Understanding the Vital Restriction on Directors in Relation to Company

Table of Contents

1. Contracts in which directors are interested
2. Restrictions on loans to directors
3. Related Party Transactions

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1. Contracts in which directors are interested

A director must work in the best interests of the company, as he is in fiduciary relationship with the company. He should not take undue advantage of his position as ‘director’ of the company. He should not make any secret profit. In order to ensure that he does not misuse his position, certain responsibilities have been cast on him.

Interested director – The term “Interested director” was defined in section 2(49) of Companies Act, 2013 as existing upto 9-2-2018. This definition has been omitted w.e.f. 9-2-2018, as the definition was too broad. Hence, now the term ‘interested director’ will apply to (a) contracts or arrangements as specified in section 184(2) of Companies Act, i.e. more than 2% shareholding or CEO of the body corporate or firm where director is partner, owner or member (b) Loans where director is interested as per section 185(2) of Companies Act, 2018 (c) Related party transactions under section 188 of Companies Act, 2013.

1.1 Disclosure of interest in contract or arrangement

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 by company shall disclose the nature of his concern or interest at the meeting of the Board in which the contract or arrangement is discussed. He shall not participate in such meeting.

The contract or arrangement may be –

(a) 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 is a promot­er, manager, Chief Executive Officer of that body corporate; or

(b) with a firm or other entity in which, such director is a partner, owner or member, as the case may be – section 184(2) of Companies Act, 2013 [Corresponding to section 299(1) of the 1956 Act].

In case of section 8 (licensed i.e. non-profit) companies, the disclosure is required only if transaction with related party exceeds Rs one lakh – MCA Notification dated 5-6-2015 issued under section 462 of Companies Act, 2013.

If director becomes interested at a later stage – If any director was not so concerned or interested at the time of entering into such contract or arrange­ment, but became concerned or interested after the contract or arrangement is entered into, he shall disclose his concern or interest forthwith when he becomes concerned or interested or at the first meeting of the Board held after he becomes so concerned or interested – proviso to section 184(2) of Companies Act, 2013.

Contract voidable at option of assessee if interest not disclosed or director participated in the Board meeting – A contract or arrangement entered into by the company without disclosure by director as required under section 184(2) or with participation by a director who is concerned or interested in any way, directly or indirectly, in the contract or arrangement, shall be voidable at the option of the company – section 184(3) of Companies Act, 2013.

Thus, the contract is not void ab initio. It becomes void only if company does so.

No prohibition on entering into contract with company, unless prohibited under other law – There is no prohibition under the Companies Act on entering into contract with company. However, if there is restriction or prohibition is some other rule or law, that restriction or prohibition will prevail – section 184(5)(a) of Companies Act, 2013.

Contract or arrangement between two companies or body corporates where director holds 2% or more paid up capital – Provisions of section 184 of Companies Act, 2013 shall apply only to any contract or arrangement entered into or to be entered into between

(a) two companies or

(b) between one or more companies and one or more bodies corporate, where any of the directors of the one company or body corporate or two or more of them together holds or hold 2% or more of the paid-up share capital in the other company or the body corporate- section 184(5)(b) of Companies Act, 2013 – words in italics inserted w.e.f. 9-2-2018.

While calculating the 2% shares in other company, only investment of directors is considered. Investment of his relatives is not to be considered. [This seems to be a loophole].

If the director is a partner in any firm, the provisions in respect of interest apply irrespective of the investment of the director in the firm or the ratio of profit in such partnership firm, i.e. even if his share of profit is less than 2% in partnership firm, or his investment is less than 2% in the firm, he is regarded as interested in the contract with that partnership firm.

In Needle Industries (India) Ltd. v. Needle Industries Newey (1981) 51 Comp Cas 742 = (1981) 3 SCR 698 = (1981) 3 SCC 333 = AIR 1981 SC 1298 = (1982) 1 Comp LJ 1 (SC), it was held mere sentimental interest or ideological concern or friendship is not enough to make a person ‘interested director’.

