Related Party Transactions

Private companies can no longer be private in their operations and will now need to follow prescribed procedure and disclose the details through filings. However there is still some respite to the smaller private companies i.e. those below the prescribed threshold and those who only conduct business on an arm’s length basis.

Certain transactions with related parties such as the following cannot be entered into by a company except with the consent of the Board of Directors at a meeting of Board:

1)         Sale, purchase or supply of any goods or materials;

2)         Selling or otherwise disposing off or buying property of any kind;

3)         Leasing property of any kind;

4)         Availing or rendering of services;

5)         Appointment of an agent for purchase or sale of goods or materials services or properties;

6)         The appointment of the related party to any office or place of profit in the company, its subsidiary or associate company.

Compliance needed

1)         Board meeting and passing of board resolution. The rules prescribe the compliances in relation to notice of meetings.

2)         In cases where the Thresholds are met, an extra-ordinary general meeting of the shareholders has to be convened for approving the same. The compliance in relation to the EoGM are available in the rules.

3)         The contract / arrangement shall be reported in the Board report / directors report which shall be forwarded to shareholders along with rationale, basis or justification for entering into such transaction.

Under this Act, unlike the earlier Companies Act, no approval of Central Government is needed for appointment of directors to office or place of profit in the Company or its subsidiary

Exceptions

No compliance is needed where the related party transactions are :

(a)   in the ordinary course of business and

(b)   carried on an arm’s-length basis. Arms length is defined under the Act as a transaction between two related parties that is conducted as if they were unrelated so that there is no conflict of interest.

Apart from the aforesaid, no other exceptions are applicable to related party transactions under the Act.

Identifying the Exceptions

The common test for identifying whether the transaction is in the ordinary course of business, would be to check and confirm whether the proposed transaction(s) is covered under the object clause of the Company and/ or incidental/ ancillary to the attainment of objects of the Company.

In order to ascertain whether the transaction is on arm’s length basis, one should check and confirm whether the terms of contract / arrangement are similar to the terms that are generally entered into with other parties who are unrelated.

It would be advisable to obtain confirmation from the Auditors as well on whether the views of the company are in line with the auditors’ views on whether certain transactions are in ordinary course and on arm’s length basis.

The procedure laid down under the Act and Rules should be followed for transactions that are with related parties and not in the ordinary course of business or not on arm’s-length basis.

Thresholds

The much debated thresholds as provided in the Rules read as follows:

1)         A company with paid up capital of less than INR 10 crores is not required to obtain prior approval of the members by way of a special resolution for a contract or arrangement with a related party; or

2)         Transactions meeting the following thresholds also require a special resolution:

1. as contracts or arrangements with respect to items 1 to 5 listed above with criteria, as mentioned below –

                             i.              sale, purchase or supply of any goods or materials directly or through appointment of agents over 25% of the annual turnover;

                            ii.              selling or otherwise disposing of, or buying, property of any kind directly or through appointment of agents over 10% of net worth;

                          iii.              leasing of property of any kind over 10% of the net worth or exceeding 10% of turnover;

                          iv.              availing or rendering of any services directly or through appointment of agents exceeding 10% of the net worth.

1. appointment to any office or place of profit in the company, its subsidiary company or associate company at a monthly remuneration exceeding INR 2.5 lakhs; or
2. remuneration for underwriting the subscription of any securities or derivatives thereof of the company exceeding 1% of the net worth.

One of the ways to interpret the thresholds is to say that related party transactions of companies meeting the paid up capital thresholds exceeding the transactional thresholds mentioned in second part of the rule only require a special resolution.

However, the relevant proviso as well as the rule requires all companies to follow certain norms for entering into related party transactions. This will include a wide net of private companies that provide inter-group support. However, the paid up capital threshold of INR 10 crores is quite high exempting many smaller companies from the rigours of compliance at a shareholder level.

Non-compliance

Any contract entered into with a related party in contravention of the provisions of Section 188 of the Act is voidable at the option of the Board.

Further, any such contract if so authorized by any Director in contravention of the provisions, would entail the concerned Director indemnifying the Company against any loss incurred by the Company.

The offense is punishable with fine which shall not be less than INR 25,000/- but which may extend to INR 5 Lakhs.