Sec 188

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18 January 2016 What is the status of Private company with respect to Sec 188 related party transactions?

Also, what if the majority of the shareholders are interested, How can the OR be passed?

Arpit Shah

Arpit Shah (Expert)
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19 January 2016 Related Party Transaction Under Companies Act, 2013

Related Party Transaction Under the Companies Act, 2013:
INTRODUCTION:
Meaning of related party:
Section 2(76) of the Companies Act, 2013 (“the Act”) defines the word “related party”:
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 or his relative is a member or director;
v. a public company in which a director or manager is a director and 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:
Provided that nothing in sub-clauses (vi) and (vii) shall apply to the advice, directions or instructions given in a professional capacity;
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;
For the purposes of sub-clause (ix) a director or key managerial personnel of the holding company or his relative with reference to a company, shall be deemed to be a related party – Rule 3 of Companies (Specification of definitions details) Rules, 2014.
Ministry of Corporate Affairs issued the Companies (Removal of Difficulties) Fifth Order, 2014 dated 9th July, 2014 and clarified that the word “OR” in sub-clause (v) has appeared inadvertently and therefore defeating the intention of this clause. The word “AND shall be substituted for the word “OR”.
MCA issued Companies (Removal of Difficulties) Sixth Order, 2014 dated 24th July, 2014 and clarified that in sub-clause (iv)after the word “manager” the word “OR HIS RELATIVE” shall be inserted.
MCA vide exemption Notification dated 5th July, 2015 exempted private companies from clause (viii) of Section 2(76) for the purpose of Section 188 of the Act.
After this exemption notification in case of private companies holding, subsidiary or associate companies will not be related parties for the purpose of Section 188 unless they fall any other category as specified in Section 2(276).
Nature of transaction:
The Companies Act, 2013 widened the scope of related party transaction. The Companies Act, 1956 covered only purchase or sale of goods or supply of services and subscription of any shares or debentures of the company under the related party transaction. However, Companies Act, 2013 has brought immovable properties and leasing of property also under the ambit of related party transaction.
Approval of Board of directors:
Section 188(1) of the Act provides that except with the consent of the Board of Directors given by a resolution at a Meeting of the Board and subject to such conditions as may be prescribed, no company shall enter into any contract or arrangement with a related party with respect to—
a. sale, purchase or supply of any goods or materials;
b. selling or otherwise disposing of, or buying, property of any kind;
c. leasing of property of any kind;
d. availing or rendering of any services;
e. appointment of any agent for purchase or sale of goods, materials, services or property;
f. such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company; and
g. Underwriting the subscription of any securities or derivatives thereof, of the company.
The agenda of the Board meeting at which the resolution is proposed to be moved shall disclose-
a. the name of the related party and nature of relationship;
b. the nature, duration of the contract and particulars of the contract or arrangement;
c. the material terms of the contract or arrangement including the value, if any;
d. any advance paid or received for the contract or arrangement, if any;
e. the manner of determining the pricing and other commercial terms, both included as part of contract and not considered as part of the contract;
f. whether all factors relevant to the contract have been considered, if not, the details of factors not considered with the rationale for not considering those factors; and
g. any other information relevant or important for the Board to take a decision on the proposed transaction.
Where any director is interested in any contract or arrangement with a related party, such director shall not be present at the meeting during discussions on the subject matter of the resolution relating to such contract or arrangement.
Approval of the company by Ordinary resolution:[1]
MCA has amended the Companies (Meetings of Board and its Powers) Rules, 2014 vide Companies (Meetings of Board and its Powers) Second Amendment Rules, 2014 on 14th August, 2014 and changed the criteria for passing of special resolution for related party transaction.
(a) As contracts or arrangements with respect to clauses (a) to (e) of sub-section (1) of section 188, with criteria as mentioned below –
i. Sale, purchase or supply of any goods or materials, directly or through appointment of agent, exceeding ten per cent. of the turnover of the company or rupees one hundred crore, whichever is lower, as mentioned in clause (a) and clause (e) respectively of sub-section (1) of section 188;
ii. Selling or otherwise disposing of or buying property of any kind, directly or through appointment of agent, exceeding ten per cent of net worth of the company or rupees one hundred crore, whichever is lower, as mentioned in clause (b) and clause (e) respectively of sub-section (1) of section 188;
iii. Leasing of property of any kind exceeding ten per cent of the net worth of the company or ten per cent. of turnover of the company or rupees one hundred crore, whichever is lower, as mentioned in clause (c) of sub-section (1) of section 188;
iv. Availing or rendering of any services, directly or through appointment of agent, exceeding ten per cent. of the turnover of the company or rupees fifty crore, whichever is lower, as mentioned in clause (d) and clause (e) respectively of sub-section (1) of section 188:
Explanation.—It is hereby clarified that the limits specified in sub-clauses (i) to (iv) shall apply for transaction or transactions to be entered into either individually or taken together with the previous transactions during a financial year.
(b) For appointment to any office or place of profit in the company, its subsidiary company or associate company at a monthly remuneration exceeding two and half lakh rupees as mentioned in clause (f) of subsection (1) of section 188; or
(c) For remuneration for underwriting the subscription of any securities or derivatives thereof, of the company exceeding one per cent. of the net worth as mentioned in clause (g) of sub-section (1) of section 188.
Explanation.- (1) The Turnover or Net Worth referred in the above sub-rules shall be computed on the basis of the Audited Financial Statement of the preceding Financial year.
No member of the company shall vote on such resolution, if he is a related party, to approve any contract or arrangement which may be entered into by the company. However, MCA has exempted to private companies from this requirement vide notification dated 5th July, 2015.
MCA vide circular no 30/2014 dated 17th July, 2014 clarified that word “related party” referred to in the second proviso has to be construed with reference only to the contract or arrangement for which the said special resolution is being passed.