1.2 Disclosure to be made in meeting of Board of Directors

The disclosure of interest should be made in the meeting of Board of Directors. Disclosure by circulating the details to directors is not admissible as disclosure – section 184(1) of Companies Act, 2013 [corresponding to section 299(1) and 299(3)(c) of the 1956 Act]

Rule 8(5) of Companies (Meetings of Board and its Powers) Rules, 2014 had made the same provision. This sub-rule has been omitted w.e.f. 18-3-2015. However, still, in view of section 184(1) of Companies Act, 2013, the disclosure is required at Board meeting only.

There is no restriction in making disclosure in Board meeting through video conference.

1.3 General notice to Board

Every director shall disclose his concern or interest in any company or companies or bodies corporate, firms, or other association of individuals which shall include the shareholding, in such manner as may be prescribed. The disclosure shall be –

(a) at the first meeting of the Board in which he participates as a director

(b) thereafter at the first meeting of the Board in every financial year or

(c) whenever there is any change in the disclosures already made, then at the first Board meeting held after such change – section 184(1) of Companies Act, 2013 [corresponding to section 299(3)(a) of the 1956 Act].

The disclosure should be in form MBP.1. It is his duty to ensure that it is disclosed at the meeting held immediately after date of notice – Rule 9 of Companies (Meetings of Board and its Powers) Rules, 2014.

Normal practice is that all directors used to submit a list of companies in which they are directors, companies in which they hold shares and firms in which they are partners/proprietors. Such notice expires at the end of financial year and it is renewed by giving fresh notice in the first Board meeting of next financial year.

Notices must be kept at registered office and in proper custody – All notices given by directors should be kept at registered office and preserved for eight years from end of financial year. These should in custody of Secretary or person authorized by Board – Rule 9(3) of Companies (Meetings of Board and its Powers) Rules, 2014.

Specific disclosure when contract comes for discussion even if general disclosure made and non-participation in meeting – Even if general disclosure as required under section 184(1) of Companies Act, 2013 has been made, specific disclosure is required when the contract comes before the Board for discussion.

When the contract comes for discussion, the interested director shall not participate in the Board meeting – section 184(2) of Companies Act, 2013.

In case of private company, the director is required to disclose his interest in contract. Then he can participate in the meeting (and vote) – MCA Notification dated 5-6-2015 issued under section 462 of Companies Act, 2013.

1.4 Effect of non-disclosure of interest

If a director fails to disclose his interest in any contract or arrangement to Board of Directors as required, his office as director becomes vacant – section 167(1)(e) of Companies Act, 2013 [Corresponding to section 283(1)(i) of the 1965 Act]

If a director of the company contravenes the provisions of section 184 of Companies Act, 2013 [relating to disclosure], he shall be liable to a penalty of one lakh rupees – – section 184(4) of Companies Act, 2013 as amended on 21-12-2020.

Earlier, there was provision for imprisonment and fine.

Thus, contract continues to be valid and enforceable, unless it is avoided by Board.

2. Restrictions on loans to directors

The restrictions are covered under section 185 of Companies Act, 2013. This entire section has been re-written w.e.f. 7-5-2018.

Under revised provisions, loans to directors or firms in which they are interested can be only as per provisions of section 185 of Companies Act.

As per section 185(1) of Companies Act, 2013, as substituted w.e.f. 7-5-2018, no company shall, directly or indirectly advance any loan, including any loan represented by a book debt to or give any guarantee or provide any security in connection with any loan taken by

(a) any director of company or of a company which is holding company or any partner or relative of any such director or

(b) any firm in which any such director or relative is a partner.

Such loan or security or guarantee can be given in connection with any loan taken by any person in whom any of the directors of the company is interested, if

(a) special resolution is passed in general meeting and

(b) the loans are utilised by borrowing company for its principal business activities – section 185(2) of Companies Act, 2013, as substituted w.e.f. 7-5-2018.

