Related Party Transactions Under Section 188

Short answer: Section 188 of the Companies Act, 2013 governs transactions between a company and its related parties. It mandates Board approval for specified transactions. If a transaction's value exceeds prescribed monetary limits, prior approval from shareholders through an ordinary resolution is also required. Non-compliance can make the contract voidable at the company's option and attract penalties for directors.

Who is considered a "related party"?

A person or entity is considered a "related party" under Section 2(76) of the Companies Act, 2013 if they fall into specific categories in relation to the company. Understanding this definition is the first step to ensuring compliance. The key relationships include:

• A director or their relative.
• A key managerial person (KMP) or their relative.
• A firm in which a director, manager, or their relative is a partner.
• A private company in which a director or manager or their relative is a member or director.
• A public company in which a director or manager is a director and holds, along with their relatives, more than 2% of its paid-up share capital.
• Any corporate body whose Board of Directors, managing director, or manager is accustomed to act in accordance with the advice, directions, or instructions of a director or manager of your company.
• Any person on whose advice, directions, or instructions a director or manager of your company is accustomed to act.
• The company's holding, subsidiary, or associate company.
• A director or KMP of the holding company or their relative.

What transactions are covered by Section 188?

Section 188(1) lists specific types of transactions between a company and its related parties that require consent. These transactions, unless they are in the ordinary course of business and at arm's length, must be approved by the Board of Directors. The covered transactions are:

• 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 the purchase or sale of goods, materials, services, or property.
• Appointment of a related party to any office or place of profit in the company, its subsidiary company, or associate company.
• Underwriting the subscription of any securities or derivatives of the company.

What are the approval requirements for RPTs?

There is a two-tier approval mechanism for Related Party Transactions (RPTs). The primary requirement is Board approval. However, if the transaction crosses certain financial thresholds, shareholder approval becomes mandatory.

1. Board Approval: Every RPT listed under Section 188 requires the consent of the Board of Directors, given via a resolution at a Board Meeting. Crucially, any director who is interested in the transaction cannot be present during the discussion or vote on that matter, as per Section 184 of the Act.

2. Shareholder Approval: If the RPT exceeds the prescribed monetary limits (detailed in the next section), prior approval from the shareholders by way of an Ordinary Resolution is required. In such a vote, no member of the company who is a related party can vote on the resolution.

An important exemption exists for transactions that are both in the company's ordinary course of business and conducted on an arm's length basis. Such transactions do not require any Board or shareholder approval under Section 188.

What are the monetary limits for shareholder approval?

Shareholder approval is triggered when a transaction with a related party exceeds the thresholds defined in Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014. These limits are calculated based on the company's turnover or net worth.

Transaction Type	Shareholder Approval Required if Transaction Value Exceeds:
Sale, purchase, or supply of any goods or materials (directly or through an agent)	10% of the company's annual turnover or ₹100 crore, whichever is lower.
Selling or otherwise disposing of or buying property of any kind	10% of the company's net worth or ₹100 crore, whichever is lower.
Leasing of property of any kind	10% of the company's annual turnover or ₹100 crore, whichever is lower.
Availing or rendering of any services (directly or through an agent)	10% of the company's annual turnover or ₹50 crore, whichever is lower.
Appointment to any office or place of profit in the company, its subsidiary, or associate	Monthly remuneration exceeding ₹2.5 lakh.
Remuneration for underwriting the subscription of any securities	1% of the company's net worth.

Note: Turnover or net worth will be as per the last audited financial statements.

What is an "arm's length transaction"?

An arm's length transaction is a transaction between two parties that is conducted as if they were unrelated, so that there is no conflict of interest. The core principle is that the terms and conditions, especially the price, are fair and reflect market value. To prove a transaction is at arm's length, a company should ideally have supporting documentation, such as independent valuation reports, quotations from unrelated third parties for similar transactions, or other evidence demonstrating that the deal is commercially sound and not influenced by the relationship.

Worked example

Let's consider a scenario for a Bengaluru-based tech startup, 'CodeGenius Solutions Pvt. Ltd.'.

• Company Financials (FY 2025-26):
  • Annual Turnover: ₹8 crore
  • Net Worth: ₹3 crore
• Proposed Transaction: The company wants to hire a marketing consultant, Mr. Sharma. Mr. Sharma is the brother of one of the company's directors, making him a 'related party'.
• Contract Terms: The proposed service contract is for one year, with a total fee of ₹60 lakh.