MCA also clarified that contracts entered into by companies, after making necessary compliances under Section 297 of the Companies Act, 1956, which already came into effect before the commencement of Section 188 of the Companies Act, 2013, will not require fresh approval under the said section 188 till the expiry of the original term of such contracts. Thus, if any modification in such contract is made on or after 1st April, 2014, the requirements under section 188 will have to be complied with.
The explanatory statement to be annexed to the notice of a general meeting convened pursuant to section 101 shall contain the following particulars namely:-
(a) Name of the related party ;
(b) Name of the director or key managerial personnel who is related, if any;
(c) Nature of relationship;
(d) Nature, material terms, monetary value and particulars of the contract or arrangement;
(e) Any other information relevant or important for the members to take a decision on the proposed resolution.
After the amendment of Companies (Meetings of Board and its Powers) Rules, 2014 on 14th August, 2014 essence of related party is changed entirely. Now every company whether small or big, private or public will be required to pass ordinary resolution for related party transaction. MCA has removed paid-up capital criteria for ordinary resolution.
The Companies (Amendment) Act, 2015 passed by Parliament and made following changes for related party transaction:
Empowering Audit Committee to give omnibus approvals for related party transactions proposed to be entered into by the company subject to such conditions as may be prescribed.
The amendments include replacing “special resolution” with “ordinary resolution” for approval of related-party transactions.
Exempt related party transactions between holding companies and wholly owned subsidiaries from the requirement of approval.
Transactions entered into by the company in its ordinary course of business and undertaken at an arm’s length basis do not need any prior approval:
The word “ordinary course of business” is not defined in the Companies Act, 2013 or in Rules made thereunder.
No specific criteria have been provided in the Act whether the transaction is in ordinary course or not. Whether the transaction entered is ordinary course of business or not will depend on the particular business activity of the company. Transaction in ordinary course of business will cover the usual transactions of a business and of a company.
One should consider variety of factors to determine whether the transaction is in ordinary course or not like size, volume, frequency, purpose of transaction etc.
Arm’s length transaction meaning:
Arm’s length transaction means a transaction between two related parties which is conducted as if they are unrelated, so that there is no conflict of interest.
If a transaction fulfills both the criteria no approval will be required under section 188 of the Act.
To minimise confusion and litigation, the government will bring fresh guidelines to clearly explain the meaning of terms “arm’s length basis” and “ordinary course of business”, used in the Companies Act, 2013.[2]
Disclosures:
Every contract or arrangement entered into under sub-section (1) of the Act shall be referred to in the Board’s report to the shareholders along with the justification for entering into such contract or arrangement.
Applicability:
Section 188 of the Act is applicable to all kinds of companies whether private or public.
MCA issued exemption notification dated 5th July, 2015 to give certain exemptions to private limited companies for related party transaction.
The notification does not five full exemptions to private companies but it gives exemption to private companies with some riders.
It has exempted private companies from Section 2(76)(viii) for the purpose of Section 188.
A related party can vote for ordinary resolution is case of related party transaction.
Consequences of contravention:
Where any contract or arrangement is entered into by a director or any other employee, without obtaining the consent of the Board or approval by a ordinary resolution in the general meeting-
and if it is not ratified by the Board; or
by the shareholders at a meeting within three months from the date on which such contract or arrangement was entered:
such contract or arrangement shall be voidable at the option of the Board and if the contract or arrangement is with a related party to any director, or is authorised by any other director, the directors concerned shall indemnify the company against any loss incurred by it – Section 188(3).
Recovery of loss:
It shall be open to the company to proceed against a director or any other employee who had entered into suchcontract or arrangement in contravention of the provisions of this section for recovery of any loss sustained by it as a result of such contract or arrangement – Section 188(4).
Penal Provisions:
Any director or any other employee of a company, who had entered into or authorized the contract or arrangement in violation of the provisions of this section shall,—
in case of listed company, be punishable with imprisonment upto one year or with fine not less than twenty-five thousand rupees but which may extend to five lakh rupees, or with both; and
in case of any other company, be punishable with fine not less than twenty-five thousand rupees but which may extend to five lakh rupees.
Central Government approval:
The Companies Act, 2013 has removed central government approvals for related party transaction which was mandatory under the 1956 Act for companies having paid-up share capital of rupees one crore or more.
Conclusion:
The Companies Act, 2013 extended the compliance required in case of related party transaction. The amended provisions issued by the Ministry in the name of Companies (Meeting of Board and its Powers) Second Amendment Rule, 2014 made harder for private and small companies to comply with related party transaction and as well increased the practical difficulties to larger companies.
The parliament has passed the Companies (Amendment) Act, 2015 which replace “special resolution” with “ordinary resolution” for approval of related-party transactions by minority shareholders and also exempt related party transactions between holding companies and wholly owned subsidiaries from the requirement of approval of non-related shareholders. These amendments will provide a big relief to corporate for related party transaction.
Disclaimer : Kindly note that the entire content of this Article have been developed on the basis of relevant statutory provisions and as per the information existing at the time of preparation of i.e Act, Rules, notification, clarification, circulars, issued by MCA, SEBI or any other statutory authority. Though I have made upmost efforts to provide authentic information, however, I do not undertake any liability in any way whatsoever, to any person in respect of anything arising by reliance upon the content of this article. It shall not be used as a legal opinion and not to be used for rendering any professional advice.