Explanatory statement to proposed special resolution – The explanatory statement attached to notice of general meeting shall disclose the full particulars of the loans given, or guarantee given or security provided and the purpose for which the loan or guarantee or security is proposed to be utilised by the recipient of the loan or guarantee or security and any other relevant fact.

Since the explanatory statement requires all details of proposed loan, a general and omnibus approval to board for giving such loans is not permissible.

Loan can be only to another company or body corporate – The loan can be given only to another company or body corporate, not to director or his relative or any partnership firm.

Meaning of “to any other person in whom director is interested” – The expression “to any other person in whom director is interested” means the following [Explanation to section 185(2) of Companies Act, 2013 as substituted w.e.f. 7-5-2018:

(a) any private company of which any such director is a director or member.

(b) any body corporate at a general meeting of which not less than 25% of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together; or

(c) any body corporate, the Board of directors, managing director or manager, whereof is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company.

Non-applicability of the restriction – The restrictions in respect of loans to directors (directly or indirectly) are not applicable in following cases [section 185(3) of Companies Act, 2013 as substituted w.e.f. 7-5-2018].

(a) Giving of any loan to a managing or whole-time director

(i) as a part of the conditions of service extended by the company to all its employees; or

(ii) pursuant to any scheme approved by the members by a special resolution, or

(b) a company which in the ordinary course of its business provides loans or gives guarantees or securities for the due repayment of any loan and in respect of such loans an interest is charged at a rate not less than the rate of prevailing yields of one year, three year, five year or ten year Government security closest to the tenor of the loan, or

(c) Any loan made by holding company to its wholly owned subsidiary or any guarantee given or security provided in respect of any loan made to wholly owned subsidiary. However, the loan should be used by the wholly owned subsidiary company for its principal business activities, or

(d) Any guarantee given or security provided by holding company in respect of loan made by any Bank or Financial Institution to its subsidiary (need not be wholly owned subsidiary). However, the loan should be used by the subsidiary company for its principal business activities.

Restriction not applicable to specified private companies – The restrictions under section 185 of Companies Act, 2013 are not applicable to a private company

(a) in whose share capital other body corporate has not invested any money

(b) which has borrowings from banks and FI or any body corporate not more than twice of their paid up capital or ` 50 crores (whichever is lower) and

(c) The private company is not in default in repayment of such borrowings – MCA Notification dated 5-6-2015 issued under section 462 of Companies Act, 2013.

Thus, if a private company fulfils these conditions, it can give loan or guarantee to director or to any other person in whom director is interested.

Restriction not applicable to Government company if loan or security approved by Government – Restriction on giving loans or security to director or other person in whom director is interested, is not applicable to Government company if loan or security approved by concerned administrative ministry of Government – MCA Notification dated 5-6-2015 issued under section 462 of Companies Act, 2013.

Penalty for contravention – The company and every officer who is in default shall be punishable with fine which shall not be less than ` five lakh but which may extend to ` twenty-five lakh.

Every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to six months or with fine which shall not be less than five lakh rupees but which may extend to twenty-five lakh rupees.

Further, the director or the other person to whom any loan is advanced or guarantee or security is given or provided in connection with any loan taken by him or the other person, shall be punishable with imprisonment which may extend to six months or with fine which shall not be less than ` five lakh but which may extend to ` twenty-five lakh, or with both – section 185(4) of Companies Act, 2013 as substituted w.e.f. 7-5-2018.]

3. Related Party Transactions

Related party transactions are inevitable in any business. Business can grow only with mutual cooperation and support.

Para 15 of the AS-18 beautifully explains inevitability of related party transactions as follows – Related party relationships are a normal feature of commerce and business. For example, enterprises frequently carry on separate parts of their activities through subsidiaries or associates and acquire interests in other enterprises – for investment purposes or for trading reasons – that are of sufficient proportions for the investing enterprise to be able to control or exercise significant influence on the financial and/or operating decisions of its investee.

