A related party transaction (RPT) is a transaction between the company and a related party. A related party includes directors, key managerial personnel, their relatives and their firms or companies. Section 188 of the Companies Act, 2013 governs RPTs.
The ordinary course and arm's length
A transaction is outside the scope of Section 188 if it is in the ordinary course of business and at arm's length. "Ordinary course" means the transaction is part of the company's normal business. "Arm's length" means the transaction is on terms that would apply between unrelated parties. If both conditions are met, the transaction does not need the Section 188 approval.
The approval requirement
If the transaction is not in the ordinary course or not at arm's length, it requires approval:
- Board approval, by a resolution at a board meeting
- Shareholder approval, by an ordinary resolution, if the transaction exceeds the prescribed threshold
The board approval must be obtained before the transaction. The shareholder approval must be obtained before the transaction, and the related party cannot vote on the resolution.
The audit committee approval
For listed companies, the audit committee must approve the RPT. For unlisted companies, the audit committee approval is not mandatory, but it is good practice.
The practical points
The company should identify the related parties and the transactions. It should determine whether the transaction is in the ordinary course and at arm's length. If it is, the Section 188 approval is not needed. If it is not, the company should obtain the board or shareholder approval before the transaction.
Call to Action: We advise companies on RPT identification, approval and Section 188 compliance. For an RPT review, contact office@anujdesaiassociates.com, Ph No. 9619456656, Website https://anujdesaiassociates.com, LinkedIn linkedin.com/in/ca-anuj-desai-122547230.