Latest Blogs from SBS and Company LLP

    Related Party Transactions – Section 188

    Section 188 of the Companies Act, 2013 [No.18 of 2013], notified to be effective from 01.04.2014, integrates the provisions of Sections 294, 294A, 294AA, 297 and 314 of the Companies Act, 1956 [No.1 of 1956].

    The provisions of Section 188 are applicable to all Companies, including OPC/Small Companies.

    To understand the concept of “RELATED PARTY TRANSACTION”, we need to understand as to who are the said related party (ies).

    Accordingly:

    As per Section 2 (76) r/w Rule No.3 of the Companies (Specification of definitions details) Rules, 2014, and the Companies (Specification of definitions details) Amendment Rules, 2014* the term “related party”, with reference to a company, means:-

    1. a director or his relative;
    2. a key managerial personnel or his relative;
    3. a firm, in which a director, manager or his relative is a partner;
    4. a private company in which a director or manager is a member or director;
    5. a public company in which a director or manager is a director or holds along with his relatives, more than two per cent, of its paid-up share capital;
    6. 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;
    7. 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;
    8. 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;
    9. a director (other than an Independent Director1 ) or key managerial personnel of the holding company or his relative with reference to a company.

    The relative part is defined by Section 2 (77) of the Companies Act, 2013. As per Section 2 (77) r/w Rule No.4 of the Companies (Specification of definitions details) Rules, 2014, the term ‘‘relative’’, with reference to any person, means anyone who is related to another, if/as:

    1. they are members of a Hindu Undivided Family;
    2. they are husband and wife; or
    3. Father (including Step-Father);
    4. Mother (including Step-Mother);
    5. Son (including Step-Son);
    6. Son’s wife;
    7. Daughter;
    8. Daughter’s husband;
    9. Brother (including Step-Brother);
    10. Sister (including Step-Sister).

    All the relatives as listed above are to be considered as related parties as per Section 2(76), and compliance of Section 188 is to be made in respect of the transactions therein.

    ASSOCIATE COMPANY:

    As per Section 2 (6), "Associate Company", in relation to another company, means a company in which that other company has a significant influence, but which is not a subsidiary company of the company having such influence and includes a joint venture company.

    Explanation: For the purposes of this clause, "significant influence" means control of at least 20 % of total share capital, or of business decisions under an agreement;

    Accordingly what are related party transactions?

    Related Party transactions mean any Contract/arrangement between the parties mentioned in the 1st column and 2nd column, for any of the items/services mentioned in the 3rd column in the table hereunder:

      Contract/arrangement between For
    1 2 3
    Company and

    a director or his relative; or

    a key managerial personnel or his relative; or

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

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

    a public company in which a director or manager is a director or holds along with his relatives, more than two per cent, of its paid-up share capital; or

    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; or

    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; or

    any company which is:-

    a holding, subsidiary or an associate company of such company; or

    a subsidiary of a holding company to which it is also a subsidiary; or

    a director (other than an Independent Director) or key managerial personnel of the holding company or his relative with reference to a company

    sale, purchase or supply of any goods or materials;

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

    leasing of property of any kind;

    availing or rendering of any services;

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

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

    underwriting the subscription of any securities or derivatives thereof, of the company

    Whose approvals and what kind of approvals are required?

    Board Approval:

    Every Company with the Paid-up Share Capital of upto Rs.10 Crores and for the transactions with following limits as to Turnover / Networth, no contract or arrangement shall be entered with a related party, except with the consent of the Board of Directors given by a resolution passed at a meeting:

    S No. Transaction with related Party Value of the transaction
    1 Sale, purchase or supply of any goods or materials directly or through appointment of agents. [Sec.188 (1) (a) & (e)] Not exceeding 25 % of the annual turnover*
    2 Selling or otherwise disposing of, or buying, property of any kind directly or through appointment of agents [Sec.188 (1) (b) & (e)] Not exceeding 10 % of net worth*
    3 Leasing of property of any kind directly or through appointment of agents [Sec.188 (1) (c)] Not exceeding 10 % of net worth*
    4 Availing or rendering of any services directly or through appointment of agents [Sec.188 (1) (d) & (e)] Not exceeding 10 % of net worth*
    5 Appointment of any related party to any office or place of profit in the company, its subsidiary company or associate company [Sec.188 (1) (f)] At a monthly remuneration not exceeding Rs.2.5 Lakhs
    6 Remuneration for underwriting the subscription of any securities or derivatives thereof of the company [Sec.188 (1) (g)] Not exceeding 1 % of the net worth*

    (*) - Turnover or Net Worth referred above shall be on the basis of the Audited Financial Statement of the preceding Financial Year.