3.1 Conflicts of interests in related party transactions

Duty of a Director is comparable to that of a trustee. Like trustee, he is in a fiduciary position vis-à-vis the company. He is expected to act in the best interests of the company. Whenever personal interests and company interests clash, his personal interests should be secondary to the interests of the company.

In reality, the position is quite different. Ways are devised to siphon of funds of the company for personal gains. There are many ways of doing this, but one most popular way is to divert funds of company through transactions with related parties.

Transactions with related parties are also used as a tool of ‘tax management’. Provisions exist in income tax (like transfer pricing), excise law (in valuation) and customs law (in valuation) to control ‘tax planning’ through related party transactions.

The Companies Act, 2013 has made elaborate provisions to control such related party transactions and ensure that related party transactions are not used as tool to divert funds of the company for personal benefit of directors.

3.2 Meaning of ‘related party’

Section 2(76) of Companies Act, 2013 defines ‘related party’ as follows

“Related party” with reference to a company means —

(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 [The words ‘or his relative’ have been added vide Companies (Removal of Difficulties) Sixth Order, 2014 w.e.f. 24-7-2014]

(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 [The word ‘and’ was substituted in place of ‘or’ vide Companies (Removal of Difficulties) Fifth Order, 2014].

(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 under 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 body corporate which is—

(A) a holding, subsidiary or an associate company of such company

(B) a subsidiary of a holding company to which it is also a subsidiary; or

(C) an investing company or the venturer of the company.

Explanation.—For the purpose of this clause, “the investing company or the venturer of a company” means a body corporate whose investment in the company would result in the company becoming an associate company of the body corporate.

(ix) such other person as may be prescribed.

Under the clause (ix), it has been specified that a director (other than an independent director) or Key Managerial Personnel (KMP) of the holding company or his relative with reference to a company, shall be treated as ‘related party’ of the company – Rule 3 of Companies (Specification of Definitions Details) Rules, 2014.

The clause (viii) [words in italics] haven been inserted w.e.f. 9-2-2018. The clause was reading as follows upto 9-2-2018 –

(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

Key Managerial Personnel (KMP) – “Key managerial personnel”, in relation to a company, means —

(i) the Chief Executive Officer or the Managing Director or the Manager

(ii) the Company Secretary

(iii) the wholetime director

(iv) the Chief Financial Officer; and

(v) such other officer as may be prescribed

(vi) such other officer, not more than one level below the directors, who is in whole-time employment, designated as Key Managerial Person by the Board and

(vii) such other officer as may be prescribed [section 2(51) of Companies Act, 2013]. [The words in italics have been added w.e.f. 9-2-2018]

Effect of the amendment w.e.f. 9-2-2018 is that an officer one level below the level of wholetime directors can is designated as KMP by Board.

Interested director – The term “Interested director” was defined in section 2(49) of Companies Act, 2013 as existing upto 9-2-2018. This definition has been omitted w.e.f. 9-2-2018, as the definition was too broad. Hence, now the term ‘interested director’ will apply to

(a) contracts or arrangements as specified in section 184(2) of Companies Act, i.e. more than 2% shareholding or CEO of the body corporate or firm where director is partner, owner or member

(b) Loans where director is interested as per section 185(2) of Companies Act, 2018

(c) Related party transactions under section 188 of Companies Act, 2013.

Relative – “Relative” means a person who is a relative of 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 [section 2(77) of Companies Act, 2013 – corresponding to sections 2(41), 6 and Schedule IA of the 1956 Act]

A person shall be deemed to be relative of another, if he or she is related to another in any of the following manner –

(1) Father (including step father)

(2) Mother (including step-mother)

(3) Son (including step-son)

(4) Son’s wife

(5) Daughter

(6) Daughter’s husband

(7) Brother (including step-brother)

(8) Sister (including step-sister) – Rule 4 of Companies (Specification of Definitions Details) Rules, 2014.

