A company, in the course of doing business, enters into various transactions, including transactions with related parties. Related party transactions are common because the management is aware of the credentials of the related party and therefore can enter into such transaction with confidence and ease.
A related party transaction is not always a cause of concern. The concern arises only when such transaction is beneficial to the related party but disadvantageous to other stakeholders of the company. It is very important for the sake of good corporate governance that there should not be any conflict of interest and to ensure that, related party transactions should be entered into on an arm’s length basis with proper regulatory and statutory compliances and disclosures.
The term “related party”, with reference to a company is defined under section 2(76) of the Companies Act, 2013, as-
- Director of the company or his relative.
- Key managerial personnel of the company or his relative.
- Firm in which the partner is the director of the company, manager of the company or his relative.
- Private Company in which member or director is the director or manager of the company.
- Public Company in which a director or manager is-
- director of the company, or
- any person who with his relatives holds more than two per cent of paid-up share capital of the company
- Body corporate in which board of directors, managing director or manager is accustomed to act in accordance with the advice, directions or instructions given in professional capacity by director or manager of the company.
- Person on whose advice, directions or instructions which are given in professional capacity a director or manager of the company is accustomed to act.
- any company which is-
- Holding, subsidiary or an associate company of such company, or
- Subsidiary of a holding company to which company is also a subsidiary
- Such other person as may be prescribed. Rule 3 of the Companies (Specification of Definitions Details) Rules, 2014 provides that a director other than an independent director, or key managerial personnel of the holding company or his relative with reference to a company shall be deemed to be a related party.
Section 2 (77) of the Companies Act, 2013 defines the term “relative” with reference to any person as one who is related to another, if—
- they are members of a Hindu Undivided Family, or
- they are husband and wife, or
- one person is related to the other in such manner as may be prescribed. Rule 4 of the Companies (Specification of Definitions Details) Rules, 2014 provides that a person shall be deemed to be the relative of another, if he or she is related to another in the following manner-
- Father including step-father
- Mother including step-mother
- Son including step son
- Son’s wife (Daughter in Law)
- Daughter’s husband (Son in Law)
- Brother including step-brother
- Sister including step-sister
It is important to point that Companies Act, 1956 included various other relation within the meaning of the term relative. Following relations have been kept out of the purview of the term relative in the Companies Act, 2013 - Father’s father, Father’s mother, Mother’s mother, Mother’s father, Son’s son, Son’s son’s wife, Son’s daughter, Son’s daughter’s husband, Daughter’s son, Daughter’s son’s wife, Daughter’s daughter, Daughter’s daughter’s husband, Brother’s wife, Sister’s husband.
According to the SEBI(LODR) Regulations, 2015, in addition to the above, any person or entity belonging to the promoter or promoter group of the listed entity and holding 20% or more of shareholding in the listed entity shall be deemed to be a related party.
Related party transaction means any contract or arrangement between a company and its related party, with respect to certain transactions covered under Section 188 of the Companies Act, 2013. It is important to understand that every transaction with a related party need not be a ‘related party transaction’ within the meaning of Companies Act.
Section 188 of the Companies Act covers the following transactions:
- 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.
A transaction of giving loan, making investment, providing guarantee, etc. is not covered under Section 188 of the Companies Act despite being a transaction of financial nature. Such a transaction with a related party will not be a related party transaction in terms of Section 188 of Companies Act.
Regulation 2(zc) of SEBI(LODR) Regulations, 2015 defines “related party transaction” as transfer of resources, services or obligations between a listed entity and a related party irrespective of whether a price is charged.
India has one of the most elaborate set of laws and regulations governing approvals and disclosures of related party transactions for both listed and unlisted companies-
- Companies Act, 2013 read with the Rules made thereunder
- Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015
- Companies (Auditor’s Report) Order, 2016
- Accounting Standards
- Secretarial Standards
- All transactions, or any modifications thereof, with the related parties need to be approved by the Audit Committee even if they are not covered under Section 188 of the Companies Act. However, the Audit Committee can grant an omnibus approval subject to the conditions mentioned in Rule 6A of the Companies (Meetings of Board and its Powers) Rules, 2014.
