Among the most scrutinised aspects of corporate governance in India, related party transactions occupy a central and often contentious position. When a company enters into a transaction with a director, a promoter, a key managerial personnel, or a company in which any of these individuals have a significant interest, the potential for conflicts of interest is high. Indian corporate law has developed a detailed regulatory framework to ensure that such transactions are conducted at arm’s length, with proper disclosure, and with appropriate shareholder oversight. Understanding this framework is essential for every business, but it is particularly critical for closely-held companies where the line between personal and corporate interest is often blurred.
Under Section 188 of the Companies Act, 2013, certain categories of transactions between a company and its related parties require prior approval of the board of directors, and in some cases, approval by way of an ordinary resolution passed by shareholders. The categories include sale, purchase, or supply of goods or materials, selling or buying property, leasing property, availing or rendering of services, appointment of agents, related party to place of profit, and underwriting of shares or debentures. The specific thresholds beyond which shareholder approval is required are prescribed by the Rules made under the Act and are periodically updated.
A “related party” is defined broadly under Section 2(76) of the Companies Act to include directors and their relatives, key managerial personnel and their relatives, companies in which directors hold significant stakes, subsidiaries, holding companies, and associated entities. The definition is deliberately expansive to capture the full range of relationships through which conflicts of interest might materialise.
For businesses working with a corporate law firm for businesses India, understanding which transactions qualify as related party transactions, and ensuring they are properly documented and approved, is a matter of both legal compliance and business risk management.
The arm’s length principle is central to the related party transaction framework. Transactions must be conducted on terms that are ordinary and commercially reasonable, equivalent to what would be agreed between unconnected parties in similar circumstances. Where transactions are not at arm’s length or where they do not occur in the ordinary course of business, they require specific board approval with an interested director recusing themselves from the deliberation and vote. The interested director’s abstention must be documented in the board minutes.
Beyond the Companies Act, SEBI’s LODR Regulations impose additional and more stringent requirements on listed companies. Under these regulations, all related party transactions, whether or not they fall within the thresholds prescribed under the Companies Act, must be disclosed to the stock exchange on a half-yearly basis. Material related party transactions, defined as those exceeding ten percent of annual consolidated turnover, require shareholder approval through an ordinary resolution in which related parties cannot vote on the resolution. SEBI’s framework is notably stricter and has been progressively tightened over the years to align with international governance standards.
Risk advisory corporate law India professionals consistently identify related party transactions as a high-risk area precisely because founders and promoters often do not distinguish adequately between the interests of the company and their personal or family interests. Common examples of problematic transactions include companies renting premises from a director’s family member at above-market rates, companies engaging the services of a promoter-controlled entity without competitive benchmarking, and loans extended to group companies or promoter-related entities without security or proper documentation.
The consequences of non-compliance are significant. Section 188 violations can attract civil penalties and can make the implicated directors personally liable for any gain made or loss caused to the company. In cases where fraudulent intent can be established, criminal liability under Section 447 of the Companies Act, which deals with fraud, can also arise. For listed companies, SEBI enforcement actions including fines, disgorgement orders, and restrictions on capital market access have all been imposed in related party transaction matters.
The best defence is procedural clarity. Every company should maintain a Related Party Transaction Policy, typically mandated for listed companies and advisable for all companies with external investors or complex ownership structures. This policy should identify all related parties, prescribe the process for approval of transactions before they are entered into, specify the documentation requirements, and set out the disclosure obligations to the board and shareholders.
top indian corporate consultancy advisors recommend that companies conduct periodic related party transaction audits, particularly before fundraising rounds or prior to merger and acquisition activity, where such transactions can become deal-breakers if not properly documented and approved.
The law is not designed to prevent companies from doing business with related parties. It is designed to ensure that such business is transparent, fair, and in the company’s best interest. Following the prescribed process rigorously protects not just the company but every director and shareholder who relies on the integrity of the company’s governance.
