Which contracts with a related party need approval?
A contract with a related party needs the board’s approval when it is one of the contracts in section 188 and it is not both in the ordinary course of business and at arm’s length. Members vote only when the contract also crosses the threshold in the rules. Where the company must have an audit committee, that committee approves related-party transactions as well.
No. The committee is required for a listed company and for a public company that meets the paid-up, turnover, or borrowing test. A private company is outside that requirement.
Which contracts are covered?
A related party is defined in section 2(76). It includes a director, key managerial personnel, and their relatives, a firm in which a director or manager is a partner, and a holding, subsidiary, or associate company. Section 188(1) lists the contracts: sale or purchase of goods or materials, buying or selling property, leasing property, availing or rendering services, appointing an agent for those deals, appointing the related party to an office or place of profit, and underwriting securities.
If the contract is in the ordinary course of business and on an arm’s length basis, section 188(1) does not apply. The audit committee, where one is required, can still have to approve the transaction under section 177.
Who has to approve?
The board gives consent by a resolution at a meeting. The resolution is not passed by circulation. An interested director does not take part and is not counted for the quorum. The agenda states the name of the related party, the nature and duration of the contract, the material terms and value, any advance, and how the price was set.
An audit committee is required for a listed company, and for a public company with paid-up capital of ₹10 crore or more, turnover of ₹100 crore or more, or outstanding loans, borrowings, debentures, or deposits above ₹50 crore. The committee has at least three directors. It may give an omnibus approval on the conditions in the rules. A transaction of not more than ₹1 crore entered without the committee’s approval can be ratified within three months. If it is not ratified, it is voidable at the committee’s option.
A contract entered without the board’s consent, or without the members’ approval where that approval was required, can be ratified within three months. Otherwise it is voidable at the option of the board or of the shareholders. A director who is the related party, or who authorised the contract, indemnifies the company against loss.
The board’s report includes the particulars of contracts under section 188(1) in Form AOC-2. The company also keeps the register of contracts under section 189. A director who fails to disclose an interest under section 184 is liable to a penalty of ₹1 lakh.
When do members vote?
Members pass an ordinary resolution before the company enters the contract, when the value crosses the threshold. Turnover and net worth are taken from the audited financial statements of the preceding financial year. The limits apply to the transaction alone or taken together with earlier transactions in the same financial year.
| Contract | Member approval |
|---|---|
| Goods or materials | 10% or more of turnover |
| Property | 10% or more of net worth |
| Leasing property | 10% or more of turnover |
| Services, or an agent for these contracts | 10% or more of turnover |
| Office or place of profit | Monthly remuneration above ₹2.5 lakh |
| Underwriting | Remuneration above 1% of net worth |
A member who is a related party does not vote on that resolution. A private company is outside that restriction. The restriction also does not apply where ninety per cent or more of the members, in number, are relatives of promoters or are related parties. The ordinary resolution is not filed in Form MGT-14.
A director or other employee who enters into or authorises a contract in violation of section 188 is liable to a penalty of ₹25 lakh in a listed company, and ₹5 lakh in any other company.
Frequently asked questions
Four questions cover the audit committee, a circular, a related member’s vote, and MGT-14.
Does every company need an audit committee?
No. The committee is required for a listed company and for a public company that meets the paid-up, turnover, or borrowing test. A private company is outside that requirement.
Can the board approve by a circular?
No. The board’s consent under section 188 is a resolution at a meeting. An interested director does not participate.
Can a related-party member vote?
Not in a company that is inside the voting bar. A private company is outside that bar. So is a company in which ninety per cent or more of the members, in number, are relatives of promoters or are related parties.
Is Form MGT-14 filed for the members’ resolution?
No. The members’ approval under section 188 is an ordinary resolution, and that resolution is not one of the resolutions filed in MGT-14.
Sources
The contracts are section 188 of the Companies Act, 2013. Member approval is rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014. The penalty in section 188(5) is the figure substituted in 2020.