- In case of transactions covered under Section 188 of the Companies Act, the company cannot enter into such transactions without the consent of the board of directors by way of an ordinary resolution.
- If the quantum of the amount involved in a related party transaction exceeds certain thresholds [provided under Rule 15 of Companies (Meetings of Board and its Powers) Rules, 2014], then the prior approval of the company by way of an ordinary resolution in the general meeting is required to enter into a related party transaction.
- However, no resolution is required if the related party transaction is entered into by the company in its ordinary course of business and on an arm’s length basis. But the Audit Committee approval is required to ensure that the matter is actually done in the ordinary course of business and at arm’s length basis.
It is important to note that the director is barred from being present during discussions on a related party transaction in which such director is interested. Similarly, a member, is barred from voting on a resolution to approve a related party transaction when such member is a related party.
All related party transactions have to be recorded in one or more registers maintained by the company in form MBP 4 in accordance with Rule 16 (1) (c) of Companies (Meetings of Board and its Powers) Rules, 2014. The entries in the register have to be authenticated by the company secretary of the company or by any other person authorised by the Board for this purpose and it has to remain in the custody of such person. The register has to be kept at the registered office of the company and the register has to be preserved permanently.
Transaction can be avoided if approval/consent not taken
Any contract or arrangement in terms of Section 188 of the Companies Act is entered into by a director or any other employee of the company is voidable at the option of the Board or shareholders of the company if
- it has been entered without obtaining the consent of the Board or approval by a resolutionin the general meeting under section 188(1) of the Act, and
- it has not been ratified by the Board or the shareholders at a meeting within three months from the date on which such contract or arrangement was entered into.
SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 lays down the obligations of listed companies while entering into any related party transaction.
- According to these regulations, all related party transactions will require prior approval of the audit committee and only independent directors in the Committee will approve related party transactions.
- All material related party transactions shall require approval of the shareholders through resolution and no related party can vote in that resolution even if such related party is not related to that particular transaction.
All the related party transactions have to be disclosed in the Board’s report to the shareholders along with the justification for entering into such transactions.
- Details of all material transactions with related parties have to be disclosed in the quarterly compliance report on corporate governance submitted to the recognized stock exchanges within twenty-one (21) days from the end of quarter.
- A listed company is required to submit disclosures of related party transactions on a consolidated basis to the stock exchanges and publish the same on its website within thirty (30) days from the date of publication of its standalone and consolidated financial results for the half year.
- The annual report of a listed company must contain related party disclosures as specified in Para A of Schedule V of SEBI (LODR) Regulations, 2015.
- A listed company is also required to disclose the policy on dealing with related party transactions on its website.
Detailed disclosure norms in respect of related party transactions are covered in the Accounting Standards. Currently, two accounting standards are in force:
- Indian Accounting Standard (Ind AS) – notified under the Companies (Indian Accounting Standards) Rules, 2015.
- Accounting Standard (AS) – notified under the Companies (Accounting Standards) Rules, 2006.
However, most of the companies are required to follow Ind AS only. Ind AS 24 relates to Related Party disclosures.
Ind AS 24 has an expansive definition of related party. According to Ind AS 24 A person or a close member of that person’s family is related to a reporting entity if he-
- has control or joint control of the reporting entity;
- has significant influence over the reporting entity; or
- he is a member of the key management personnel of the reporting entity or of a parent of the reporting entity.
Close members of the family of a person are those family members who may be expected to influence, or be influenced by, that person in their dealings with the entity including:
- That person’s children, spouse or domestic partner, brother, sister, father and mother;
- Children of that person’s spouse or domestic partner; and
- Dependants of that person or that person’s spouse or domestic partner.