    For the Board of Directors to take the decision as to related party transaction, the agenda of the Board meeting at which the resolution is proposed to be moved shall disclose:

    1. the name of the related party and nature of relationship;
    2. the nature, duration of the contract and particulars of the contract or arrangement;
    3. the material terms of the contract or arrangement including the value, if any;
    4. any advance paid or received for the contract or arrangement, if any;
    5. the manner of determining the pricing and other commercial terms, both included as part of contract and not considered as part of the contract;
    6. 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
    7. any other information relevant or important for the Board to take a decision on the proposed transaction.

    Further Points:

    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

    Members approval:

    Every Company with the Paid-up Share Capital of Rs.10 Crores or more and for the transactions with following limits as to Turnover / Networth, no contract or arrangement shall be entered with a related party, except with the prior approval of the Company by a special resolution:

    S.No. Transaction with related Party Value of the transaction
    1 Sale, purchase or supply of any goods or materials directly or through appointment of agents. [Sec.188 (1) (a) & (e)] Exceeding 25 % of the annual turnover*
    2 selling or otherwise disposing of, or buying, property of any kind directly or through appointment of agents [Sec.188 (1) (b) & (e)] Exceeding 10 % of net worth*
    3 leasing of property of any kind directly or through appointment of agents [Sec.188 (1) (c)] Exceeding 10 % of net worth*
    4 Availing or rendering of any services directly or through appointment of agents [Sec.188 (1) (d) & (e)] Exceeding 10 % of net worth*
    5 Appointment of any related party to any office or place of profit in the company, its subsidiary company or associate company [Sec.188 (1) (f)] At a monthly remuneration exceeding Rs.2.5 Lakhs
    6 Remuneration for underwriting the subscription of any securities or derivatives thereof of the company [Sec.188 (1) (g)] Exceeding 1 % of the net worth*

    (*) - Turnover or Net Worth referred above shall be on the basis of the Audited Financial Statement of the preceding Financial year.

    For the Members to take the decision as to related party transaction, the explanatory statement, pursuant to Section 102, to be annexed to the notice of a general meeting, shall contain the following particulars namely:-

    1. name of the related party;
    2. name of the director or key managerial personnel who is related, if any;
    3. nature of relationship;
    4. nature, material terms, monetary value and particulars of the contract or arrangement;

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

    Further points:

    1. No member2 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 a related party.
    2. 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.

    Exemptions:

    • Any transactions entered into by the company in its ordinary course of business other than transactions which are not on an arm’s length basis, shall not come under the purview of this section. “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.
    • As per Section 2(76) (iv), a private company in which a director or manager is a member or director, is said to be a related party. However, the relatives of Director or Manager have not been included here, accordingly, it is presumed that a Contract by a Company with a Private Company, in which the relatives of the Director/Manager are Directors/Shareholders, will not attract the provisions of Section 188.

    Tabular review of the provisions seen so far:

    S No Nature of Transaction Approvals
    1 Any transaction can be entered into by a company in the ordinary course of its business with a related party on an arm’s length basis. No approvals are required.

     

    Contracts/Arrangements entered without approval / Consent of the Board/Members -188(3):

    Where any contract or arrangement is entered into by a director or any other employee, without:

    1. obtaining the consent of the Board; or
    2. approval by a Special resolution in the General Meeting under the 1st provisio to Section 188(1), as the case may be;

    then the said Contract/arrangement is to be ratified by the Board or General Meeting, as the case may be, within Three (03) months from the date on which such contract or arrangement was entered.