[1] Amended under the Companies (Amendment) Act, 2015 from Special resolution to Ordinary resolution.
[2] http://www.business-standard.com/article/companies/govt-to-bring-guidelines-for-arm-s-length-basis-and-ordinary-course-of-business-114120400196_1.html

Arpit Shah

Arpit Shah (Expert)
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19 January 2016 Related Party Transaction Analysis- Section 188 of Companies Act 2013

Applicability of Section 188: Section 188 Related to related Party Transaction applies to Both Public Limited and Private Limited Companies.
Related Party with reference to a Company, means –
a director or his relative;
a Key Managerial Personnel or his relative;
a firm, in which a director , manager or his relative is a partner;
a private company in which a director or a manager is a member or director;
a public company in which a director or a manager is a director or holds along with his relatives, more than 2% of its paid-up share capital;
any Body corporate whose Board of Directors, managing director or a manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager;
any person on whose advice, directions or instructions a director or a manager is accustomed to act
Provided that nothing in sub-clauses (vi) and (vii) shall apply to the advice, directions or instructions given in a professional capacity;
any company which is—
a holding, subsidiary or an associate company of such company; or
a subsidiary of a holding company to which it is also a subsidiary
For example, Mr. Y is a practicing Company Secretary and if the Board of X Ltd considers his advice and acts upon it, he cannot be considered as a related party to any one or to that Company in anyway as Mr. Y is in a Professional Capacity
Relative:
Relative, with reference to any person, means anyone who is related to another, if –
(i) they are members of a Hindu Undivided Family
(ii) they are husband and wife; or
(iii) one person is related to the other in such manner as may be prescribed;
A person shall be deemed to be the relative of another, if he or she is related to another in the following manner:-
Father – includes step – father
Mother – includes step- mother
Son – includes step – son
Son’s Wife
Daughter
Daughter’s husband
Brother – includes step- brother
Sister – includes step – sister
Transactions:

