Understanding Related Party Transactions in Corporate Governance

Understanding Related Party Transactions in Corporate Governance

Effective governance of RPTs relies on robust systems and ethical practices to prevent misuse and regulatory avoidance.

INTRODUCTION

Every company, at some juncture, finds itself transacting with people or entities already in its sphere of influence, including directors, key managerial personnel (KMPs), their relatives, firms or private companies where such persons hold an interest, public companies with significant shareholding by these individuals, and bodies corporate, which are classified as Related Party Transactions (RPTs). These arrangements made with parties who have pre-existing relationships with the company, in and of themselves, are not inherently problematic; in fact, they often help keep the wheels of business turning smoothly.

However, as is often cautioned, familiarity can breed complacency—and at its worst, outright conflict. When companies mix business with relationships, the line between sound corporate judgment and personal interests gets increasingly faint, holding the door open for preferential treatment and triggering concern about whether the deck is stacked against minority shareholders.

To ensure that such transactions are conducted fairly and transparently, without compromising the interests of minority shareholders or the company as a whole, laws and regulations surrounding RPTs are consistently being reformed for enhanced compliance, approval mechanisms, and disclosure requirements.

LEGAL MATRIX

The following is a diagrammatic representation of the definitions of related parties under various laws:

UNDERSTANDING WHAT CONSTITUTES A RPT 

COMPREHENSIVE GUIDE ON COMPLIANCE

The first step is to identify the type of entity.

1. Private Entity

i. Identify RPT (S. 188 r/w S. 2(76))

ii. Check: Ordinary Course of Business + Arm’s Length Basis

iii. If yes:

• No further Board or shareholder approval required (subject to exemptions for certain companies)

iv. If no:

a. Obtain Board Approval

• Decision at board meeting (not by circulation)
• Disclosures in the agenda
• Interested director → Declare interest (Form MBP-1); and remain absent in the meeting

b. If Audit Committee (AC) is required, obtain its prior approval

v. Exceeding Threshold → Shareholder Approval

• Ordinary resolution required
• RPs cannot vote, except where 90% or more members are relatives/promoters/relatives of RPs
• No prior shareholder approval for transactions between the holding company and wholly owned subsidiary (if accounts are consolidated and placed before shareholders for approval).
• Explanatory statement with disclosures

vi. Record in Register (Form MBP-4) u/s 189

vii. Disclosures in Form AOC-2, signed with the Board’s Report

2. Listed Public Entity

i. Identify RPT (S. 188 r/w S. 2(76))

ii. Check: Ordinary Course of Business + Arm’s Length Basis

iii. Prior AC Approval

• Only independent directors approve RPTs
• Omnibus approval for recurring transactions (Rule 6A) valid for 1 year
• AC reviews all transactions periodically
• AC approval exempt for remuneration/sitting fees to director, KMP, or SMP if:

a. RP not part of promoter/promoter group

b. Transaction not material RPT as per Reg. 23(1)

• Remuneration payable to employees who are RPs but not directors, KMP, or SMP: prior AC approval required
• Material remuneration or remuneration paid to promoter/promoter group requires AC and shareholder approval
• AC to define “material modification”
• Payments by subsidiary to promoter directors require approval of the listed parent’s AC if significant RPT (>10% standalone turnover)
• SMPs appointed as directors/KMPs in subsidiaries are RPs of subsidiaries; transactions with such SMPs are RPTs requiring AC approval unless exempted
• RPTs ≤ lower of 1% of annual consolidated turnover or ₹10 crore (FY total): Only minimum information per Annexure-13A required for AC approval
• RPTs ≤ ₹1 crore (FY total): Information required as per Companies Act
• Subsidiary RPTs >₹1 crore require parent AC approval if exceeding the lower of:

(i) 10% of the annual standalone turnover of subsidiary (last audited FS); or

(ii) Schedule XII materiality threshold of the listed entity

• Subsidiary without audited FS for ≥1 year: prior AC approval if exceeding lower of:

