The Statutory Gateway
The third proviso to Section 188(1) exempts a related-party transaction from board and shareholder approval if it is in the ordinary course of business and on an arm’s length basis. Both conditions must be satisfied cumulatively. A transaction that is in the ordinary course but not at arm’s length remains within Section 188. A transaction at arm’s length but outside the ordinary course also remains within the section. The exemption is not a partial defence; it is a complete exemption only when both limbs are established.
The Absence of a Definition
“Ordinary course of business” is not defined in the Act. The MCA has not prescribed a quantitative test. The practical consequence is that the company bears the burden of constructing an evidentiary record that demonstrates the transaction is of a type that the company routinely enters into with unrelated parties, on terms that are comparable. A one-off transaction with a related party, even if priced at market, is difficult to characterise as ordinary course without a documented policy that treats it as such.
Building the Evidentiary Record
The file should contain: the company’s RPT policy defining ordinary course by reference to the nature of the transaction and the business of the company; a comparability analysis showing that the same type of transaction is entered into with unrelated parties; board minutes recording the basis for the ordinary-course conclusion; and pricing documentation demonstrating arm’s length. The audit committee should review the ordinary-course determination before the transaction is executed, not after the annual audit raises a query.
The Audit Committee’s Role
For companies required to constitute an audit committee, every related-party transaction—including those claiming the ordinary-course exemption—should be placed before the committee for noting or approval. The committee’s review of the ordinary-course character is the strongest contemporaneous evidence that the company applied its mind. A transaction executed without audit committee visibility, and later defended as ordinary course, is exposed to a finding that the exemption was invoked retrospectively.
Ordinary Course and Materiality
The ordinary-course exemption operates independently of the materiality thresholds. Even a transaction that exceeds the Section 188 monetary thresholds is exempt if it is in the ordinary course and at arm’s length. Conversely, a transaction below the threshold but outside the ordinary course still requires board approval. Materiality determines the approval tier when the exemption is unavailable; it does not create the exemption.
Documentation for the Auditor and the ROC
Form AOC-2 requires the company to state whether the transaction was in the ordinary course and at arm’s length. A “yes” without a supporting comparability file is a disclosure without substance. The ROC adjudicating a Section 188 violation will typically request the RPT policy, the audit committee minutes, the comparability analysis, and the pricing basis. If these documents do not exist, the ordinary-course claim collapses.
When the Exemption Should Not Be Claimed
A transaction that is structurally unusual for the company—an asset sale to a promoter entity, a loan to a related party outside the lending business, or a service arrangement with no comparable third-party contract—should not be forced into the ordinary-course box. The stronger course is to obtain board or shareholder approval and document the commercial rationale, rather than to assert an exemption that the file cannot support.
Call to Action: For an RPT ordinary-course documentation review or audit committee presentation, contact office@anujdesaiassociates.com or 9619456656. Website: https://anujdesaiassociates.com. LinkedIn: linkedin.com/in/ca-anuj-desai-122547230.