Associate Company – “Associate company”, in relation to another company, means a company in which that other company has a significant influence, but which is not a subsidiary company of the company having such influence and includes joint venture company.

Explanation – For the purpose of this clause –

(a) The term ‘significant influence’ means control of at least 20% of total voting power or control or participation in business decisions under an agreement

(b) ‘Joint Venture’ means a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement = explanation to section 2(6) of Companies Act, 2013 as amended on 7-5-2018.

The term used is ‘total voting power’. Thus, w.e.f. 7-5-2018, preference share holding will be considered only if payment of dividend is in arrears for more than two years.

Earlier Explanation as existing upto 7-5-2018 – The earlier explanation as follows – For the purposes of this clause, “significant influence” means control of at least twenty per cent of total share capital, or of business decisions under an agreement [section 2(6) of Companies Act, 2013].

For purpose of the aforesaid definition (prior to 7-5-2018), “Total Share Capital” means the aggregate of the –

(a) paid-up equity share capital; and

(b) convertible preference share capital – Rule 2(1)(r) of Companies (Specification of Definitions Details) Rules, 2014.

Thus, non-convertible preference capital and uncalled and/or unpaid equity capital was not required to be considered for purpose of definition of ‘associate company’.

Control – “Control” shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner [section 2(27) of Companies Act, 2013]

Meaning of ‘accustomed to act’ – Shadow director and dummy director – If a director is accustomed to act under advice, directions or instructions of another person (except where such advise is given in professional capacity), such person is considered as ‘related party’. Such person is often termed as ‘shadow director’. The person who is acting on basis of his advice or instructions can be termed as ‘dummy director’. ‘Accustomed’ means on regular basis and not on rare basis or once in a while. It is difficult to establish that a director is accustomed to act on advise or directions of another person. In fact, if a director admits to doing that, he will be failing in his duty as director. Sometimes, peons, clerks or drivers are appointed as directors of some companies effectively administered by ‘remote control’ by such ‘shadow director’. In such cases, it may be able to establish who is in real control of the company [Some examples in politics can be Smt. Sonia Gandhi or Late Balasaheb Thakare].

3.3 Two public companies ‘related person’ if director holds more than 2% paid up capital of another

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 is related party – section 2(76)(v) of Companies Act, 2013.

[The word ‘and’ was substituted in place of ‘or’ vide Companies (Removal of Difficulties) Fifth Order, 2014].

3.4 Strange results due to rule based definition

Definition of ‘related party’ is rule based and not principle based. Such definition can sometimes lead to absurd results.

For example, Mr Mukesh Ambani and Mr Anil Ambani may not be on speaking terms, but the biological fact that they are brothers cannot be denied. Hence, they become ‘related party’ as per rule based definition, though ground realities may be quite different.

It is also possible to manipulate the provisions so that though they are related parties, they do not fit in the definition of ‘related party’. One crude way of doing this is to appoint clerks, drivers and peons as directors (and even shareholders).

Though such directors can come within the clause ‘any person under whose advice, directions or instructions a director or manager is accustomed to act’, this becomes difficult to prove. Of course if a director admits that he is acting on advice and directions of another person, he is surely violating all his duties as a director.

3.5 Consent of Board in case of related party transaction

A company can enter into specified related party transaction only with approval of Board and subject to prescribed conditions – section 188(1) of Companies Act, 2013 [Corresponding to section 297 of the 1956 Act].

The consent must be obtained in the Board meeting and not by circular resolution.

The provision applies to following contracts or arrangements

(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 agents 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.

Meaning of ‘office or place of profit’ – ‘Office or place of profit’ means any office or place —

(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 way of remuneration, salary, fee, commission, perquisites, any rent-free accommodation, or otherwise [Explanation to section 188(1) of Companies Act, 2013].

