Related Party Transactions

It is common for companies to indulge in business with their pre-existing professional and personal network. These close associates can be major shareholders, subsidiary companies or minority-owned companies. The transaction may relate to sales, lease, loans, etc., known as related party transactions (RPT).

• Related party transactions (RPTs) involve business dealings within a company's network, such as subsidiaries, major shareholders, or associates, and are common in the corporate world.
• The Companies Act of 2013 mandates the disclosure and oversight of RPTs to protect shareholder interests and ensure fair business practices.
• Non-compliance with RPT regulations can lead to voided transactions, legal proceedings, and penalties, including fines and imprisonment for involved directors or employees.

Related party transactions (RPTs) are defined as business transactions where a company engages with its preexisting personal or professional network. This is a common practice in the business world. Related party transactions can be carried out with closely associated subsidiary companies, major shareholders, minority-owned companies, and other such entities. Such transactions could be related to loans, sales, leases, etc.

Such transactions are perfectly legal in the corporate world. However, it is necessary to disclose all related party transactions. Otherwise, they can be harmful to the interests of company shareholders.

In recent years, more and more related party transactions with questionable aspects have been reported. Even in the case of prominent Indian companies, whistleblowers have come forth to disclose these transgressions. Such transactions are thus heavily regulated by the laws.

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The first natural question upon learning about related party transactions is who exactly counts as a related party. Firstly, let us see the definition according to the Indian Accounting Standards. According to this guideline, parties are classified as related when there is a significant influence or control that one party can exercise over the other party’s operations or finances in a given timeframe.

Related parties can include:

• Relatives of a director
• Relatives of a senior management
• Companies with directors or partners or senior management related to the primary company’s director or management
• A firm under the influence of senior management or a director
• Subsidiary, associate, or holding company of the primary entity
• A public company with over 2% of paid-up capital held by the primary company’s director or their relatives

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Now, let us understand the definition of related party transactions in more detail. It is interesting to note that such transactions are quite common in everyday business practices. Entering into business with your pre-existing network can help you save costs and manage operations better, among other benefits. However, there are times when RPTs have the potential to be detrimental to a company as they can inherently be biased. RPTs could be set up to favour the company but be harmful to shareholders. Thus, such transactions are regulated by law.

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In India, the Companies Act of 2013 is the major regulator of RPTs. The act primarily lays down a safety framework that all businesses must follow. One major rule states that a company must disclose all RPTs to its shareholders in its board report.

The following table provides clear and concise information on the specific types of transactions that require oversight, the approval thresholds, and the regulatory requirements set by the Companies Act of 2013. This will help you understand the governance and compliance aspects of related party transactions.

Important notes about the information above:
 

• These limits apply to transactions in a financial year
• For calculating the turnover, the audited financial statements of the last year should be used

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There are several ways in which irregularities can arise in related party transactions. Let us understand a few of these situations:

• If compliance with the framework of the Companies Act of 2013 is not met, the concerned related party transactions can be rendered void.
• When RPT agreements or contracts are not ratified by the shareholders or board of directors, they can be rendered void by the shareholders or the board.
• When a director authorises a related party contract, they must indemnify the business against all potential losses.
• If any losses are caused by RPTs, the firm can initiate proceedings against the concerned person.
• Concerned employee/director can be liable for:
  • A fine ranging between Rs. 2,500 and Rs. 5 lakh
  • Up to 1 year imprisonment
  • Or both

Related party transactions are a prevalent and necessary aspect of business operations, facilitating cost savings and efficient management. However, due to their potential for bias and harm to shareholders, they are strictly regulated under the Companies Act of 2013 in India. Ensuring transparency and compliance in these transactions is crucial for maintaining corporate integrity and shareholder trust.