    What if Contract/arrangement is not ratified:

    If the said Contract/arrangement is not ratified by the Board or General Meeting, as the case may be, within three months from the date on which such contract or arrangement was entered into, then:

    1. such contract or arrangement shall be voidable at the option of the Board; and
    2. ) if the contract or arrangement is with a related party to any director, or is authorised by any other director, the directors concerned shall indemnify the company against any loss incurred by it.

    Right of Recovery by the Company - 188(4):

    In addition to the right of indemnification/ recovery from the Director/employee concerned, the Company can proceed against a director or any other 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.

    Compliances:

    1. Every contract or arrangement entered into under sub-section (1) shall be referred to in the Board’s report to the shareholders in form AOC-2 [Rule 8(2) of the Companies (Accounts) Rules, 2014], along with the justification for entering into such contract or arrangement
    2. Entries of contracts or arrangements with a related party with respect to transactions to be made in the Register to be maintained under Section 189 [Register of Contracts or arrangements in which Directors are interested].
    3. If OPC enters into a contract with the sole member of the company who is also its director, the company shall, unless the contract is in writing:
    • ensure that the terms of the contract or offer are contained in the memorandum or are recorded in the minutes of the first Board meeting held after entering into the contract.
    • inform ROC about such contract within 15 days of entering into the contract.

    Requirements of fresh approvals under Section 188, for past contracts:

    No Fresh approvals are required for contracts entered in to by Companies pursuant to Section 297 of the Companies Act, 1956, and which have already come in to effect before the commencement of Section 188 of the Companies Act, 2013, till the expiry of the original term of such contracts.

    In case of any modifications in such contract is made on or after the commencement of Section 188 i.e., 01.04.2014, the provisions of Section 188 are to be complied with.

    Penalties for non-Compliance of Section 188:

    The Penalties for non-compliance of the provisions of the Section 188 are very severe. Any director or any other employee of a company:

    1. who had entered into; or
    2. authorised the contract or arrangement in violation of the provisions of this section shall:
    • in case of listed company, be punishable with imprisonment for a term which may extend to one 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
    • 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/-.

    Other Penalties to the concerned Director(s):

    Apart from the above penalties, if the said Director has been convicted of the offence dealing with related party transactions, then is dis-qualified to be appointed as a Director for a period of 5 years, pursuant to Section 164(1)(g) of the Companies Act, 2013.

    Section 188 v/s. Section 185 – The Big Debate?

    Will a transaction of Sale of a goods/materials by a Company to a Director [a related party under Section 188 of the Companies Act, 2013], ON CREDIT i.e., a CREDIT SALE, amount to an indirect Loan to the Director, in the form of a Book debt, under Section 185 of the Act?

    Does it?

    My Interpretation: a big “NO” and a big “YES”.

    NO/ NOT APPLICABLE: Section 185 is not applicable for the following reasons:

    All of us are aware that Section 185 is a Prohibitive section, which starts with “Save as otherwise provided in this Act”, whereas its counterpart i.e., Section 295 of the Companies Act, 1956, starts with “Save otherwise provided in sub-section (2)”

    From the opening lines of Section 185, it can be deduced that, “Save as otherwise provided in the Act” indicates to some other section in the Act, which provides/should provide for the same i.e., section 188, in regard to a transaction of Credit Sale. Pursuant to Section 188, the related party transactions are either to be approved by the Board/Members depending upon the limits, and at the time of granting the approval the Board/Members would have considered the material terms which includes, the modes of payment, credit period allowed for the transaction, etc.,.

    If at all the director makes payment for the Credit transaction, within the credit period as allowed by the Board/Member at the time of approval of the transaction, then, it cannot be constituted as a Book debt.

    YES/ APPLICABLE : Section 185 is applicable for the following reasons:

    If at all the Director is not making the payment with in the credit period as allowed by the Board/member, or where there is no action on part of the board for recovery of amounts from the Director, then the same amounts to a Book Debt.

    Download

    Tags:

    Subscribe SBS AND COMPANY LLP updates via Email!