In U C Raman v. P.T.A. Rahim (2014) 8 SCC 934, it was held that office of profit must yield pecuniary gain as profit. Merely getting travelling allowance and daily allowance is not ‘office of profit’ – same view in Jaya Bachchan v. UOI (2006) 5 SCC 266.

Disclosure in agenda of the Board meeting – Agenda of Board meeting shall disclose details as specified in Rule 15(1) of Companies (Meeting of Board and its Powers) Rules, 2014.

Interested director not to be present – Interested director shall not be present at the meeting during discussions on the subject matter relating to matter – Rule 15(2) of Companies (Meetings of Board and its Powers) Rules, 2014.

This restriction is not applicable to private company. The director is required to disclose his interest in the resolution. Then he can participate in the Board meeting (and vote) – MCA Notification dated 5-6-2015 issued under section 462 of Companies Act, 2013.

3.6 Prior approval in general meeting by ordinary resolution in case of large companies or large contracts

In the case of a company having paid-up share capital of not less than prescribed amount, or transactions not exceeding prescribed sums, the contract or arrangement can be entered into by company only after prior approval by ordinary resolution in general meeting – first proviso to section 188(1) of Companies Act, 2013 [Till 29th May 2015, special resolution was required].

Related party not to vote at the general meeting – The member who is a related party shall not vote at the general meeting – second proviso to section 188(1) of Companies Act, 2013.

The restriction on voting applies only to the contract or arrangement for which the resolution in respect of related party transaction is passed – MCA circular No. 30/2014 dated 17-7-2014. [Thus, the related party can vote on other resolutions to be passed in the general meeting]. [Till 29th May 2015, special resolution was required].

Third proviso has been added to this sub-section [i.e. to section 188(1)] w.e.f. 9-2-2018, providing that this restriction shall not apply if 90% or more members are relatives of promoters or are related parties.

Thus, in case of public company, a member can vote in general meeting even if he is interested in the resolution, if 90% or more members are relatives of promoters or are related parties.

Provision does not apply to private company – This sub-section is not applicable to a private company – MCA Notification dated 5-6-2015 issued under section 462 of Companies Act, 2013.

Thus, in case of private company, a member can vote in general meeting even if he is interested in the resolution.

Drafting mistake – The term ‘not exceeding prescribed sums’ is not correct. It should be ‘exceeding prescribed sums’.

This drafting mistake has really made the section ineffective. Central Government will have to amend the section. In the meanwhile, it may issue notification under section 470 of Companies Act, 2013 to remove the difficulty.

Where prior approval is required – In following cases, prior approval by special resolution in general meeting is required – Rule 15(3) of Companies (Meetings of Board and its Powers) Rules, 2014 [as amended w.e.f. 14-8-2014].

(a) as contracts or arrangements with respect to clauses (a) to (e) of sub-section (1) of section 188 with criteria, as mentioned below. [The words in italics in following sub-clauses have been inserted w.e.f. 30-3-2017]-

(i) sale, purchase or supply of any goods or materials directly or through appointment of agent, amounting to 10% or more of the turnover of the company*, as mentioned in section 188(1) clause (a) and clause (e) respectively. The limit shall apply for all transaction/s together during the financial year [* – the words were ‘or rupees one hundred crore, whichever is lower’. These have been omitted w.e.f. 18-11-2019]

(ii) selling or otherwise disposing of, or buying, property of any kind directly or through appointment of agents amounting to 10% or more of net worth of the company, * as mentioned in section 188(1) clause (b) and clause (e) respectively. The limit shall apply for all transaction/s together during the financial year [* – the words were ‘or rupees one hundred crore, whichever is lower’. These have been omitted w.e.f. 18-11-2019]

(iii) leasing of property of any kind amounting to ten per cent or more of turnover of the company, as mentioned in section 188(1)(c). The limit shall apply for all transaction/s together during the financial year [words in italics substituted w.e.f. 18-11-2019].

