Companies Act Section 188 — Related party transactions

CHAPTER XII MEETINGS OF BOARD AND ITS POWERS

Commercial / Corporate

Summary

Sub-section (1) sets the general rule: a company cannot enter into a contract or arrangement with a related party unless the Board of Directors first gives its consent through a resolution passed at a Board meeting, and subject to any conditions that may be prescribed by rules. The types of contracts or arrangements covered include: sale, purchase or supply of goods or materials; selling, disposing of, or buying property of any kind; leasing property of any kind; availing or rendering services; appointing an agent for purchase or sale of goods, materials, services or property; appointing the related party to any office or place of profit in the company, its subsidiary, or associate company; and underwriting the subscription of any securities or derivatives of the company.

The first proviso to sub-section (1) adds that for companies with a paid-up share capital of not less than a prescribed amount, or for transactions exceeding prescribed sums, the contract or arrangement cannot be entered into without the prior approval of the company by a resolution. The second proviso states that no member of the company who is a related party may vote on such a resolution to approve the contract or arrangement. The third proviso says this voting restriction does not apply to a company where ninety per cent or more of its members, in number, are relatives of promoters or are related parties. The fourth proviso says the entire sub-section does not apply to transactions entered into in the ordinary course of business, except for those that are not on an arm's length basis. The fifth proviso says the requirement of passing a resolution under the first proviso does not apply to transactions between a holding company and its wholly owned subsidiary, if the subsidiary's accounts are consolidated with the holding company and placed before shareholders at the general meeting for approval.

The Explanation to sub-section (1) defines two terms. The expression "office or place of profit" means any office or place where, if held by a director, the director receives from the company anything beyond the remuneration he is entitled to as director, such as salary, fee, commission, perquisites, rent-free accommodation, or otherwise; or, if held by an individual other than a director, or by a firm, private company, or other body corporate, that person or entity receives from the company anything by way of remuneration, salary, fee, commission, perquisites, rent-free accommodation, or otherwise. The expression "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.

Sub-section (2) requires that every contract or arrangement entered into under sub-section (1) must be referred to in the Board's report to the shareholders, along with the justification for entering into it.

Sub-section (3) deals with contracts or arrangements entered into by a director or any other employee without obtaining the Board's consent or the approval by a resolution in the general meeting under sub-section (1). If such a contract or arrangement is not ratified by the Board or, as the case may be, by the shareholders at a meeting within three months from the date it was entered into, the contract or arrangement shall be voidable at the option of the Board or the shareholders. Additionally, 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.

Sub-section (4) states that, without prejudice to sub-section (3), the company is free to proceed against a director or any other employee who entered into such a contract or arrangement in contravention of this section, to recover any loss sustained by the company as a result of that contract or arrangement.

Sub-section (5) sets the penalties for any director or any other employee who entered into or authorised a contract or arrangement in violation of this section. In the case of a listed company, the person is liable to a penalty of twenty-five lakh rupees. In the case of any other company, the person is liable to a penalty of five lakh rupees.

Official Text

(1) Except with the consent of the Board of Directors given by a resolution at a meeting of the Board and subject to such conditions as may be prescribed, no company shall enter into any contract or arrangement with a related party with respect to—

(a) sale, purchase or supply of 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;

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

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

(g) underwriting the subscription of any securities or derivatives thereof, of the company:

Provided that no contract or arrangement, in the case of a company having a paid-up share capital of not less than such amount, or transactions exceeding such sums, as may be prescribed, shall be entered into except with the prior approval of the company by a2[resolution]:

Provided further that no member of the company shall vote on such 1[resolution], to approve any contract or arrangement which may be entered into by the company, if such member is a related party: 3[Provided also that nothing contained in the second proviso shall apply to a company in which ninety per cent. or more members, in number, are relatives of promoters or are related parties:] Provided also that nothing in this sub-section shall apply to 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: 1[Provided also that the requirement of passing the resolution under first proviso shall not be applicable for transactions entered into between a holding company and its wholly owned subsidiary whose accounts are consolidated with such holding company and placed before the shareholders at the general meeting for approval.] Explanation.— In this sub-section,—

(a) the expression “office or place of profit” means any office or place—

(i) where such office or place is held by a director, if the director holding it receives from the company anything by way of remuneration over and above the remuneration to which he is entitled as director, by way of salary, fee, commission, perquisites, any rent-free accommodation, or otherwise;

(ii) where such office or place is held by an individual other than a director or by any firm, private company or other body corporate, if the individual, firm, private company or body corporate holding it receives from the company anything by way of remuneration, salary, fee, commission, perquisites, any rent-free accommodation, or otherwise;

(b) the expression “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.

(2) Every contract or arrangement entered into under sub-section (1) shall be referred to in the Board’s report to the shareholders along with the justification for entering into such contract or arrangement.

(3) 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 1[resolution] in the general meeting under sub-section (1) and if it is not ratified by the Board or, as the case may be, by the shareholders at a meeting within three months from the date on which such contract or arrangement was entered into, such contract or arrangement 2[shall be voidable at the option of the Board or, as the case may be, of the shareholders] and 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.

(4) Without prejudice to anything contained in sub-section (3), it shall be open to the company to 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.

(5) Any director or any other employee of a company, who had entered into or authorized the contract or arrangement in violation of the provisions of this section shall,—

(i) in case of listed company, be 3[liable to a penalty of twenty-five lakh rupees]; and

(ii) in case of any other company, be 4[liable to a penalty of five lakh rupees]].