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Related Party and Arm’s Length Transaction under The Companies Act, 2013
06 Apr 2015

Related party transaction is covered under section 188 of The Companies Act, 2013. Earlier Related Party Transaction was contained in section 297 of The Companies Act, 1956. Section 188 provides for the various transactions which cannot be entered in to by any company without the consent of Board of Directors. A Resolution has to be passed at a Board meeting and the consent has to be given by the Board of Director, then only can the company enter into such transaction.

Related Party means any person or an entity that is related to the company. Parties are considered to be related only if one party can exercise significant influence over the other party in making any financial decisions or has ability to control the other party.

Related Party is defined under section 2(76) of The Companies Act, 2013. Related Party Transaction involves transfer of resources, obligations between company and their related party and services. Section 188 is applicable to both private as well as public companies.

Related Party covers Individuals like any Key Managerial Personnel or his relative, director or Key Managerial Personnel of holding company or his relative.

Related party can be other than individuals which includes a holding, subsidiary or associate company. A Firm in which a manager, director or his relative is a partner. A subsidiary of a holding company to which it is also a subsidiary. A Private company in which director or manager is a member.

Definition of Related Party:

Related Party as defined under section 2(76) read with rule 3 of companies(specification of definition) Rules, 2014 says related party with reference to company means,

A Key Managerial Personnel or his relative;

Ø      A Private company in which a director or manager is a member.

Ø      A director or his relative.

Ø      A holding, subsidiary or an associate company.

Ø      A director or Key Managerial Personnel of the holding company or his relative.

Ø      A Public company in which director or manager is a director or holds along with his relative more than 2% of its paid up share capital.

Related Party Transaction:

The Companies Act, 2013 says no company shall enter into any contract without the prior consent of the Board of Director given by a resolution at meeting of the Board.

Any Transaction between a company and its related party relating to activities given below will be related party transaction;

Ø      Leasing of property of any kind.

Ø      Sale,purchase of any goods.

Ø      Selling or buying or disposing of any kind of property.

Ø       Providing or availing any services.

Ø    Appointment of any agent for sale or purchase of any goods or  services.

Ø      Appointment of such related party to any office or place of profit  in the company or its subsidiary.

For any transaction Board meeting is required and special resolution is passed in general meeting subject to paid up share capital or Turnover and some other conditions as prescribed. For special resolution, the member who is not related to transaction may vote.

Section 188(1) will not be applicable if any company does any transaction which is covered under section 188(1) of The Companies Act, 2013 and the company does its business by way of Arm’s Length basis.

Arm’s Length Transaction:

It means a transaction between two related parties that is conducted as if they were unrelated, so as to avoid any conflict of interest.

The concept of an arm’s length transaction is to ensure that both parties in the transaction are acting in their own self-interest and are not subject to any pressure from the other. It ensure that parties to transaction are on equal footing. It is used specifically in contract law to make an equitable agreement which stands up to legal scrutiny, even though parties may be closely related or may have shared interest.

Certain Approvals Required:

The following approval is required for entering into transaction with related party:

Approval of Board of director:

Every company or director interested in any contract with a related party should seek the approval of the board in their meeting along with some other conditions as may be prescribed. 

Approval by Special Resolution:

Related party transaction in case of company having paid up share capital of Rupees 10 crores or more.

Ø  Sale or purchase of any goods directly or through appointed agents exceeding 25% of annual turnover.

Ø  Selling,disposing or buying of any kind directly or through appointed agents exceeding 10% of net worth.

Ø    Leasing of any property exceeding 10% of net worth or exceeding 10% of turnover.

Ø  Providing or availing of any services directly or through appointed agents exceeding 10%of net worth.

Certain Disclosures Required:

Disclosures made in notice of Board Meeting:

The Board meeting agenda at which the resolution is proposed to be moved would disclose:

Ø    Particulars of the contract;

Ø    Nature and duration of the contract;

Ø    Name of the related party and relationship;

Ø     If there is any advance paid or received against the contract;

Ø    The manner of determining the pricing whether included as a part of contract or not considered as a part of contract it has to be disclosed.

Ø  Whether all factors relevant to contract has been considered or not, if it is not considered then reason for not considering those factors.

Disclosures made in Board’s Report:

Every Related party transaction shall be disclosed in the Board’s Report along with the reason for entering into such transaction.

Disclosure made by Interested Director:

Any Director of the company who is interested in entering into any transaction shall disclose his interest in the meeting of the Board in which such contract is being discussed, such contract entered into are as follows;

Ø  Transaction entered into with a firm in which such director is a partner or member; or

Ø  Transaction entered into with any corporate body in which such director holds more than 2% of shareholding in such corporate body; or

Ø   Transaction entered into with organization in which such director is a manager or promoter.

Penalty for non-compliance of Related Party or Arm’s Length Transactions:

If there is any contract which is entered into by a director or any other employee without the prior consent of the Board or approval by special resolution in the general meeting and if it is not ratified by the Board or by the shareholders at a meeting within three months from the date of such contract entered into shall be voidable at the option of the Board.

If the contract is with related party and director, then such director shall indemnify the loss incurred by the company due to such contract.

Any director or employee who enters into any contract or violate the provisions of “Related Party” or “ Arm’s Length” provisions / section will be penalized as:

Listed Company-Imprisonment for a period of one year or fine of Rs. 25,000/- and may extend up to Rs. 5, 00,000/-

Unlisted Company-Fine which shall not be less than Rs. 25,000/- and may extend up to  Rs. 5, 00,000/-/

For any clarification please contact at: [email protected]  

HPACS Team                                                           

Kumar Vineet