of the financial year requires new approval Summary approval is not granted for transactions involving the sale or disposal of a company’s business.

• Consent of the Board of Directors (as per Section 188 of the Act) –The Board of Directors gives its consent to related party transactions only at its meeting. Such meetings may be held in person or by video conference or other audio-visual means as may be prescribed. Such approval of the board of directors cannot be obtained by adopting a circular resolution or in any other way (as prescribed by Section 175 of the Act). Rule 15 of the Company (Meetings of the Board and its Powers) Regulations 2014 sets out the required information to the Board in the agenda of the meeting at which the resolution is proposed to be moved. A director having an interest in any contract or arrangement shall not be present at the meeting for the consideration of this subject resolution relating to such contract or arrangement.
• Shareholders’ approval (as per Section 188 of the Act) – Prior approval of the shareholders by proper resolution is required if the company enters into a contract or arrangement with a related party if the transaction exceeds the prescribed limits [i.e. as prescribed in rule 15(3) of the Companies (Meetings of the Board and its Powers) Rules, 2014]. The said rule has a prescribed monetary limit for each type of prescribed transaction. The stated limits apply to transactions to be concluded either individually or together with previous transactions during the financial year. The said rule stipulates that the disclosure in the explanatory report must be attached to the notice of the general meeting. Below are some important points regarding shareholder approval:
  • A member of a company shall not vote on an ordinary resolution approving a related party transaction if such member is a related party (this provision does not apply to the private companies. MCA notification dated 06/05/2015).
  • Shareholder’s consent shall not apply where 90% or more members (by number) are relatives or related persons of the promoters (applicable to the private companies and public companies, both).
  • In the case of a wholly-owned subsidiary, an ordinary resolution passed by the holding company shall be sufficient for concluding transactions between the wholly-owned subsidiary and the holding company, provided that the financial statements of the subsidiary are consolidated with the holding company and submitted to the shareholders at the general meeting for approval.
  • Certain exemptions apply to Government Companies (MCA Notification dated 05.06.2015).

The exception to the provisions of Section 188 of the Act

The consent of the board of directors and the prior consent of the shareholders is not required if such a transaction with a related party is part of its normal activity and under usual conditions. The Act did not define “ordinary business”. To this end, the board must exercise its judgment. However, the law defined arm’s length transactions. It is a transaction between two related parties that is conducted as if they were unrelated to avoid a conflict of interest. There is no exception to obtaining audit committee approval.

Disclosure in Board Report

Every contract or arrangement entered into by the company shall be referred to in the Board’s report to the shareholders together with the justification for entering into such contract or arrangement [Section 188(2) of the Act]. According to Section 134 (3) of the Act, the report of the board of directors contains the details of contracts or arrangements with connected persons in the prescribed form (form AOC-2).

Register of contracts or arrangements in which the executives are interested

According to Section 189 of the Act, the Company maintains a register (form MBP-4) for transactions with related parties. After entering the data in the register, this register will be placed before the next board meeting and signed by all directors present at the meeting. Entries in the register are made at once, whenever there is a reason for entry, in chronological order and must be verified by the company secretary or another person authorized by the board of directors. The register will be kept permanently and will be kept in the custody of the company secretary or another person authorized to do so by the board of directors.

Checkpoints to be focused on

Section 188(3) of the Act governs the ratification of a transaction with a related party entered into by a director or other employee without the approval of the board of directors or the approval of the shareholders at the general meeting. The Ministry of Corporate Affairs (circular dated 17/07/2014) exempted companies from the obligation to comply with the provisions of Section 188 of the Act, resulting from compromises, arrangements, and mergers regulated according to the special provisions of the Companies Act.

Final words

The related party transaction provisions are one of the most amended provisions of the Act. In this view, “related party transactions” are one of the critical tests of corporate governance. The checklist provided applies to related party transactions by private or unlisted public companies. In the case of listed companies, the provisions of Section 188 of the Act and Regulation 23 of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, both have to be complied with.