Compliance Check:

1. Identify the Transaction Type: This is 'availing of any services'.
2. Check Shareholder Approval Threshold: For services, the limit is 10% of annual turnover or ₹50 crore, whichever is lower.
   • 10% of ₹8 crore turnover = ₹80 lakh.
3. Compare Transaction Value to Threshold: The contract value is ₹60 lakh. Since ₹60 lakh is less than the ₹80 lakh threshold, shareholder approval is not required.
4. Determine Board Approval Requirement: Since this is a specified RPT, it requires Board approval. The director whose brother is the consultant must disclose his interest, and he cannot participate in the Board meeting's discussion or vote on this resolution.
5. Arm's Length and Ordinary Course of Business: The company must also be able to justify that hiring a marketing consultant is in its ordinary course of business and that the ₹60 lakh fee is at an arm's length price (i.e., comparable to what would be paid to an unrelated consultant with similar expertise).

Common mistakes

1. Incomplete Identification of Relatives: Overlooking the broad definition of 'relative' under the Companies Act, leading to unintentional non-disclosure of RPTs.
2. Misinterpreting 'Ordinary Course of Business': Incorrectly assuming a transaction is 'ordinary' without it being a frequent, normal, or routine activity for that specific company. A one-off large real estate purchase by a software company, for example, is likely not in its ordinary course of business.
3. Lack of Arm's Length Justification: Proceeding with a transaction without any documentation (like a valuation report or market comparison) to prove the price is fair.
4. Procedural Errors in Meetings: Allowing an interested director to be counted for quorum or to vote at a Board meeting, or allowing a related party shareholder to vote on the special resolution.
5. Forgetting Statutory Registers: Failing to make the necessary entries in the Register of Contracts and Arrangements in which directors are interested (Form MBP-4).

How SP & SC helps

Navigating the complexities of Section 188 is crucial for good corporate governance and avoiding penalties. SP & SC provides comprehensive compliance support to ensure your company adheres to all legal requirements for related party transactions. We assist in identifying RPTs, advising on the correct approval process, drafting robust Board and shareholder resolutions, obtaining valuations to support arm's length pricing, and maintaining all required statutory registers under the Companies Act. Our goal is to make compliance seamless, allowing you to focus on your business. For detailed guidance, explore our tax and compliance consultation services.

Frequently asked questions

Can a related party vote on the resolution for their transaction?

No. The second proviso to Section 188(1) explicitly states that no member of the company who is a related party shall vote on an ordinary resolution passed to approve a contract or arrangement in which they are interested.

Does Section 188 apply to private companies?

Yes, Section 188 applies to both private and public companies. While the Ministry of Corporate Affairs has issued certain exemptions for private companies over time, the core requirements of Section 188 generally remain applicable. It is essential to check the latest notifications for any specific exemptions that may apply to your company. You can read more about a private limited company registration and its compliance.

What are the consequences of non-compliance with Section 188?

If a transaction is entered into without the required Board or shareholder approval, it is voidable at the option of the company. Further, under Section 188(5), if the contract is with a related party of a director, or is authorised by any other director, that director must indemnify the company against any loss incurred. Penalties can also be imposed: for listed companies, a fine up to ₹25 lakh, and for other companies, a fine up to ₹5 lakh for the director at fault.

Are transactions between a holding company and its wholly-owned subsidiary exempt?

Yes, there is a significant exemption. Transactions entered into between a holding company and its wholly-owned subsidiary whose accounts are consolidated with the holding company and placed before the shareholders at the general meeting for approval are exempt from the requirement of shareholder approval under Section 188(1).

How are RPTs disclosed in financial statements?

Related party transactions must be disclosed in the company's financial statements as per the applicable Accounting Standards (Ind AS 24). This includes disclosing the name of the related party, the nature of the relationship, the nature of the transactions, and the amounts involved.

Get a fixed-fee quote

Ensuring compliance with Section 188 requires careful documentation and procedural accuracy. To avoid penalties and maintain good governance, it's best to seek professional advice. Share your documents with us, and we will provide a written fixed-fee quote for handling your related party transaction compliance from end to end. Contact SP & SC or message us on WhatsApp at +91 90356 74566. We are here to help you navigate any corporate compliance challenge.