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Laws Regarding Related Party Transaction under the Companies Act, 2013

By Arunesh Bhardwaj July 29, 2016

Related Party Transaction means a transaction wherein the parties involved are related to each other in a way or the other. Company Act, 2013 has defined the term related party. According to Section 2(76) of the Companies Act, 2013 (herein after referred as ‘the Act’) related party with respect to a company will mean:

  1. A director or KMP or their relative, 
  2. A firm wherein the director or manager or any of their relative is a partner,
  3. A private company of which a director or manager is a member or director;
  4. A public company in which a director or manager is a director or holds more than two per cent of its paid-up share capital along with his relatives or alone,
  5. Any corporate body whose Board of Directors, managing director or manager acts in accordance with the advice, directions or instructions of a director or manager;
  6. Any person on whose advice, directions or instructions a director or manager is accustomed to act,
  7. Any holding, subsidiary or an associate company.

It has also been mentioned that a person who is giving advice in a professional capacity won’t be considered as a related party to the Company. Further in Section 2(77) of the Act, the term relative with reference to a person has been defined. The Companies (Specification of definitions details) Rules, 2014 under Rule 3 and 4 have given a list of people who can be considered as a relative under Section 2(77) of the Act.

As per Section 188 of the Act, no company shall enter into any contract or any kind of agreement with a related party, without the consent of Board of Directors which can be given by a resolution at a Board meeting with respect to sale, purchase or supply of any kind of material or any property; or any other contract mentioned in Section 188(1) of the Act. Further it is mentioned that no member will be allowed to vote on the resolution if such member is a related party. The transaction in the ordinary course of the business with the related parties at the arm’s length is exempted from this section. The term arm’s length transaction is further defined as a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest.

Rule 15 of Companies (Meetings of Board and its Powers) Rules, 2014 (hereinafter Rules, 2014) gives certain conditions that are required to be fulfilled before entering a contract with the third party. It says that the Board meeting at which the resolution regarding the related party is proposed needs to disclose the full details of the related party which has to include the name of the related party, the nature of the relationship, the period and the terms of the contract entered between the parties and any other essential information. Further, in case the paid up share capital of the company is ten crore or more then the arrangement or the contract with a third party can only be entered after passing of a special resolution. There are other conditions wherein a special resolution is needed to be passed by the Board in order to execute an arrangement or contract with the related party:

  1. If the arrangement or contract is with respect to sale, or purchase or supply of any goods or materials whose worth is more than twenty five percent of the annual turnover of the company.
  2. If the arrangement or contract is with respect to selling or disposing of any property whose worth exceeds ten percent of the net worth of the company.
  3. If the arrangement or the contract is related to leasing of a property whose value exceeds ten percent of the net worth or ten percent of the turnover of the company.

Also, as per Rule 16 of Rules, 2014; every company will have to maintain a register wherein the details of all the Companies in which any director has any concern or interest will be entered and the director is bound to give the details as per Section 184 of the Act.

The contract so entered as per sub-section 1 has to be referred in the Board’s Report under Section 134(3) (h) of the Act. If, such contract is entered without the consent of the Board or without the approval by a resolution and is not ratified by the shareholders within three months, then such contract shall be held to be voidable at the option of the Board and if the contract is with related party to any director then the loss incurred by the Company shall be indemnified by the aforementioned director. The Company can also proceed against the director or any other employee of the company who has entered into an agreement or contract of such nature as mentioned in Section 188(1) of the Act without the permission or approval for recovery of any loss incurred by the Company as a result of the contract or agreement so entered. Section 188(5) of the Act, mentions the punishment for any director or any employee who entered or authorized any contract or arrangement in violation of Section 188. The punishment so mentioned is different for the listed company and is different for rest of the companies. For the listed company the punishment is imprisonment for a term which may extend to one year or with a fine which shall not be less than twenty five thousand rupees and which may extend to five lakhs rupee or both; whereas for the other companies, the fine shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees.

The consequence of being convicted of an offence dealing with related party transaction is also mentioned in Section 164 (1) (g) of the Act wherein it is mentioned that if a person is convicted of an offence dealing with related party transaction during preceding five years then that person will be disqualified from the appointment of director.

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Tags: Companies Act 2013 , Related Party Transaction , KMP , Director , Relative , Relationship , Section 2(76) , The Companies (Specification of definitions details) Rules , Rule 3 , Rule 4 , director , board of directors , BoD

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related party transaction ,   related party ,   companies act ,   Company law ,   Companies Act 2013 ,   Section 188 ,   violation ,   consequences

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