Related Party Transaction Simplified
By Satchit Bhogle July 27, 2016
A 4th year student of W.B.N.U.J.S, Kolkata
What is a related party?
A related party is a director or key managerial personnel or their relative, or a firm or company in which they are interested, e.g. by being a director or partner, or by holding along with his relatives more than 2% of its paid-up share capital. “Key managerial personnel” include the Chief Executive Officer, Managing Director , manager, company secretary, whole-time director, or Chief Financial Officer. Every director must disclose his concern or interest in any companies or bodiescorporate, firms, or other associations, including shareholding (i) at the first meeting of the Board in which he participates asa director; thereafter, (ii) at the first meeting of the Board in every financial year; and (iii) wheneverthere is any change in the disclosures already made, at the first Board meeting afterthe change.
Which transactions are permitted?
Related party transactions are permitted with a resolution of the Board. Thus, a company is not permitted to enter into a contract or arrangement with a related party for the exchange of goods and services or transfer of property, and a related party cannot be appointed as an agent for purchase or sale of goods, materials, services or property, or to any office or place of profit in the company (having remuneration above that already received as salary, fee, perks, etc.),its subsidiary company or associate company, or to underwrite the subscription of any securities or derivatives of the company, without a resolution of the Board. If the related party with reference to that contract or arrangement[i] is a director, his relative or a company or firm in which he is interested, he is not permitted to vote on the resolution, or be present at the meeting in which the contract or arrangement is discussed.
However, there are no special requirements for transactions entered into by the company with a related party in its ordinary course of business on an arm's length basis, i.e. conducted as if they were unrelated so that there is no conflict of interest. This means that the transactions should be independent and on such terms and conditions as a transaction with any other party. This provision replaces the requirement under the 1956 Act that the transaction between the company and its related party be in cash at prevailing market price.
Similarly, loans by a company to its director or a party the director is interested in is also not permitted, except as a part of the conditions of service extended by the company to all its employees, or pursuant to any scheme approved by the members by a specialresolution. Loans to the company by the director are still permitted.
Transactions below an amount to be prescribed, or contracts by a company having a paid-up share capital more than an amount to be prescribed, also require a special resolution. The 2013 Act requires that every such contract or transaction must be justified in the Board's report to shareholders. Fortunately, the 2013 Act omits the blanket requirement under the 1956 Act for a company having a paid-up share capital of Rs. 1 crore or more to obtain the prior permission of the Central Government to contract with a related party.
Do older contracts or arrangements need to be reviewed?
Section 188 of the 2013 Act (“Related party transactions”) came into force on 1 April 2014. Before this date, the applicable provisions were Sections 297, 300 and 314 of the 1956 Act. Contracts and arrangements entered into before 1 April 2014, so long as they comply with the requirements under the 1956 Act, do not require fresh approval until their original term expires.[ii] If they are to be renewed thereafter, or modified after 1 April 2014, then they must comply with Section 188 of the 2013 Act.[iii]
What are the consequences of violating the requirements?
Where any contract or arrangement is entered into by a director or any other employee, without obtaining the consent of the Board or approval by a special resolution, and if it is not ratified by the Board or, as the casemay be, by the shareholders at a meeting within three months, it shall be voidable atthe option of the Board. In the same manner, if such a contract or arrangement is entered into, and the Director has not made a disclosure, or has participated in the discussions, etc. on it, it is voidable at the option of the Board. Such an act is punishable with a stiff fine, and in the case of a listed company, may even attract imprisonment. If the contract or arrangement is with a related party of anyDirector, or is authorised by any other Director, the Directors concerned shall indemnify thecompany against any loss incurred by it.
For extending a prohibited loan to a director, both the company and director may face fine of up to Rs. 25 lakhs for violation of this provision, and the director may face imprisonment as well.
[i] Ministry of Corporate Affairs, Government of India, General Circular No. 30/2014 dated 17 July 2014 (“Clarifications on matters relating to Related Party Transactions”), para 1.
[ii] Ibid, para 3.
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