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Section 188: Related Party Transaction

Nishant Mishra 
on 31 March 2020

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Section 188 along with Companies (Meeting of the Board and its Power) Rule,2014 deals with the"Related Party Transaction".Further few provisions of Section 177 is also applicable since the companies which required to constitute the Audit Committee are required to take the approval of the Audit Committee for Related Party Transactions.

Before going into detail provisions, it will be prudent to understand the meaning of the term "Related Party".The term related party has been defined under clause (76) of Section 2 of Companies Act, 2013.

Related Party, with reference to a company, means-

(i) a director or his relative;

(ii) a Key Managerial Personnel or his relative;

(iii) a firm, in which a director, manager or his relative is a partner;

(iv) a private company in which director or manager or his relatives is a member or director;

(v) a public company in which a director, or manager is a director and holds along with his relatives, more than 2% of the paid-up share capital;#

(vi) any body 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;

(vii) any person on whose advice, directions or instructions a director or manager is accustomed to act;

Provided that nothing in sub-clause (vi) and (vii) shall apply to the advice, directions or instructions given in a professional capacity;

(viii) any body corporate which is -

Section 188: Related Party Transaction

(A) a holding, subsidiary or an associate company of such company;
(B) a subsidiary of a holding company to which It is also a subsidiary company. (Sister Subsidiary Company)
(C) An investing company or the venturer of the company.

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.

This means that Investing Company or the Venturer Company have significant control in such other company by investment controlling more than equal to 20% of the voting power.

(ix) Such other person as may be prescribed;

Rule 3 of the Companies (Specification of Definitions Details) Rules, 2014, prescribe such other person for sub-clause (ix).

Related Party- For the purpose of sub-clause (ix) of clause (76) of section 2 of the Act, a director other than an independent director or key managerial personnel of the holding company or hisrelative with reference to the company shall be deemed to be a related party.

# It is to be noted that in case of a public company, there are two conditions need to be fulfilled to term such the public company as the related party that director or the manager should be the director in such a public company and such director or manager should hold either himself or along with relatives more than 2% of paid-up share capital i.e. equity or preference both will be reckoned.

To understand the definition of Related Party, it is important to understand the definition of Relative. Section 2 Clause (77) defines the Relative.

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

(1) Father, including step-father.
(2) Mother, including the step-mother.
(3) Son, including the step-son.
(4) Son’s wife.
(5) Daughter.
(6) Daughter’s husband.
(7) Brother, including the step-brother;
(8) Sister, including the step-sister.

The following transaction with "Related Party" covered under provisions of the Companies Act, 2013.

(a) sale, purchase or supply of any goods or materials;
(b) selling or otherwise disposing of, or buying, the property of any kind;
(c) leasing of property of any kind;
(d) availing or the rendering of any services;
(e) appointment of any agent for the 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, it's subsidiary company or associate company; and

(the expression "office or place of profit" means any office or place -

(i) where such office or place is held by a director, if the director holding it 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;

(ii) where such office or place is held by an individual other than a director or by 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;)

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

Depending upon the value of the transaction will decide whether such a transaction will take place only after Board Resolution or Ordinary Shareholder Resolution will also be required. In the following cases, Ordinary Resolution will be required if the value of such transaction whether done directly or through agent and value of such transaction either independently or jointly exceed 10% of the turnover of the Company. For contract and arrangement with respect to clauses (a) to (e) of sub-section (1) of section 188.

i. sale, purchase or supply of any goods or material, amounting to 10% or more of the turnover

ii. leasing of property any kind amounting to ten per cent or more of the turnover of the company,

iii. availing or rendering of any services, amounting to ten percent or more of the turnover of the company:

In the case of selling and buying of Properties if its 10% or more of the net worth of the Company.

Limit to of 10% of turnover or net worth, as the case may be, shall be taken both individually and together during the Financial Year. For example, if the Company enter into the transaction and the value of such transaction is 5% of the turnover of the Company then Company does not need to pass any Ordinary Resolution.

If the Company enter into transaction and value of such a transaction is 10% of the turnover of the Company then Company need to pass Ordinary Resolution for such transaction.

If the Company enter into transaction and value of such transaction is 6% of the turnover of the Company and Company also previously entered into transaction and value of such transaction is 4% of the turnover of the Company then the Company need to pass Ordinary Resolution.

This limit to be calculated for each Financial Year.

In the case of appointment to any office or place of profit in the Company, it's subsidiary the company, or associate company, the Ordinary Resolution will be required if monthly remuneration exceeds two and a half lakh rupees.

In the case of underwriting the subscription of any securities or derivatives thereof of the company exceeds one percent of the net worth of the Company.

