Related Party Transactions under Section 188 of the Companies Act, 2013

Related Party Transactions under Section 188 of the Companies Act, 2013

Companies often need to transact with entities connected to their own promoters or management — a subsidiary buying raw material from a director's other business, for instance. Because such transactions carry an inherent risk of being tilted in favour of the insider rather than the company, Section 188 lays down a structured approval and disclosure framework to protect minority shareholders and ensure fairness.

•      A director or key managerial personnel (KMP) or their relatives.

•      A firm in which a director, manager or their relative is a partner.

•      A private company in which a director or manager is a member or director.

•      A public company in which a director or manager is a director and holds, along with relatives, more than 2% of paid-up capital.

•      Holding, subsidiary or associate companies, and subsidiaries of a common holding company.

•      Any person on whose advice, directions or instructions a director or manager is accustomed to act (excluding professional advice).

•      Sale, purchase or supply of goods or materials.

•      Selling or disposing of, or buying, property of any kind.

•      Leasing of property of any kind.

•      Availing or rendering of services.

•      Appointment of any agent for purchase or sale of goods, materials, services or property.

•      Appointment of related parties to any office or place of profit in the company, its subsidiary or associate.

•      Underwriting the subscription of securities or derivatives of the company.

All related party transactions require prior approval of the Board through a resolution passed at a board meeting (not by circulation). If the transaction value exceeds thresholds prescribed under Rule 15 (varying by transaction type, generally a percentage of turnover or net worth), prior approval by an ordinary resolution of shareholders is also required. For listed companies, additional and often stricter requirements apply under SEBI's Listing Regulations, including audit committee approval for all related party transactions.

Transactions entered into by the company in its ordinary course of business and on an arm's length basis (i.e., as if between unrelated parties, on normal commercial terms) are exempt from the Section 188 approval requirement, though disclosure in the Board's Report (Form AOC-2) is still generally required for transparency.

A related party who is a member cannot vote on a shareholder resolution to approve a related party contract or arrangement (except where 90% or more of members, in number, are relatives of promoters or are related parties, in which case this restriction is relaxed for private companies).

•      Classifying a transaction as 'arm's length' without maintaining supporting benchmarking evidence.

•      Allowing an interested director to vote on a related party matter at the board or shareholder level.

•      Missing the shareholder approval requirement when a transaction crosses the prescribed Rule 15 threshold.

•      Failing to disclose exempt (ordinary course, arm's length) transactions in Form AOC-2, assuming exemption also means no disclosure.

Q1. Do all related party transactions require shareholder approval?

No, only those exceeding prescribed value thresholds under Rule 15 require shareholder approval by ordinary resolution; smaller transactions require only board approval, and ordinary-course arm's-length deals may be exempt altogether.

Q2. Is disclosure required even for exempt (arm's length, ordinary course) transactions?

Yes, particulars of such contracts are still generally disclosed in the Board's Report through Form AOC-2 for transparency, even though formal Section 188 approval is not required.

Q3. Can a wholly-owned subsidiary transaction with its holding company be exempt from shareholder approval?

Transactions between a holding company and its wholly-owned subsidiary, whose accounts are consolidated with the holding company and placed before shareholders at the general meeting for approval, are exempt from the shareholder approval requirement under Section 188, subject to conditions.

Q4. What is an 'office or place of profit'?

It refers to any office where the related party receives remuneration, fee, commission or benefit beyond what they'd get as a mere director; appointing a related party to such a position requires compliance with Section 188.

Q5. Are transactions with a company's own wholly-owned subsidiary always exempt from Section 188?

Transactions with a wholly-owned subsidiary can be exempt from the shareholder approval requirement if the accounts are consolidated and placed before shareholders, but board approval and other procedural requirements may still apply depending on the transaction's nature.

Q6. How is 'arm's length' pricing determined for related party transactions?

It generally follows the same commercial logic as transfer pricing under tax law — the terms should be comparable to what would be agreed between unrelated parties in similar circumstances, though the Companies Act does not prescribe a specific formal methodology like the Income-tax Act does.

Q7. Do related party transaction rules differ for listed companies?

Yes, SEBI's Listing Regulations impose additional, often stricter requirements on listed companies, including mandatory Audit Committee approval for all related party transactions and lower materiality thresholds for shareholder approval.

Related party transaction compliance is one of the most scrutinised areas in corporate governance because of its potential for insider benefit at the company's expense. Companies should maintain a robust related party identification and approval workflow, and document arm's length pricing carefully to justify any exemption claimed.