(i) 10% of aggregate paid-up capital + securities premium (≤3 months old) of the subsidiary

(ii) Schedule XII materiality threshold of the listed entity

iv. If not in ordinary course or not at arm’s length → Board Approval

• Board meeting required (not by circulation)
• Disclosures in the agenda
• Interested director → Declare interest (Form MBP-1)

v. Exceeding Threshold per Schedule XII → Shareholder Approval

• Ordinary resolution required; RP cannot vote to approve, irrespective of whether it is a RP to the transaction or not
• Notice to shareholders must include all required minimum information a/w the explanatory statement per Industry Standards
• RPTs ≤ lower of 1% of annual consolidated turnover or ₹10 crore (FY total): Only minimum information required in the notice
• RPTs ≤ ₹1 crore (FY total): Even minimum information not required
• No prior shareholder approval for transactions between the holding company and wholly owned subsidiary (if accounts are consolidated and placed before shareholders for approval).

vi. Record in Register (Form MBP-4) u/s 189

vii. Disclosures & Reporting

• Disclosures of all material transactions quarterly in the corporate governance compliance report
• Disclosures in annual report (corporate governance section)
• Disclosures to stock exchanges and on the company website every 6 months upon publication of its standalone and consolidated financial results

3. Unlisted Public Entity

i. Identify RPT (S. 188 r/w S. 2(76))

ii. Check: Ordinary Course of Business + Arm’s Length Basis

iii. If yes:

• No further Board or shareholder approval required (subject to exemptions for certain companies)

iv. If no:

a. Obtain Board Approval

• Decision at board meeting (not by circulation)
• Include the disclosures in the agenda
• Interested director → Declare interest (Form MBP-1); and remain absent at the meeting before discussion

b. If AC required, obtain its prior approval

v. Exceeding Threshold → Shareholder Approval

• Ordinary resolution required
• RPs cannot vote, except where 90% or more members are relatives/promoters/relatives of RPs
• No prior shareholder approval for transactions between the holding company and wholly owned subsidiary (if accounts are consolidated and placed before shareholders for approval).
• Explanatory statement with disclosures

vi. Record in Register (Form MBP-4) u/s 189

vii. Disclosures in Form AOC-2, signed with the Board’s Report

4. Foreign Subsidiaries of Listed Entities

i. Identify RPT (CA, 2013, LODR, Accounting Standards, Secretarial Standards)

• Parent entity collects compliance data from foreign subsidiary
• Local foreign law, not determinative; Indian law, prevails for disclosure + control

ii. Parent Entity Responsibility

• Obtain necessary information from the foreign subsidiary
• Ensure compliance with Indian laws & regulations
• Information provided by the subsidiary considered authoritative

iii. Threshold-based Approvals (subsidiary is a party, listed entity is not)

a. Subsidiary RPTs >₹1 crore require parent AC approval if exceeding the lower of:

(i) 10% of the annual standalone turnover of the subsidiary (last audited FS); or

(ii) Schedule XII materiality threshold of the listed entity

b. Subsidiary without audited FS for ≥1 year: prior AC approval if exceeding lower of:

(i) 10% of aggregate paid-up capital + securities premium of the subsidiary (≤3 months old)

(ii) Schedule XII materiality threshold of the listed entity

iv. Additional LODR Compliance

• Identify group RPTs (parent/other subsidiaries)
• Periodic disclosure to the listed holding company
• Maintain uniform RPT governance across the group

5. Foreign Subsidiaries of Unlisted Entities

i. Identify RPTs per Companies Act, 2013

ii. Application of Ind AS-24

iii. Indian law governs identification and reporting

iv. Exemptions

• WOs → No AC required
• JVs → Exemption from AC
• Dormant companies → AC not mandatory

v. Best Practice Recommendations

• Adopt formal RPT Policy
• Detail internal protocols for review, approval, disclosure
• Ensure good governance and internal control

vi. Parent Company Coordination

• Collect compliance data from foreign subsidiary
• Ensure consistent reporting standards
• Uniform application of Indian laws & regulations

vii. Maintain records as per Indian company law requirements (Record in Register (Form MBP-4) u/s 189)

