Understanding Related Party Transactions under the Companies Act, 2013

Introduction:

The Companies Act, 2013, governs the corporate landscape in India, providing a comprehensive framework for the regulation and management of companies. One crucial aspect of corporate governance addressed by the Act is Related Party Transactions (RPTs). Related Party Transactions are transactions between a company and its related parties, which include directors, key managerial personnel, their relatives, and entities in which they have a significant influence.

Definition of Related Party Transactions:

As per Section 2(76) of the Companies Act, 2013, a Related Party Transaction is defined as a transaction entered into by a company with a related party. Related parties are classified into three categories:

1. Related Parties under Section 2(76)(i):
   • Director or his relative
   • Key managerial personnel or his relative
   • Firm, in which a director, manager, or his relative is a partner
   • Private company in which a director or manager is a member or director
   • Public company in which a director or manager is a director or holds along with his relatives, more than 2% of its paid-up share capital
2. Related Parties under Section 2(76)(ii):
   • Public companies where directors, along with their relatives, hold more than 10% of the paid-up share capital
3. Related Parties under Section 2(76)(iii):
   • 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

Regulatory Framework:

Section 188 of the Companies Act, 2013, lays down the provisions governing Related Party Transactions. Key elements of the regulatory framework include:

1. Approval by the Board:
   • All RPTs require prior approval by the Board of Directors. Interested directors must abstain from voting.
2. Shareholder Approval:
   • Certain RPTs may require approval from the shareholders through a special resolution.
3. Disclosure Requirements:
   • Full disclosure of RPTs in the Board’s report, including details of the transaction, the nature of the relationship, and the material terms.
4. Pricing and Commercial Terms:
   • Transactions must be conducted at arm’s length and on commercial terms. Any deviation requires justification.
5. Audit Committee Scrutiny:
   • The Audit Committee plays a crucial role in scrutinizing and approving RPTs.

Penalties for Non-Compliance:

Non-compliance with the provisions related to RPTs can result in severe consequences. Section 188(3) outlines penalties, including fines and imprisonment for officers in default.

Challenges and Best Practices:

1. Conflict of Interest:
   • Mitigating conflicts of interest is crucial. Companies should establish robust procedures for identification, disclosure, and resolution of potential conflicts.
2. Transparent Reporting:
   • Transparent reporting in financial statements enhances accountability and builds investor confidence.
3. Corporate Governance:
   • Strong corporate governance practices, including an independent board and effective audit committees, are essential.

Conclusion:

Related Party Transactions, though essential for business growth, pose challenges to corporate governance. The Companies Act, 2013, provides a comprehensive framework to ensure transparency, accountability, and fairness in such transactions. Companies must adhere to these regulations, fostering a culture of integrity and ethical conduct in their operations.