Related Party Transactions

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Related Party Transactions

The term “Related Party” when discussed in generality itself resembles that it talks about someone related but when we talk about the legal understanding of the same under the Corporate Law it is clearly defined under § 2(76) of the Companies Act, 2013. The definition provided under the Act is exhaustive in nature. Under the Companies Act, 2013, there is a concept of “Related Party Transactions” which has been incorporated under § 188 of the Act. Related Party Transactions basically happens when the management of the company enters into a contract with related parties, that is, officers and directors of the firm and their relatives, large shareholders, or other parties affiliated with these individuals. Such contracts are commonly referred to as related party transactions.[1] Over a period of time, the concept of related party transactions has been developed through a large number of case laws and certain amendments under the Companies Act. Analyzing the business and commercial transactions in the market it can be concluded that majorly wherever the larger organizations are involved the impact of their transactions always affect the people at large. If in such organizations there is any fraudulent act committed it would directly affect people, so further just to avoid such mishaps with the people’s vested interests such regulations have been brought into the Act. When we compare the Companies Act, 2013 with the Companies Act, 1956 incorporation of this concept was not there, but it was divided into several names in the latter Act, now in the former Act the concept has been incorporated specifically under § 188 of the Act with the clarity of the terms used, by the means of definitions under § 2 of the said Act. It is the duty of employee or the director to disclose the information and if such duty is violated on part of the employee or director, they are punishable with imprisonment up to one year or with a fine ranging between Rs. 25,000/- to Rs. 5,00,000/- or both if the default is made under listed companies, while for default in the other companies other than the listed companies only the abovementioned fine is charged.

That the application of the procedure under companies law regarding the related party transactions is not done in a proper manner which is not actually justified for the shareholders. The disclosure before the Registrar of Companies is although mandatory but the exception of arm’s length is being misused.

Legal provisions 

The transactions entered into by a company i.e. the principal should be disclosed to the shareholders i.e. agents and their rights should not be infringed by keeping them in disguise as they are the ones who have their financial interests vested with the company. To protect the rights and interests of these shareholders, The Companies Act, 2013 incorporates and establishes legal obligations on the Directors of the company to avoid the conflict of interests.

Under the Companies Act, 2013 § 188 talks about the Related Party Transactions which is read with the § 2(76) of the Act stating the definition of the related party. It includes-

“(i) a director or his relative; (ii) a key managerial personnel or his relative; (iii) a firm, in which a director, manager or his relative is a partner; (iv) a private company in which a director or manager is a member or director; (v) a public company in which a director or manager is a director or holds along with his relatives, more than two per cent. of its paid-up share capital; (vi) any body corporate 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; (vii) any person on whose advice, directions or instructions a director or manager is accustomed to act; (viii) any company which is— (A) a holding, subsidiary or an associate company of such company; or (B) a subsidiary of a holding company to which it is also a subsidiary; (ix) such other person as may be prescribed”[2].

The established Principal-Agent relationship always include the fiduciary interests of the agent towards the principal.[3] To act in a fair or impartial manner, the Directors should be free of conflicting interests. If the Directors will be having personal vested interests in a company they may act in a prejudicial manner.[4] The contract becomes voidable if there is no disclosure by the Director that he is related or is having an interest in a particular transaction.[5] Under § 2(49) and § 184 of the Companies Act, 2013 lies the duty of the director to disclose the information to avoid the conflict of interests.

There’s an exception under which the related party transactions are approved i.e. Arm’s Length Transaction. It is not objectively defined under the Companies Act, 2013 but the concept of the same is provided under the explanation of § 188(1) of the Act which states that both the parties enter into the transaction as if being unknown to each other, additionally that both the parties act in their own interests and are not influenced with either of them so that there is no conflict of interests at the later stage.

For the approval of the same, employee or director interested in the transaction has to disclose all the information in reference to the related party as to why the transaction is being entered into with the related party, details of the transaction and its term, etc. before the Board of the company. Also, a special resolution is to be passed for the approval under which the interested director is not allowed to vote.

Comparision between Laws in India & Belgium

The Belgian approach to Related Party Transactions and minority protection relies to a great extent on transparency. The definition of Related Party Transactions and Related Parties (RPs) follows the International Accounting Standards (IAS).[6] While in India, Indian Accounting Standard 24 (Ind AS 24) governs the Related Party Transactions. Article 524 of the Belgium Company Law establishes an obligation over the Belgian companies to disclose about the intra-company transactions which are the transactions entered into between two subsidiary companies of a parent company. Also, a mandate is present before the directors of the companies to disclose the information before the auditor’s committee and the shareholders. Analyzing the Companies Act, 2013 (India) it can be concluded that the concept of intra-company transactions is still subjective in India also prior to this Act there was no clarity under the concept of related party transactions under the Indian laws and based on the principles of common law precedents the concept has been developed in this era. In the meantime, the Belgian laws have been developed and the process of board approval, committee approval, the disclosure of information in detail has been incorporated. The author is of the view that the Companies Act, 2013 when glanced into indicates that the incorporation of these laws in India is borrowed from the Belgian laws and the development in these laws is done according to the application in the Indian society. When analyzing the Belgian laws in reference to the Related Party Transactions it can be assessed that the Belgian laws have tried to cover a huge part but there are loopholes which can be taken advantage of by the Directors under the transactions between a company and its subsidiaries to the second degree are exempted which ties in with accounting law in Europe that restricts compulsory disclosure to consolidated accounts that also eliminate transactions between parent companies and direct subsidiaries[7] violating the concept of intra-company transactions. Therefore, when compared with this concept there might be a loophole when exclusion of subsidiaries are present and the shareholders are not aware of the transactions being entered into which may violate their vested interests with the company.