“Office or place of profit”
(i) where such office or place is held by a director, if the director holding it receives from the Company anything by way of remuneration over and above the remuneration to which he is entitled as director, by way of salary, fee, commission, perquisites, any rent – free accommodation, or otherwise;
(ii) where such office or place Is held by an individual other than a director or by any firm, private company or other body corporate, if the individual , firm, private company or body corporate holding it receives from the company anything by any way of remuneration, salary, fee, commission, perquisites, any rent-free accommodation, or otherwise;
Arm Length Transaction
It means a transaction between two unrelated parties that is conducted as if they were unrelated, so that there is no conflict of interest. (i.e.) there is no need to put any interest by any party in such contract by any way.
In short, there is no interest in any contract; such contract automatics cover the meaning of Arm Length Transactions.
The ultimate scope of this section is “interest”, if any interest is there by anyway the Section shall be effective, if there is no interest is there, the section shall be in neutral.
Approval
♠ BOARD APPROVAL:
All Companies must get Board’s approval irrespective of the Capital of the company or value of the transaction.
The Approval Should be sought at a duly convened Board Meeting.
The Approval cannot be obtained by passing a circulation resolution
All the directors of the Company including the “Interested Directors” (Related parties to such contract) can participate in the Board Meeting.
But the Directors who are related to the contracts which are going to be discussed in the meeting shall not be present at the meeting during the discussion alone.
The Directors who are related parties to such contract or agreement cannot vote for the same.
Quorum
The Quorum for the Board Meeting where Related Party Transaction is discussed should form 2/3rd majority excluding the Interested directors.
For example, X Ltd is having 6 Directors in which 2 directors are related parties. When the Board Meeting is held and the Quorum for the Meeting should be (6*2/3= 4). Therefore excluding the related parties, the rest of the directors fulfilled the quorum and so meeting was held.
Shareholder’s Approval
Companies having paid-up share capital of Rs.10 Crores or more
Or
Sale, purchase or supply of any goods or materials directly or through appointment of agents exceeding 25% of the annual turnover
Selling or otherwise disposing of, or buying, property of any kind directly or through appointment of agents exceeding 10% of net worth
Leasing of property of any kind exceeding 10% of the net worth or exceeding 10% of turnover
Availing or rendering of any services directly or through appointment of agents exceeding 10% of the net worth
Appointment to any office or place of profit in the company, its subsidiary company or associate company at a monthly remuneration exceeding Rs. 2.5 Lakhs
Remuneration for underwriting the subscription of any securities or derivatives thereof of the company exceeding 1% of the net worth
Important Points:
Turnover or net worth shall be on the basis of the Audited Financial Statements of the preceding financial year.
No Member of the Company shall vote on such special resolution to approve any contract or arrangement if such member is a related party
In case of wholly owned subsidiary, the special resolution passed by the holding company shall be sufficient for the purpose of entering into the transactions between wholly owned subsidiary and holding company.
Exemption
The Section will not apply to transactions entered by the Company in its Ordinary course of business, on arm’s length basis.
The term “Ordinary Course of business” will cover the usual transactions, practices and customs of a business and of a Company.
Disclosures
Disclosures to be made in notice of the Board:
The Board Meeting agenda at which the resolution is proposed to be moved shall disclose the following:
name of the related party and nature of relationship;
nature, duration of the contract and particulars of the contract or arrangement;
material terms of the contract or arrangement including the value, if any;
any advance paid or received for the contract or arrangement, if any; and
the manner of determining the pricing and other commercial terms, both included as part of contract and not considered as part of the contract;
whether all factors relevant to the contract have been considered, if not, the details of factors not considered with the rationale for not considering those factors; and
any other information relevant or important for the Board to take a decision on the proposed transaction.
Disclosure by interested Directors:
Every director of a company who is in any way, whether directly or indirectly, concerned or interested in a contract or arrangement or proposed contract or arrangement entered into or to be entered into:
with a body corporate in which such director or such director in association with any other director, holds more than 2% shareholding of that body corporate, or
with a body corporate in which such director is a promoter, manager, Chief Executive Officer of that body corporate; or
with a firm or other entity in which, such director is a partner, owner or member, as the case may be
shall disclose the nature of his concern or interest at the meeting of the Board at which the contract or arrangement is discussed.
Disclosures to be made in the explanatory statement to be annexed to notice of general meeting:
name of the related party ;
name of the director or key managerial personnel who is related, if any;
nature of relationship;
nature, material terms, monetary value and particulars of the contract or arrangement;
any other information relevant or important for the members to take a decision on the proposed resolution.
Disclosures to be made in Board’s Report:
Every related party transaction or contract shall be disclosed in the Board’s report along with the justification for entering into such contract or arrangement.
Disclosures to be made in Register of contracts or arrangements in which directors are interested
Every company shall maintain one or more registers in Form MBP 4, and shall enter therein the particulars of contracts or arrangements with a related party with respect to transactions to which section 188 applies.
Format of MBP-4
MBP4
Non-Compliance
Any contract or arrangement entered into by any Director or any other employee, without obtaining the consent of the Board or approval by special resolution in the general meeting and if it is not ratified by the Board or, as the case may be, by the shareholders at the meeting within 3 months from the date on which such contract or arrangement was entered into, then in case if such contract or arrangement is entered with related party to any director, or is authorised by any other director, the Directors concerned shall indemnify the Company against any loss incurred by it.
No Central Government approval is required for entering into any related party transactions.
No approval of Central Government is required for appointment of any Director or any other person to any office or place of profit in the Company or its Subsidiary.
Penalty
The Company can take necessary actions against any Director or employee in case any transaction is entered without the consent of the Board or Company for recovery of any loss sustained by it.
In case of default of any Director or other employee of the company, who had authorized the contract or arrangement in violation of the provisions of this section shall –
(i) In case of Unlisted Company, be punishable with fine which shall not be less than Rs.25,000 but which may extend to Rs.5,00,000.
(ii) In case of Listed Company, be punishable with an imprisonment for a term which may extend to 1 year or with fine which shall not be less that Rs. 25,000 but which may extend to Rs.5,00,000, or with both.

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