Related Party Transaction

Related Party Transaction: The Deal With Those Close to the Company

Companies do not deal only at arm's length with strangers. They routinely transact with persons closely connected to them — their promoters, their directors, the relatives and entities controlled by these insiders. Such related party transactions (RPTs) are not illegitimate in themselves; many are commercially sensible (a holding company lending to a subsidiary, a director providing specialised services). But they carry an inherent risk: the insider on both sides of the deal may be tempted to use the relationship to extract value from the company at the expense of its minority shareholders or creditors. The law of RPTs addresses this risk through disclosure, approval, and (in egregious cases) avoidance.

The Definition of a Related Party

Section 2(76) of the Companies Act, 2013 defines 'related party' with reference to a list of relationships that signify connection or control. The principal categories include: (a) a director or his relative; (b) a key managerial person (KMP) or his relative; (c) a firm, private company, or body corporate in which a director or manager is a partner or director or holds, with his relatives, more than 2 per cent of the paid-up share capital; (d) any body corporate whose board or management is accustomed to act in accordance with the advice, directions, or instructions of a director or manager; (e) a company which is (i) a holding, subsidiary, or fellow subsidiary, (ii) an associate company, or (iii) a subsidiary of a holding company to which it is also a subsidiary. The definition is broad, capturing the principal ways in which persons may be connected to the company in a manner that creates the risk of conflict.

Disclosure, Approval, and Consequences of Breach

The regulatory framework operates on three levels. Approval: Section 188 of the Companies Act requires certain categories of RPT — sale or purchase of goods, properties, or services above specified thresholds; appointment of related parties to office or place of profit; underwriting of subscriptions — to be approved by the board (with the interested director not participating) and, where the transaction exceeds specified monetary thresholds, by the shareholders in general meeting (with the related party not voting). For listed companies, the SEBI Listing Regulations impose additional requirements: material RPTs (typically those exceeding specified percentage thresholds of the company's turnover or net worth) require shareholder approval, with related parties abstaining, and disclosure of the transaction on the stock exchange within specified timeframes. Disclosure: every RPT must be disclosed in the board's report and in the financial statements (under the applicable accounting standards, principally Ind AS 24), allowing shareholders and the public to assess their nature and terms. Consequences of breach: a related party transaction entered into without the required approval is voidable at the option of the company, and the related party may be required to indemnify the company for any loss suffered. The director or other party may also be liable to disgorgement, penalties under the Companies Act, and (for listed companies) SEBI enforcement. The framework seeks to bring RPTs into the light — to subject them to the scrutiny of independent directors, disinterested shareholders, and the market — recognising that disclosure and approval, rather than prohibition, are the appropriate response to transactions that are legitimate in principle but dangerous in practice.

“A deal between a company and its own controllers is a deal fraught with risk — for the temptation to favour self over company is the oldest temptation of corporate life. The law does not forbid such deals, but it brings them into the open, demands the approval of those with no stake in the favour, and reserves the power to undo what was done in breach. The shield of related-party law is sunlight: the transaction exposed is the transaction controlled.”