RATIFICATION OF RPTs

The term “ratification” refers to the process of validating an act already performed, making it legally effective. This principle draws from the Latin maxim “ratihabitio mandato aequiparatur” — a subsequent ratification of an act is treated as equivalent to prior authority. Ratification thus assumes an act not properly authorised at the outset but later given legal effect retrospectively. In Hartman v. Hornsby, the English Court described ratification as approval, by act, word, or conduct, of something improperly or unauthorisedly done in the first instance. For ratification to be valid, three conditions² must be met:

(i) the person whose act is sought to be ratified must have acted for the other;

(ii) the other person on whose behalf the act was performed by the former must be a competent person to perform the act which has been performed and must continue to be so competent legally even at the time of ratification; and

(iii) the person ratifying the act does so with full knowledge of the act ratified.

All these conditions should be established by cogent materials to be placed on record by the person who wants to claim the benefit of ratification.

S. 177 of the CA, 2013 requires that all companies mandated to constitute an AC, or those who have done so voluntarily, obtain the approval or subsequent ratification of the AC for all RPTs. This requirement extends to any proposed modification in existing transactions and applies uniformly, irrespective of whether the transactions are in the ordinary course of business or on an arm’s length basis, as S. 177 operates independently of S. 188.

When placing any RPT for approval or ratification, the listed entity must provide the AC and shareholders with the prescribed minimum information, as specified in the Industry Standards. However, if the value of a transaction (or aggregate with previous transactions, including ratified ones) does not exceed ₹1 Crore in a financial year, detailed disclosure requirements do not apply, and only minimum information per Annexure-13A is required. For notices to shareholders seeking approval of RPTs, the same exemption applies to transactions within the threshold limits.

Where the AC does not approve a transaction that is outside the scope of S. 188, it is required to make its recommendations to the Board. If any director or officer enters into a transaction not exceeding ₹1 Crore without prior approval of the AC and such transaction is not ratified within three months, it becomes voidable at the option of the Committee. In such cases, the director concerned must indemnify the company for any loss incurred.

S. 188(3) extends a similar mechanism for transactions requiring the consent of the Board or shareholders. Any contract or arrangement entered into without such consent must be ratified by the Board or shareholders, as applicable, within three months. Failing ratification, the contract becomes voidable at their option, and the directors involved are liable to indemnify the company. The company is also entitled, u/s 188(4), to initiate recovery proceedings for any loss caused by contravention.

While the LODR do not explicitly require board‑level ratification of RPTs, the Board of Directors carries an overarching responsibility to monitor and manage potential conflicts of interest, as mandated under Chapter II of the LODR.

Penalties for non-compliance are set out u/s 188(5): twenty-five lakh rupees for listed entities and five lakh rupees for other companies. Further, directors convicted under this provision face disqualification and vacation of office.

To mitigate these risks, companies must ensure the timely ratification of RPTs. The AC should review, on a quarterly basis, all RPTs entered pursuant to omnibus approvals. Further, any member with a conflict of interest must refrain from participating in discussions and voting on the relevant item.

POLICY ON RPTs

Reg. 23 of the LODR mandates that listed companies formulate a policy regarding the materiality of RPTs and the handling of these transactions, noting that the limits may vary for different classes of transactions. This includes establishing clear threshold limits that must be approved by the Board of Directors. Additionally, the policy must be reviewed and updated by the board at least once every three years. While this regulation imposes specific requirements, there is no corresponding obligation under the Act. The policy may also outline the processes for identifying, reviewing, and approving RPTs. Furthermore, it should clarify what constitutes the "ordinary course of business" for the company. This policy is required to be disclosed in a separate section on the company’s website, and a link to this information must be included in the company’s Annual Report.