Net worth as per Section 2 Clause (57) means the aggregate value of the paid-up share capital and all reserves created out of the profits.securities premium account and debit or credit balance of profit and loss account, after deducting the aggregate value of the accumulated losses, deferred expenditure and miscellaneous expenditure not written off, as per the audited balance sheet, but does not include reserves created out of revaluation of assets, write-back of depreciation and amalgamation;

Turnover as per Section 2 Clause (91) means the gross amount of revenue recognized in the profit and loss account from the sale, supply, or distribution of goods or on account of services rendered, or both, by a company during a financial year.

As per Second Proviso to Sub-Section (1) Section 188, the members who are related party shall not vote in such resolution, however, this is not applicable in case of Private Company.

90% or more member are related to promoters or related party.

In the clarification issued by the MCA, it is clarified that "Related Party" to be seen as per the transaction i.e. if Company is entering into a transaction in which Mr A is related then Mr A shall not vote when the resolution is being moved for such a transaction. However, if the company moved other resolution in the same meeting in which Mr A is not related then Mr A can vote on such motion.

All the provisions related to Related Party Transaction shall not be applicable in case the company enters into such transaction in the ordinary course of business on the arm length basis.

As per the Clarification issued by the MCA, it is stated that Provisions of Related Party Transaction i.e. Section 188 shall not be applicable incase such transaction arising out of provisions of Compromise and Arrangement.

No Ordinary Resolution will be required in case of a transaction between holding and wholly-owned subsidiary and there are accounts are consolidated and place before the Shareholders in General Meeting.

The "arm’s length transaction" means a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest.

In the above case where Ordinary Resolution to be passed, for the passing of such ordinary resolution we have to call General Meeting and for calling such General Meeting we have to give Notice as per Section 101 and statement need to be annexed with such notice as per Section 102 and as per Rule 15 of the Companies (Companies Meeting of the Board and its Power) Rules2014 such statement need to have following details;

(a) name of the related party;
(b) name of the director or key managerial personnel who is related, if any;
(c) nature of the relationship;
(d) nature, material terms, monetary value and particulars of the contract or arrangements;
(e) any other information relevant or important for the members to take a decision on the proposed resolution.

All the above-mentioned transaction which does not breach the threshold limit, the passing of Board Resolution will be sufficient. However, such Related Party Transaction to be entered subject to the following conditions.

(1) The agenda of the Board meeting at which the resolution is proposed to be moved shall disclose-

(a) the name of the related party and nature of the relationship;
(b) nature, duration of the contract and particulars of the contract or arrangement;
(c) the material terms of the contract or an arrangement including the value, if any;
(d) any advance paid or received for the contract or arrangement, if any;
(e) the manner of determining the pricing and other commercial terms, both included as part of the contract and not considered as part of the contract;
(f) 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
(g) any other information relevant or important for the Board to take a decision on the proposed transaction.

The interested Director shall not present at the Board Meeting during the discussion on such a transaction.

Detail of Related Party Transaction to stated in Board Report along with justification for entering into such transaction.

Approval for "Related Party Transaction" to be obtained before entering into the transaction or within 3 months from entering into the transaction. However, if such approval is not obtained within 3 months from entering into a transaction then such transaction shall be voidable at the option of the Board or Shareholders as the case may be.

If such transaction is with a relative of any Director or authorized by Director then such Director shall personally indemnify the Company against any loss. Further, the Company may proceed against such employee or director and recover the loss suffered.

All the Companies having Audit Committee need the approval of their Audit Committee for all the Related Party Transaction and or for subsequent modification thereof as per Section 177.

Audit Committee may also give omnibus approval, if it is satisfied that such approval will be favour of the Company after obtaining approval of the board for the Related Party Transaction subject to the following conditions.

  • The maximum value of the transactions, in aggregate, which can be allowed under the omnibus route in a year;
  • the maximum value per transaction which can be allowed;
  • extent and manner of disclosures to be made to the Audit Committee at the time of seeking omnibus approval;
  • review, at such intervals, as the Audit Committee may deem fit, related party transaction entered into by the company pursuant to each of the omnibus approval made;
  • transactions which cannot be subject to the omnibus approval by the Audit Committee.
  • These above conditions to be formed by the Audit Committee based on the following factors
    • the repetitiveness of the transactions (in past or future);
    • justification for the need of omnibus approval.

Audit Committee while giving omnibus approval shall give the following details;

  • name of the related parties;
  • nature and duration of the transaction;
  • The maximum amount of transaction that can be entered into;
  • any other information relevant or important for the Audit Committee to take a decision on the proposed transaction:

In case where the value of the transaction is not available at the time of making omnibus approval, the Audit Committee may still give omnibus approval subject to the condition that the value of such transaction shall not exceed 1 crore per transaction.

Omnibus approval shall be valid for one financial year only.

Any director or any other employees 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 the listed company, be punishable with imprisonment for a term which may extend to one year or with fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees, or with both; and

(ii) In case of any other company, be punishable with fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees.

The author can also be reached at csnishantmishra@yahoo.com


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