In recent months, the topic of ‘related party transactions’ (RPTs) has been the subject of intense media interest and discussions.
This article proposes to analyze the provisions in the Companies Act, 2013 (“the 2013 Act”) pertaining to RPTs in brief and explore whether the law, as it stands, requires further modifications to adequately address the concerns voiced from within the industry and without.
In layman’s language, RPT means an act of a company of entering into a contract or arrangement with a ‘related party’ on favourable or more advantageous commercial terms as compared to an ‘unrelated party’.
Section 2(76) of the 2013 Act (as amended by the Companies (Amendment) Act, 2017) enumerates the various categories of ‘related party’ with reference to a company. Further, Section 2(77) of the 2013 Act sets out the meaning of the term ‘relative’, with reference to a person. Additionally, the Companies (Specification of definitions details) Rules, 2014, framed by the Central Government, provides a list of more relatives in terms of Clause (77) of Section 2, including father (includes step-father), mother (includes step mother), son, son’s wife, daughter, daughter’s husband, brother (includes step brother) and sister (includes step sister).
The precursor to the 2013 Act, the Companies Act, 1956 (“the 1956 Act”), dealt with RPTs under Section 297. The said Section provided that
Section 188 of the 2013 Act, titled ‘Related party transactions’, was enacted pursuant to the recommendations of the Expert Committee Report on Company Law, 2005 constituted under the Chairmanship of Dr. Jamshed J. Irani. The Committee recommended that having a ‘Shareholder Approval and Disclosure-based regime’ was more appropriate for approval of RPTs rather than a ‘Government Approval-based regime’ as prevailed previously. The Committee further suggested that in addition to the disclosure requirements in respect of RPTs, certain transactions between a company and director or persons connected with director, in respect of sale, purchase of goods, materials or services, should take place only with the approval of the Board of Directors. It was further recommended that beyond a certain threshold limit, the approval of shareholders, by a special resolution, should be mandated.
Section 188 of the 2013 Act expressly bars any RPTs on the matters contained therein, except with the approval of the Board of Directors and in certain cases with the approval of the company by a resolution. The approval of the Board is required for a wide array of items such as (a) selling, purchasing or supplying 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 etc. It further stipulates that every contract or arrangement entered into under sub-section (1) of Section 188 shall be referred to in the Board’s report to the shareholders along with justification for entering into such contract. The Section further provides penalties/ punishments for a director or employee who acts in contravention of the said provisions.
However, the fourth Proviso to Section 188(1) whittles down the rigor of the above rule by providing that nothing in the said sub-section would apply to any transaction entered into by the company in its ‘ordinary course of business’ other than transactions which are not on ‘an arm’s length’ basis. Explanation (b) to Section 188(1) defines the expression ‘arm’s length transaction’ to mean a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest.
The procedure to be followed by a company for entering into an RPT is detailed in Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014 (“2014 Rules”). The said Rule inter-alia stipulates that a company shall enter into any contract or arrangement with a related party subject to the condition that a detailed agenda of the Board meeting at which the resolution is proposed to be moved, discloses material details.
Further, sub-Rule (3) prescribes certain threshold limits above which the prior approval of the company would be required by way of a resolution.
In the authors’ view, recent news reports on controversies surrounding RPTs unerringly point to the need for reform of the present legal regime, especially in relation to the following aspects:
To conclude, it is imperative that the Central Government engages with the industry bodies and representatives to bring suitable legislative changes with alacrity, so as to ensure greater probity in corporate governance and protection of shareholders’ interests.
Contributed by: Ajit Warrier, Partner; Aditya Nayyar, Principal Associate – Designate; Devansh Agarwal, Associate
This is intended for general information purposes only. The views and opinions expressed in this article are those of the author/authors and does not necessarily reflect the views of the firm.
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