Navigating Related Party Transactions under the Companies Act, 2013

In the world of corporate governance, related party transactions (RPTs) are a critical area that demands careful attention and proper management. These transactions, while often necessary for business operations, can potentially lead to conflicts of interest if not handled appropriately. This blog post will delve into the key aspects of RPTs, including who qualifies as a related party, the procedures companies must follow for such transactions, and the crucial role of the audit committee in overseeing these matters.

Who Qualifies as a Related Party?

Under Section 2(77) of the Companies Act, related parties include:

1. Directors or their relatives

2. Key managerial personnel or their relatives

3. Firms where a director, manager, or their relative is a partner

4. Private companies where a director or manager (or their relative) is a member or director

5. Public companies where a director or manager holds over 2% of the paid-up share capital (including their relatives)

6. Anybody corporate whose Board, managing director, or manager is accustomed to acting on the advice of a director or manager of the company

7. Any person on whose advice a director or manager is accustomed to act (excluding professional advisors)

8. Holding, subsidiary, or associate companies

9. Subsidiaries of a holding company

10. An investing company or venture of the company

Step-by-Step Procedure for Related Party Transactions

When a company engages in a Related Party Transaction, the following step-by-step procedure must be followed under the Companies Act, 2013:

1. Board Approval

• The Board of Directors must approve the transaction by passing a resolution at a Board meeting before entering into the agreement.

2. Disclosure of Details

• The company must disclose the following to the Board:

  • Name of the related party

  • Nature of the relationship

  • Nature, duration, and particulars of the contract

  • Material terms and pricing

  • Any other relevant information

3. Shareholder Approval (if applicable)

• Shareholder resolution is required for transactions exceeding certain thresholds:

  • Sale/purchase/supply of goods > 10% of turnover

  • Selling/buying property > 10% of net worth

  • Leasing property > 10% of turnover

  • Availing/rendering services > 10% of turnover

  • Appointing to office or place of profit with monthly remuneration > ₹2.5 lakhs

  • Underwriting of securities > 1% of net worth

4. Voting Restrictions

• Related parties are prohibited from voting on resolutions related to their transactions.

5. Ratification (if required)

• If a transaction is entered into without the required approval, it must be ratified by the Board or shareholders within three months to remain valid.

Role of the Audit Committee

The Audit Committee plays a critical role in ensuring that Related Party Transactions are handled transparently and in compliance with legal requirements.

1. Composition and Applicability

For listed public companies and certain prescribed classes of companies, the Audit Committee must be constituted with at least three directors, the majority of whom must be independent. This composition ensures objectivity in decision-making.

2. Approval and Oversight

The Audit Committee has the authority to approve proposed RPTs before they are finalized. Under Rule 6A of the Companies (Meetings of Board and its Powers) Rules, 2014, RPTs must receive prior approval from the committee, which must also ensure the terms are fair and in the company’s best interest.

3. Omnibus Approvals

To streamline recurring transactions, the committee can grant omnibus approvals for RPTs that are repetitive in nature. These approvals are valid for one financial year and are based on pre-approved criteria set by the Board.

4. Broader Monitoring Functions

Beyond RPTs, the Audit Committee performs ongoing oversight in areas such as:

• Scrutinizing inter-corporate loans and investments

• Reviewing the independence and performance of auditors

• Examining financial statements and audit reports

• Evaluating internal financial controls and risk management systems

• Overseeing the vigil mechanism, which allows employees and directors to report concerns confidentially

Through these measures, the Audit Committee ensures that RPTs do not compromise the integrity or interests of the company.

Audit committee applicability:

Not all companies are mandated to form an audit committee. As per Section 177 of the Companies Act, only the following classes of companies must constitute an Audit Committee:

1. Listed public companies

2. Public companies meeting any of the following thresholds:

   • Paid-up share capital of ₹10 crore or more

   • Turnover of ₹100 crore or more

   • Outstanding loans, debentures, and deposits exceeding ₹50 crore

Such companies must constitute an audit committee consisting of at least three directors, with a majority being independent directors.

Related party transactions under income tax law in India:

Apart from corporate law, RPTs are also subject to scrutiny under the Income Tax Act, 1961, particularly in the context of transfer pricing and arms-length pricing requirements.

To know more about related party transactions under income tax law, click here.

Conclusion:

Related Party Transactions, while often rooted in operational needs, can give rise to governance concerns if left unchecked. A well-defined compliance process—including Board approval, shareholder transparency, and active oversight by the Audit Committee—is essential to prevent misuse and ensure fairness.

Companies that proactively manage their RPTs not only comply with the law but also strengthen stakeholder trust and maintain ethical business practices. In today's regulatory environment, proper governance of RPTs is more than a compliance issue—it's a business imperative.