SECTION 188 deals with related Party Contracts.

We shall try to understand the Statutory compliance relating to ˜RELATED PARTY CONTRACTS™ under the Companies Act, 2013 in the form of FAQs.

Applicability of the Section

Section 188 of the Companies Act, 2013 is applicable to both Private and Public companies and is effective from 1st April, 2014.  The Rules attached to Section 188 imposes more compliances on certain classes of Companies and certain types of transactions which we shall see later in this Article.

A. Who is a Related Party?

First we need to understand who is a related Party
Section 2(76), gives the definition of a ˜RELATED PARTY™ which is as under:
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 a director or manager is a member or director;

v. a public company in which a director or manager is a director or holds along with his relatives, more than 2% of its 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-clauses (vi) and (vii) shall apply to the advice, directions or instructions given in a professional capacity;

viii. any company which is”
(a) a holding, subsidiary or an associate company of such company; or
(b) a subsidiary of a holding company to which it is also a subsidiary;

ix. a director or key managerial personnel of the holding, subsidiary or associate company of such company or his relative;

x. any person appointed in senior management in the company or its holding, subsidiary or associate company i.e. personnel of the company or its holding, subsidiary or associate company who are members of core management team excluding Board of directors comprising all members of management one level below the executive directors, including the functional heads.

Individual Related Party

o a director or his relative

o a KMP or his relative

o a director or KMP of the holding, subsidiary or associate company of such
company or his relative

o any person appointed in senior management in the company or its holding, subsidiary or associate company

o any person on whose advice, directions or instructions a director or manager is accustomed to act

Other than Individuals Related Party

o a firm, in which a director, manager or his relative is a partner

o a private company in which a director or manager is a member or director

o a holding, subsidiary or an associate company

o fellow subsidiary

o a public company in which a director or manager is a director or holds along with his relatives, more than 2% of its paid-up share capital

o any body-corporate whose Board of Directors, MD or manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager provided nothing of the above shall apply if any of the above persons give advise, directions or instructions in professional capacity.

B. Which are the transactions are deemed to be related party transactions ?

Section 188(1) lists out the related party transactions which is inclusive of transactions done within the meaning of the Old Section 297 and Section 314. In addition, it has also included all related party immoveable property transactions.

The following are considered  ‘Related Party Transactions’.

Any transaction between a Company and its related party relating to:
a. sale, purchase or supply of any goods or materials;

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

c. leasing of 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.

Explanation relating to ˜Office or Place or Profit™

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;

C. How do we approve Related Party Contracts ?

i. Approval by the Board of Directors

i.Every company needs to seek the approval of its Board of Directors for entering into any related party transaction, as listed above, irrespective of the capital of the company or the value of the transaction.

ii. Approval of the Board has to be sought at a duly convened meeting of the Board and same cannot be obtained by passing of a resolution by circulation.

iii. Where any director is interested in any contract or arrangement with a related party, such director shall not be present at the meeting during discussions on the subject matter of the resolution relating to such contract or arrangement.

iv. Contract entered already without the Board approval should be approved and ratified by the Board within three months from the date of contract.

ii. Prior approval of Members by means of a Special Resolution for certain class of Companies and certain types  of transactions

In the following circumstances, in addition to approval of Board of Directors, prior approval of members by means of a special resolution must also be sought before entering into any related party transaction:

o paid-up share capital of the company being equal or exceeding Rs. 10 Crore.

o the sale or purchase or supply of any goods or materials directly or through appointment of agents exceeding 25% of the annual turnover as mentioned in clause (a) and clause (e) of Sub section (1) of Section 188

o Selling or otherwise disposing of buying property of any kind directly or through appointment of agents exceeding 10% of the net worth as mentioned in Clause (b) and clause (e) respectively of sub section (1) of Section 188

o Leasing of property of any kind exceeding 10% of the networth or exceeding 10% of the turnover as mentioned in clause (c) of Subsection (1) of Section 188

o Availing or rendering of any services directly or through appointment of agents exceeding 10% of the networth as mentioned in Clause (d) and (e) of Sub Section (1) of Section 188

o the transaction relates to appointment to any office or place of profit in the company, its subsidiary company or associate company at a monthly remuneration exceeding Rs. two and a half Lakhs.

o the transaction relates to remuneration for underwriting the subscription of any securities or derivatives thereof of the company exceeding 1% of the net worth as mentioned in clause (g) of subsection (1) of Section 188

Conditions to be observed while approving the special resolution in the Extra Ordinary General Meeting

i. No member of the company who is a related party shall vote on such special resolution, to approve any contract or arrangement which may be entered into by the company.

ii. In case of wholly owned subsidiary, the special resolution passed by the holding company shall be sufficient for the purpose of entering into the transactions between wholly owned subsidiary and holding company.