KEY PRECEDENTS

Following the allegations raised in the Hindenburg case³, SEBI scrutinised transactions involving Adani Group companies for possible retroactive classification as RPTs. SEBI concluded that the transactions did not qualify as RPTs because they predated an expanded regulatory definition.

Specifically, the definition of “related party transactions” under the LODR prior to the 2021 Amendment did not include transactions between a listed company and unrelated parties, even if those transactions indirectly benefited a RP. The 2021 Amendment, which broadened the scope of the definition, applied only prospectively from April 1, 2022, and could not be applied retrospectively. Therefore, SEBI held that the transactions in question were outside the definition of RPTs at the relevant time and did not violate any regulations.

The Legal Opinions in the Informal Guidance Note have focused on the phrase “in a contract” in the definition of RPTs under the LODR to argue that only transactions under the same contract should be aggregated while assessing materiality. However, the regulation uses the word “includes” before the phrase, indicating an expansion rather than a limitation. This means that multiple transactions, even across different contracts, should be considered together when calculating the materiality threshold. Restricting aggregation to the same contract would undermine the regulatory intent, allowing companies to bypass shareholder approvals by dividing transactions across separate contracts. Therefore, SEBI’s broader interpretation prevails, ensuring that shareholder protections and disclosure requirements are effectively upheld⁴.

In August 2024, SEBI penalised 27 entities, including Reliance Home Finance Limited (RHFL), for diverting funds through loans to financially weak borrowers without proper due diligence⁵. SEBI found that the promoters, in collusion with KMP, orchestrated a scheme to transfer funds to entities linked to them without disclosing these transactions to shareholders, violating disclosure requirements, despite the claim that these loans were at arm’s length and the ordinary course of business. SEBI held them as RPTs due to the connections established through common directorships and intertwined shareholding. SEBI asserted jurisdiction as RHFL was a listed company and concluded that the actions misled investors and manipulated the market.

In 2021, the Supreme Court⁶ held that the existence of a ‘related party’ relationship can be determined based on the substance of transactions and interrelationships rather than formal labels. The Court identified collusive transactions and “deeply entangled” relationships among entities and individuals as evidence of RP status u/s 5(7) and 5(24) of the IBC, 2016. The judgment introduced a “smoke test” to detect sham transactions created to disguise true financial relationships.

The Court emphasised that a “financial debt” requires actual disbursal of money, rejecting claims based on sham or collusive arrangements where no real debt existed. It also recognised that “related party” includes parties “acting on the advice or under the influence” of others. Significantly, the Supreme Court clarified that RP status applies to parties related at the relevant time of transactions, barring attempts to avoid exclusion from the Committee of Creditors by feigning cessation of the relationship.

BEST PRACTICES AND WAY FORWARD

Effective governance of RPTs relies on robust systems and ethical practices to prevent misuse and regulatory avoidance. Companies are encouraged to implement automated tools that map and continuously monitor RPTs, raising alerts if approvals or limits are breached. Such tools should capture approvals by the Audit Committee, Board, and shareholders, and should serve broader compliance purposes, including requirements under the Companies Act, Income Tax Act, and cost records or audits.

Best practices involve making a one-time effort to identify all RPs—especially in groups with multiple subsidiaries—and integrating this information into the management information system (MIS), to be updated at least every six months. Validation of the data by the Company Secretary and Head of MIS ensures accuracy. Companies should clearly define what constitutes ordinary business, systematically identify RPTs, and establish an approval workflow before engaging in such transactions. Documentation that substantiates arm's length pricing, along with a predetermined format for presenting transactions to the Audit Committee or Board, enhances transparency.

Senior management should be made aware of these obligations, and regular updates to the Board from the Chairman of the AC should be standard practice. Maintaining a register that serially records all RPTs and ensuring system controls are in place to track such dealings will strengthen compliance and promote an ethical corporate culture with proactive monitoring and accountability.

Disclaimer – The views expressed in this article are the personal views of the authors and are purely informative in nature.