Related Party
Transaction approval- Case Study
This article is a case study on section 188 i.e. entering into
contracts or arrangements with a related party with respect to:
Ø Case
Study:
Parties for which the case is to be discussed:
a. ABC Pvt Ltd, a Company incorporated under
Companies Act, 1956;
- Director: Mr. A and Ms. B
- Member: Mr. A and Ms. B
b. XYZ Pvt Ltd, a Company incorporated under Companies Act,
1956 and a sister concern of ABC Pvt Ltd;
- Director: Mr. A and Ms. B
- Member: Mr. A and Ms. B
Since the director and members in all the two companies are same
and the directors and shareholders of the company are “Related Parties” as per
section 2 (76) of the companies act, 2013 thus section 188 of the Companies
Act, 2013 attracts to all the companies which is described hereunder:
Ø Section 188:
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.
- Provided that no contract or arrangement, in the case of a company having a
paid-up share capital of not less than such amount, or transactions not
exceeding such sums, as may be prescribed, shall be entered into except with
the prior approval of the company by a special resolution: (Described as per
MCA Notification dated 14th August 2014)
- Provided further that no member of the company
shall vote on such special
resolution to approve any contract or arrangement which may be entered
into by the company, if such member is a related party. (*see note 1)
- Provided also that nothing in this sub-section shall apply 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 price.
Ø Definition
of Ordinary Course of business:
Companies Act, 2013 does not define the term
“ordinary course of business”.
“Ordinary course of business” covers the usual transactions, customs and
practices of a certain business and of a certain firm. This
term is used particularly to judge the validity of certain transactions. (*see note 2)
- Activities that
is necessary, normal, and incidental to the business.
These are common practices and customs of commercial transactions. An example is a contractor works with a financial institution to secure a loan to continue a project.
____________________________________________________________________________
*(Note 1) Clarification had been
given by MCA vide General Circular No. 30/2014 regarding this clause and it has
clarified that ‘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. Thus, the term 'related party' in the above
context refers only to such related party as may be a related party in the
context of the contract or arrangement for which the said special resolution is
being passed.
*(Note 2) The Division Bench of Allahabad High court in the case of
Kishori Lal Vs. CIT MANU/UP/0904/2014, while dealing with the issue of giving
loan as permitted as a part of Ancillary Object and not as a Main Objects, has
held under:-
In holding that the advance was not in the ordinary course of business, the sole consideration which weighed with the Tribunal was that the main object of the
two companies was not to engage in
money-lending business, though the ancillaryobject was to invest and deal with
the funds of the company not immediately required,
in such investments or securities and in such manner as shall from time to time be considered necessary
for the benefit of the company.
The Tribunal was of the view that the two companies were not
involved in the business of money-lending. Consequently, the Tribunal came to
the conclusion that since the main object of the two companies was not money
lending but the companies were permitted to invest their surplus funds for the
time being, this could not be regarded as being in the ordinary course of the
business.
Findings of Hon’ble High Court
Moreover, where the advance or loan was made in the ordinary
course of the business of the company, the fact that the lending of surplus
funds is not part of the main object but is at the same time permissible as an
ancillary object would not detract from the loan or advance being made in the
ordinary course of its business.
Conclusion: Objects ancillary and incidental to the main object
of the company also falls under the category of Ordinary Course of business.
Ø Problem
discussed is hereunder:
XYZ Pvt Ltd has given a property on lease to
ABC Pvt Ltd.
XYZ Pvt Ltd has taken a property on lease from
ABC Pvt ltd.
Ø Matter Raised: As the directors and shareholders are
interested in both the companies and hence related parties as per section 2
(76), to enter into any transaction company needs to pass Board Resolution or
Special Resolution as may be applicable to the company where none of the
director or shareholder is interested.
- Hence there is a requirement of appointing
Directors/ Shareholders who shall be unrelated to the companies and hence shall
be eligible to pass the board resolution/ special resolution.
Ø Opinion
1: Since for the approval of Related Party Transactions,
Board resolution or Special Resolution is required to be passed with unrelated
directors or shareholders respectively and as the case may be depending upon
the value of transactions and taking MCA Notification dated 14th August, 2014 into consideration which defines
the nature of resolution to be passed depending upon the nature of transaction,
we may appoint independent directors or unrelated additional directors and
members differently in both the companies and thus related party transaction
could be approved by taking such director’s or shareholder’s approval in the
said Board Meeting or General Meeting.
Ø Opinion
2: Generally companies have leasing of
property in their ancillary course of business which could be explained
hereunder:
As explained
in note 2 that ancillary course of
business is covered under the definition of ordinary course of business.
Further as per proviso
3 of section 188, this section does not apply to the transaction which comes
under the ordinary course of business and is at arm’s length price.
Thus taking into consideration opinion 2 there is no need for
the companies to pass any resolution under section 188 of the Companies Act,
2013 if such business falls under the ancillary course of business but as the
penal provisions defined under the Companies Act, 2013 are hard to neglect it
is always recommended to take a safer view of the picture.
*Note: Section 184 should also be taken into consideration while
implementation of sec 188.
Submitted BY
CS Nisha Sharma
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