Sections 188 and 189 of Companies Act 2013: Related Party Transactions and Register of Interested Contracts
Sections 188 and 189 of the Companies Act, 2013 regulate specified contracts and arrangements with related parties and require companies to maintain prescribed records of contracts or arrangements in which directors are interested. The provisions should be read with Sections 2(76) and 184 of the Act and Rules 15 and 16 of the Companies (Meetings of Board and its Powers) Rules, 2014.
Meaning of related party and arm's length transaction
For Section 188, the expression related party is defined in Section 2(76) of the Companies Act, 2013. The definition covers specified relationships involving directors, key managerial personnel, relatives, firms and entities in which such persons have prescribed interests, as well as specified holding, subsidiary, associate and other relationships.
Office or place of profit broadly refers to an office or position from which a director, or another person or entity covered by the provision, receives remuneration or other benefits from the company in the circumstances specified in Section 188.
Section 188: Related party transactions
Subject to the statutory exceptions, Section 188(1) requires consent of the Board of Directors by a resolution at a Board meeting before the company enters into a contract or arrangement with a related party concerning the following matters:
- sale, purchase or supply of goods or materials;
- sale, disposal or purchase of property of any kind;
- leasing of property of any kind;
- availing or rendering of services;
- appointment of an agent for purchase or sale of goods, materials, services or property;
- appointment of a related party to an office or place of profit in the company, subsidiary or associate company; or
- underwriting the subscription of securities or derivatives of the company.
Ordinary course and arm's length exception
The requirements of Section 188(1) do not apply to a transaction entered into by a company in its ordinary course of business when the transaction is also on an arm's length basis. Both conditions are relevant to this statutory exception.
Wholly owned subsidiary exception
The members' resolution requirement under the first proviso to Section 188(1) does not apply to transactions between a holding company and its wholly owned subsidiary where the subsidiary's accounts are consolidated with the holding company and placed before shareholders at the general meeting for approval.
Board approval and members' approval
Rule 15 requires the Board agenda to disclose material information about the proposed related party contract or arrangement, including the related party and relationship, nature and duration, material terms and value, advances, pricing and commercial terms, relevant factors considered, and other information important to the Board's decision. An interested director must not be present during discussion on the relevant resolution as provided by the rule.
Where the prescribed Rule 15 thresholds are met, prior approval of the company by resolution is required. A member who is a related party cannot vote on the resolution approving the contract or arrangement, subject to statutory exceptions, including the exception where ninety per cent or more members in number are relatives of promoters or are related parties.
Rule 15 thresholds for members' approval
The principal thresholds under Rule 15(3), computed with reference to the audited financial statement of the preceding financial year where applicable, are summarized below. Transactions in the relevant category are considered individually or together with previous transactions during the financial year as specified by the rule.
| Transaction category | Threshold under Rule 15 |
|---|---|
| Sale, purchase or supply of goods or materials, directly or through agent | 10% or more of turnover |
| Selling, disposing of or buying property, directly or through agent | 10% or more of net worth |
| Leasing of property | 10% or more of turnover |
| Availing or rendering services, directly or through agent | 10% or more of turnover |
| Appointment to office or place of profit in the company, subsidiary or associate | Monthly remuneration exceeding Rs. 2.5 lakh |
| Underwriting subscription of securities or derivatives | Remuneration exceeding 1% of net worth |
Board's report disclosure
Under Section 188(2), every contract or arrangement entered into under Section 188(1) must be referred to in the Board's report to shareholders together with justification for entering into it.
Unauthorized transaction, ratification and penalties
If a director or other employee enters into a contract or arrangement without the required Board consent or members' approval and it is not ratified by the Board or shareholders, as applicable, within three months, Section 188(3) makes the contract or arrangement voidable at the option of the Board or shareholders, as the case may be. Where the contract is with a related party to a director, or is authorized by another director, the concerned directors must indemnify the company against loss as provided by the section.
The company may also proceed against the director or employee for recovery of loss caused by a contravention. Under Section 188(5), a director or other employee who enters into or authorizes a contract or arrangement in violation of the section is liable to a penalty of Rs. 25 lakh in the case of a listed company and Rs. 5 lakh in the case of any other company.
Section 189: Register of contracts or arrangements in which directors are interested
Section 189 requires every company to keep one or more registers containing prescribed particulars of contracts or arrangements to which Section 184(2) or Section 188 applies. After the particulars are entered, the register must be placed before the next Board meeting and signed by all directors present.
Every director or key managerial personnel must, within thirty days of appointment or relinquishment of office, disclose the particulars required by Section 184(1) concerning interests in other associations and other prescribed information relevant to the register.
The register is kept at the registered office, is open for inspection during business hours, and members may obtain extracts or copies subject to the prescribed requirements. It must also be produced at the commencement of every annual general meeting and remain open and accessible during the meeting to persons entitled to attend.
Exceptions under Section 189(5)
The register requirement in Section 189(1) does not apply to a contract or arrangement for sale, purchase or supply of goods, materials or services where the aggregate value or cost does not exceed Rs. 5 lakh in a year, or to a banking company's collection of bills in the ordinary course of business.
Under Section 189(6), every director who fails to comply with Section 189 and the rules made under it is liable to a penalty of Rs. 25,000.
Rule 16 and Form MBP-4
Rule 16 of the Companies (Meetings of Board and its Powers) Rules, 2014 prescribes maintenance of the register under Section 189 in Form MBP-4. The prescribed form records details of related party contracts and contracts in which directors are concerned or interested, including the parties, interested director, nature of interest, principal terms, arm's length status, Board approval and voting details, transaction amount, shareholder approval where applicable, signatures and remarks.
The register is to be maintained in accordance with Rule 16 and the Act, including the prescribed custody, authentication, inspection and preservation requirements.
Practical compliance checklist
- Identify whether the counterparty falls within the statutory definition of a related party.
- Classify the transaction under the relevant clause of Section 188(1).
- Determine whether the ordinary-course and arm's-length exception applies.
- Place the prescribed disclosures in the Board agenda and obtain Board approval where required.
- Test the transaction against the current Rule 15 thresholds and obtain prior members' approval where required.
- Check voting restrictions and applicable statutory exemptions.
- Record the transaction in Form MBP-4 where Section 189 and Rule 16 require it.
- Make the required Board's report and other corporate disclosures.
- For listed companies, separately verify the applicable SEBI Listing Regulations requirements.