(iv) availing or rendering of any services directly or through appointment of agents amounting to 10% or more of the net worth of the company *, as mentioned in section 188(1) clause (d) and clause (e). The limit shall apply for all transaction/s together during the financial year [* – The words were ‘or rupees fifty crores, whichever is lower’. These words have been omitted w.e.f. 18-11-2019.

(b) 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 section 188(1)(f); or

(c) 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 section 188(1)(g) of Companies Act, 2013.

[Note – The Turnover or Net Worth referred in the sub-rules shall be on the basis of the Audited Financial Statement of the preceding Financial year]

Relaxation in case of holding and wholly owned company – In case of related party transactions between holding company and its wholly owned subsidiary, passing of resolution in general meeting is not required if accounts of holding company and its subsidiary are consolidated and placed before shareholders at general meeting for approval – fifth proviso to section 188(1) of Companies Act, 2013 [earlier it was fourth proviso upto 9-2-2018].

Explanation 2 to Rule 15(3) of Companies (Meetings of Board and its Powers) Rules, 2014 provides that passing of resolution in general meeting for approving related party is not required if special resolution is passed by holding company. It shall be sufficient to enter into transaction between holding and its wholly owned subsidiary company. Passing of resolution by subsidiary is not required.

Now w.e.f. 29th May 2015, this rule will apply only when the accounts are not consolidated and not placed before general meeting.

Holding, subsidiary or associate of private company will not be ‘related party’ – In case of a private company, a holding, subsidiary or associate company or subsidiary of its holding company will not be considered as ‘related party’. Thus, restrictions on related party transactions will not apply if a private company enters into contract or arrangement with its holding, subsidiary or associate company or subsidiary of its holding company – MCA Notification dated 5-6-2015, issued under section 462 of Companies Act, 2013.

However, if holding, subsidiary or associate company is public company, provisions will apply unless as stated above is applicable.

Requirements of explanatory statement – Explanatory statement shall contain details as specified in Explanation 2 to Rule 15(3) of Companies (Meetings of Board and its Powers) Rules, 2014.

Related party transactions not in ordinary course of business should be approved by Board in meeting – Related party transactions not in ordinary course of business should be approved by Board of Directors in meeting (not by circulation) – Annexure A of Secretarial Standard SS-1 (which is mandatory w.e.f. 1-7-2015) and Annexure IB of ICSI Guidance Note 2015 on Board Meetings.

SEBI requirements in respect of related party transactions in case of listed entities – Listed entity shall formulate policy on materiality of related party transactions. Related party transactions require prior approval of audit committee. Audit Committee can give omnibus approval subject to prescribed conditions.

These should be approved in general meeting, where related parties shall abstain from voting, Even existing continuing contracts need approval in general meeting – Regulation 23 of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015.

3.7 When the provisions relating to related party transactions do not apply

The provisions relating to related party transactions do not apply in certain situations.

Provisions not applicable to transactions in ordinary course of business – The provision of section 188(1) of Companies Act, 2013 are not applicable to any transactions entered into by the company in its ordinary course of business, other than transactions which are not on an arm’s length basis – third proviso to section 188(1) of Companies Act, 2013.

“Arm’s length transaction” means a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest – Explanation (b) to section 188(1) of Companies Act, 2013.

This provision seems very litigation prone, as it is not clear who is going to decide whether the transaction is in ‘ordinary course of business’ and whether the transaction is at ‘arm’s length’.

It seems the burden of proof will be on concerned director to establish that the transaction is in ordinary course of business and is at arm’s length.

Provision not applicable to corporate restructuring, amalgamation – Provisions of section 188 of Companies Act, 2013 are not applicable to transactions arising out of compromises, arrangements and amalgamations, dealt with under specific provisions of Companies Act, 2013 or 1956 Act – MCA circular No. 30/2014 dated 17-7-2014.

