Much ado about nothing in section 188 (Related Party)

The section 188 of the Companies Act, 2013 imposes restrictions/conditions relating to related parties transactions and for the purpose of imposing restrictions and conditions the said section 188 authorizes Central Government to make rule. The Central Government has made rule i.e rule 15 of the Companies (Meetings of Board and its Powers)Rules, 2014. In the said section 188 first time concept of interested members is introduced in the company law though the concept of interested directors were all along there. There is perception among many concerned that provision of section 188 is very harsh as it requires approval by special resolution on related party transactions in certain situations and on that special resolution the member who is interested cannot vote. As a consequence of above it can be seen that most of the companies are family owned and managed hence in that scenario passing of special resolution is not practical as most members/shareholders would be regarded as interested. In the backdrop of above let us consider the relevant provisions of section 188 read with relevant rules to understand that effectively section 188 as on today is ineffective as to passing of special resolution.

Applicable provision is section 188(1) the relevant portion of which is as under:

“(1) Except with the consent of the Board of Directors given by……… and subject to such conditions as may be prescribed, no company shall enter into any contract……with related party with respect to-

(a) sale, purchase or supply of any goods or materials;

(b) selling or otherwise disposing of, or buying, property of any kind;

(d) availing or rendering of any services;

(e) appointment of any agent for purchase or sale of goods, materials, services or property;

(f) such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company; and

(g) underwriting the subscription of any securities or derivatives thereof, of the company:

Provided that no contract or arrangement, in the case of the company having a paid-up share capital of not less than such amount, or transactions not exceeding such sums, as may be prescribed, shall be entered into except with the prior approval of the company by a special resolution:

Provided further that 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 related party:”

Analysis of the above provisions:- Before proceeding to rule made under the above provision it is important to analyse the above provisions. The first proviso of above section says that for related party transaction in case of a company having paid-up capital of not less than the amount which will be prescribed in the rule, prior special resolution is required. The first proviso also says that for a related party transaction in case of a company having transactions not exceeding an amount which will be prescribed in the rule special resolution is required. Second proviso states that on that special resolution no member of the company can vote if he is a related party. Thus for proviso one and two of section 188(1) to be effective the rule is suppose to state the amount of minimum paid-up capital when Special Resolution is required and also the maximum amount of the transactions when special resolution is required. Now lets have a look at Rule 15 of the Companies (Meetings of Board and its Powers) Rules,2014 which is the rule, the relevant portion of which is as under:

“15(3) For the purpose of first proviso to sub-section (1) of section 188, except with the prior approval of the special resolution, a company shall not enter into transaction or transactions, where the transaction or transactions to be entered into,-

(a) as a contracts or arrangements with respect to clause (a) to (e) of sub-section (1) of section 188, with criteria as mentioned below-

(i) sale purchase supply……., exceeding ten percent………;

(ii) selling or otherwise disposing of …………, exceeding ten percent………;

(iii) leasing of property of any kind…………. exceeding ten percent….;

(iv) availing or rendering of any services……….exceeding ten percent………;

(b) is for appointment to any office…….exceeding two and half lakh…..;

In the above rule there is no mention at all of amount of paid-up capital when special resolution is required though amount of transactions is mentioned when special resolution be required. But the shocking part of this rule is that section 188 authorized the rule to prescribe the amount of transactions not exceeding where as the rule has prescribed all the amounts as exceeding. Thus the rule is in complete contradiction of section 188 and therefore null and invalid and has no force of law. It is needless to state that if a rule made under a law is in contradiction of the law it has no force.

In view of the above as on today a company can enter into any related party transactions just by passing a formal board resolution. There is no need of any special resolution.

Note:- Some of the books as available in the market has misprinting in first proviso of section 188i.e they contain the amount exceeding but gazette in which law is published contains not exceeding.