D. What are the disclosure norms to be observed in placing related party contracts before the Board Meeting and in an Extra Ordinary General Meeting for approval and finally while preparing the Board Report?

i. Disclosure norms concerning Related Contracts to be placed before the Board Meeting

The following disclosures have to be made in the notice calling for the Board Meeting:

(a) name of the related party and nature of relationship;

(b) nature, duration of the contract and particulars of the contract or arrangement;

(c) material terms of the contract or arrangement including the value, if any;

(d) any advance paid or received for the contract or arrangement, if any; and

(e) any other information relevant or important for the Board to take a decision on the proposed transaction.

ii.Disclosure norms concerning Related Contracts to be placed before the Extra Ordinary General

The following disclosures have to be made in the Explanatory Statement to be annexed to notice of general meeting:

(a) name of the related party;

(b) name of the director or key managerial personnel who is related, if any;

(c) nature of relationship;

(d) nature, material terms, monetary value and particulars of the contract or arrangement;

(e) any other information relevant or important for the members to take a decision on the proposed resolution.

iii. What are disclosure norms to be observed while preparing the Board Report?

Every related party transaction or contract referred in Sub Section 1 of Section 188 shall be disclosed in the Board™s report along with the justification for entering into such contract or arrangement.

E. Is there any exemption available for related party contract?

The above mentioned provisions will not be applicable in case of transactions entered into by the company in its ordinary course of business, which are on arm™s length basis.

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.

F. Can all ‘Related Party Contracts’ which conform to ‘Arms Length Criteria’ be justified in availing exemption of non compliance?

The onus of responsibility lies with the parties entering into contracts in proving that said transactions are on ˜arms length basis™. Since the penalties and punishments are severe, it is better to bring all related party contracts under Section 188 and comply with the relevant provisions as the medicine is not that bitter than the food itself.

G. What are the consequences of non-compliance or violation of Section 188 and rules made there under?

i. If any related party transaction or contract is entered without seeking Board™s and/or members™ approval and if the same is not ratified by the Board and/or members as the case may be, within 3 months at a meeting, then the contract or transaction will be voidable at the option of the Board and if the transaction is with any related party to any director or is authorised by any other director, then the concerned directors are liable to indemnify any loss incurred by the company.

ii. Additionally, the company can also proceed against a director or employee who had entered into such contract or arrangement in contravention of the provisions of this section for recovery of any loss sustained by it as a result of such contract or arrangement.

iii. Any director or any other employee of a company, who had entered into or authorised the contract or arrangement in violation of the provisions of this section shall

(a) in case of listed company, be punishable with imprisonment for a term which may extend to 1 year or with fine which shall not be less than Rs. 25,000/- but which may extend to Rs. 5,00,000/-, or with both; and

(b) in case of any other company, be punishable with fine which shall not be less than Rs. 25,000/- but which may extend to Rs. 5,00,000/-.

iv. One is disqualified to be a Director for five years if he is convicted of an offence dealing with related party transactions under Section 188 during the last preceding five years.

H. How do we handle related party contract cases wherein the Company has only husband and wife as both Directors and members in a Company?

These type of Companies have to bring in two outsiders as shareholders giving one share each and pass special resolutions for all related party contracts in a General Meeting and file E Form No.MGT14 and register such special resolutions. This is the only way these contracts could be regularized atleast for the time being till the Ministry comes out with some relaxations/clarifications.

I. What are the other compliances concerning Related Party Transactions?

i. The Company has to maintain a register in Form No.MBP4 giving all details about the contract concerning the related party contract.

ii. The entries have to be in chronological order and shall be authenticated by the Company Secretary or any other person authorized by the Board.

iii. The Register has to maintained permanently at the registered office and should be at the custody of the Company Secretary or such other person authorized by the Board.

iv. The Company shall provide extracts of the register at the request of a member on a payment of not more than Rs.10/- as may be specified in the Articles.