Restrictions not applicable to Government companies in specified cases – Restrictions under section 188(1) of Companies Act, 2013 relating to related party transactions are not applicable in following cases – (a) Government company in respect of contract with another Government company (even if listed) (b) Government company if it obtains approval from concerned administrative ministry of Government to make such loan or give guarantee or provide security or make investment. This relaxation is not applicable to listed Government companies (except in case of contract with another Government company)- MCA Notification dated 5-6-2015 issued under section 462 of Companies Act, 2013.

Not applicable to contracts entered prior to 31-3-2014 – Contracts entered into by companies prior to 31-3-2014 under provisions of the 1956 Act do not require fresh approval under section 188 of Companies Act, 2013. However, if there is any modification to the contract after 1-4-2014, compliance with section 188 of Companies Act, 2013 will be required – MCA circular No. 30/2014 dated 17-7-2014.

3.8 Responsibility of director or KMP to disclose their interest which are to be entered in register of contracts

Every director or key managerial personnel shall, within a period of thirty days of his appointment, or relinquishment of, his office, as the case may be, disclose to the company the particulars specified in section 184(1), relating to his concern or interest in the other associations which are required to be included in the register of contracts or arrangements in which directors or KMP are interested – section 189(2) of Companies Act, 2013.

Penalty for contravention of the provision by director is Rs. 25,000 – section 189(7) of Companies Act, 2013.

Disclosure by director at Board meeting – Every director shall give notice in writing to the company at a meeting of the Board, of such matters relating to himself as may be necessary for the purpose of enabling the company to comply with the provisions of section 189 relating to registrar of contracts in which directors and KMP are interested – section 189(3) of Companies Act, 2013.

[Thus, indirectly, it means that the director is required to disclose the details of contracts or arrangements in which he is interested]

Disclosure in Board’s report of related party transactions – Every contract or arrangement entered into under section 188(1) of Companies Act, 2013 shall be referred to in the Board’s report to the shareholders along with the justification for entering into such contract or arrangement – section 188(2) of Companies Act, 2013.

Entry in register of contracts not required for small value transactions – Provisions relating to disclosure by director or KMP (Key Managerial Personnel) of transactions in which he is interested does not apply for contract or arrangement for the sale, purchase or supply of any goods, materials or services if the value of such goods and materials or the cost of such services does not exceed five lakh rupees in the aggregate in any year – section 189(5)(a) of Companies Act, 2013.

Note that disclosure in Board meeting is required. Only entry in the register of contracts is not required.

In case of section 8 (licensed i.e. non-profit) companies, the entry in register of contracts is required only if transaction with related party exceeds Rs one lakh. Even disclosure is not required, if transaction is less than Rs one lakh – MCA Notification dated 5-6-2015 issued under section 462 of Companies Act, 2013.

Entry in register of contracts not required in case of banking company for collection of Bills – Provisions relating to disclosure by director or KMP of transactions in which he is interested does not apply to contract or arrangement by banking company for collection of bills in ordinary course of business – section 189(5)(b) of Companies Act, 2013.

Note that disclosure in Board meeting is required. Only entry in the register of contracts is not required.

3.9 Consequences if contract or arrangement is not ratified by Board/general meeting

If any contract or arrangement is entered into by a director or any other employee, without obtaining the consent of the Board or approval by an ordinary resolution in the general meeting under section 188(1) of Companies Act, 2013, 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 into, such contract or arrangement shall be voidable at the option of the Board or the shareholders as applicable – section 188(3) of Companies Act, 2013. Words in italics inserted w.e.f. 9-2-2018.

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) of Companies Act, 2013.

Company can recover losses from director or other employee – Company can proceed against a director or any other employee who had entered into such contract or arrangement in contravention of the provisions of section 188, for recovery of any loss sustained by the company as a result of such contract or arrangement – section 188(4) of Companies Act, 2013.