Conclusion & Suggestions

After the detailed analysis of the Companies Act, 2013 with reference to Related Party Transactions, the author is of the view that it is necessary for the Directors to disclose the information to the Board and auditors, when entering into the related party transactions in the ordinary course of business and for the approval a resolution is to be passed by the Board. But, under the Act ordinary course of business has not been clearly defined and has been left subjective in nature. Further, considering the Arm’s Length Transactions such related party transactions are allowed if the Board and Audit committee approves it. As per the author, this exception can be taken advantage of for entering into transactions with the related parties if the procedures as per the mandate are not followed. A special committee should be established assisting the registrar of companies to keep a check upon the companies. When compared with the earlier Act there was no such provision which could provide for the loss suffered due to related party transactions but in the present Act there are fines and punishment of imprisonment which have been incorporated to protect the interests of the shareholders and to create a locus standi before the court when there is any default. The author’s hypothesis has been proved negative in the present paper. Comparison with the Belgian laws has made it evident that the Act has been developed to a very large extent with the developments through decades and legal understanding of the issues in the matter. A whole new concept of the Related Party Transactions has been introduced to bring clarity for the people and to avoid further discrepancies. In addition, the level of a check of the process in the hierarchy that has been incorporated has been able to reduce the level of frauds and defaults on the part of the employee or director making the business more transparent and viable for the shareholders.

Frequently Asked Questions

1. A corporate group has several foreign subsidiaries. Will provisions in relation to related parties apply to foreign companies as well?

The term ‘company’, as defined under the Companies Act 2013, is a company incorporated under this Act or any previous company law. The company incorporated under the relevant legislation of a foreign country is not a ‘company’ under Companies Act 2013. However, transactions by an Indian company with a foreign company, which is a subsidiary, associate, fellow subsidiary, joint venture of the same venturer or company under control of the same promoter, would be covered, based on an understanding of combined reading of revised clause 49 and Companies Act 2013

2. What is the meaning of arm’s length? Is meaning of arm’s length same as transfer pricing rules?

Arm’s length transaction means a transaction between two related parties which is conducted as if they were unrelated so that there is no conflict of interest. Most commonly used guidance in this regard under income tax provisions is given in international and domestic tax laws in the context of transfer pricing regime. One may even refer to rules for registered valuers wherein valuation methodologies are prescribed for registered valuers. It should be noted that these guidelines are not conclusive and have only persuasive value. One may consider various qualitative and quantitative assessments to determine arm’s length

3. Under the regulations, no member of the company is permitted to vote on a special resolution to approve any contract or arrangement which may be entered into by the company, if such a member is a related party. Does the bar from voting apply to all shareholders who are related parties or only those related parties who are conflicted?

In cases where shareholders are ‘related’ in some way or the other with the company (but are neither the intended transacting party nor interested in the transaction directly or indirectly that has been put up for approval) it will be inappropriate to interpret the law to say that all such shareholders are prohibited from voting. The principles of “the majority of minority” voting must not result in any unfair advantage to the minority. However, a plain reading of the regulations would suggest all related parties shall abstain from voting, whether related or unrelated. Consultation with legal experts might be required to ascertain the intent of these provisions.

4. In case of Companies Act, is the board required to approve all related party transactions?

The Companies Act 2013 prescribes that a company needs the approval of the audit committee on all related party transactions and subsequent modifications thereto. This is irrespective of whether they are in the ordinary course of business and consummated at arm’s length price or they are below prescribed thresholds. Further, for listed companies, clause 49 prescribes audit committee approval for all related party transactions and shareholders approval of all material RPTs. For normal transactions, if the company has a well laid down policy framework which explicitly lays down terms of contract/transaction and which are approved by audit committee then a separate approval will be unwarranted for each such transaction.

Edited by – Sakshi Agarwal

Approved & Published – Sakshi Raje

Reference

[1] MICHAEL RYNGAERT AND SHAWN THOMAS, Not All Related Party Transactions (Related Party Transactions) Are the Same: Ex Ante Versus Ex Post Related Party Transactions, JOURNAL OF ACCOUNTING RESEARCH, Vol. 50, No. 3, 845-882 (2012),

[2] The Companies Act, 2013, No. 18, Act of Parliament, 2013 (India).

[3] Avtar Singh, Company Law, 325 (17th ed. 2018).

[4] Aberdeen Railway Ltd. v. Blaikie Bros. (1854) 1 Macq 461(HL).

[5] Supra at 5.

[6] ORGANIZATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT, Related Party Transactions and Minority Shareholder Rights.

[7] Supra at 8.

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Shipra Sayal
I am Shipra Sayal from Nirma University, Institute of Law pursuing B.Com LLB (Hons.) Corporate law, Company law and Securities law form part of my core interest area. I love to keep myself updated with news, law and politics. I participate in Moots and Trial Advocacy competitions. My leisure time activities are playing badminton and cricket. I also enjoy watching sci-fi series and movies. I love to read, write and research as this helps a lot in shaping one’s personality and honing skills. I believe in smart work and efficient time management to get success at any work