Important disclosure requirements under Ind AS 24
- Relationships between a parent and its subsidiaries irrespective of whether there have been transactions between them.
- Name of its parent entity and the ultimate controlling party. If neither the entity’s parent nor the ultimate controlling party produces consolidated financial statements available for public use, the name of the next most senior parent that does so shall also be disclosed.
- Key management personnel compensation in total and for each of the following categories: (a) short-term employee benefits; (b) post-employment benefits; (c) other long-term benefits; (d) termination benefits; and (e) share-based payment. If key management personnel services from another entity then such disclosure not required. However, amounts incurred by the entity for the provision of such key management personnel services shall be disclosed
- If an entity has had related party transactions during the periods covered by the financial statements- it shall disclose the nature of the related party relationship as well as information about those Related Party Disclosures transactions and outstanding balances, including commitments, necessary for users to understand the potential effect of the relationship on the financial statements. At a minimum, disclosures shall include:
- Amount of the transactions,
- Amount of outstanding balances, including commitments, and
- Their terms and conditions, including whether they are secured, and the nature of the consideration to be provided in settlement; and
- Details of any guarantees given or received;
- Provisions for doubtful debts related to the amount of outstanding balances; and
- Expense recognised during the period in respect of bad or doubtful debts due from related parties.
The disclosures mentioned in abovementioned point shall be made separately for each of the following categories: (a) the parent; (b) entities with joint control of, or significant influence over, the entity; (c) subsidiaries; (d) associates; (e) joint ventures in which the entity is a joint venturer; (f) key management personnel of the entity or its parent; and (g) other related parties.
- Disclosures that related party transactions were made on terms equivalent to those that prevail in arm’s length transactions are made only if such terms can be substantiated
- Items of a similar nature may be disclosed in aggregate by type of related party except when separate disclosure is necessary for understanding the effects of related party transactions on the financial statements of the reporting enterprise.
However, a material related party transaction with an individual party cannot clubbed in an aggregated disclosure. Materiality primarily depends on the facts and circumstances of each case. In deciding whether an item or an aggregate of items is material, the nature and the size of the items are evaluated together.
Consequences of non-compliance
In terms of the Companies Act
- A company can proceed against a director or any other employee who had entered into a contract or arrangement in contravention of section 188 for recovery of any loss sustained by it as a result of such contract or arrangement. If the contract or arrangement is with a related party to any director or is authorised by any other director, the concerned directors has to indemnify the company against any loss incurred by it.
- Any director or employee of a company who had entered into or authorised the contract or arrangement in violation section 188 of the Act is liable to a penalty of -
- twenty-five lakh rupees, in case of listed company.
- five lakh rupees, in case of any other company.
- Section 164(g) of Companies Act, 2013 provides that a person shall not be eligible for appointment as a director of a company if he has been convicted of the offence dealing with related party transactions under section 188 at any time during the last preceding five years.
- If a director of the company contravenes the provisions of Section 184(1 ) or Section 184( 2), such director can be punished with an imprisonment of up to one year or a fine of up to one lakh rupees, or both.
- There are similar penal provisions for non compliance with Sections 164, 177 and 189.
In terms of the SEBI (LODR) Regulations
- Regulation 98 provides that any listed entity who contravenes any of the provisions of the regulations would be liable for the following actions by the respective stock exchange(s)-
- imposition of fines;
- suspension of trading;
- freezing of promoter/promoter group holding of designated securities, as may be
applicable, in coordination with depositories.
- any other action as may be specified by SEBI from time to time.
- There are other penal provisions under Sections 23, 23A, and 23E of the Securities Contracts (Regulation) Act, 1956 for non-compliance with the Listing Agreement or conditions, or bye-laws of a recognised stock exchange.
In view of the serious consequences for any non-compliance, it is important that the directors and the officials undertake due diligence and exercise reasonable care before entering into any related party transactions so that such transactions remain compliant with the provisions of law relating to related party transactions.
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