Related Party Transactions Under Section 188: What Every Company Must Know

Related Party Transactions Under Section 188: What Every Company Must Know

Almost every growing company transacts with people or entities connected to its own promoters, directors, or group structure — leasing office space from a director's family firm, buying services from a group company, or hiring a relative into a senior role. None of this is inherently wrong, but the Companies Act, 2013 requires these dealings to be identified, approved through the right channel, and disclosed transparently. Section 188 is the provision that governs this.

Related party transactions (RPTs) attract disproportionate scrutiny during statutory audits, funding due diligence, and ROC inspections precisely because they carry a built-in conflict-of-interest risk. Getting the classification and approval process wrong is one of the more common governance gaps found in growing private companies — this guide sets out exactly what to check.

What Counts as a "Related Party"

Under Section 2(76) of the Companies Act, "related party" with reference to a company includes, among others:

• A director or key managerial personnel (KMP) of the company, or their relatives.
• A firm in which a director, manager, or their relative is a partner.
• A private company in which a director or manager is a member or director.
• A public company in which a director or manager is a director, or holds along with relatives more than a prescribed shareholding.
• Any body corporate whose board, managing director, or manager is accustomed to act on the directions of the company's director or manager (and vice versa).
• Any person on whose advice, directions, or instructions a director or manager is accustomed to act (excluding advice given in a professional capacity).
• Holding, subsidiary, and associate companies, and subsidiaries of a company's holding company (fellow subsidiaries).
• A director or KMP of the holding company, or their relatives, in relation to the company.

"Relative" is itself a defined term (spouse, parents, siblings, children and their spouses, and certain other specified relations), so the net catches a fairly wide circle of individuals, not just the immediate director in question.

Transactions Covered Under Section 188

Section 188(1) applies specifically to transactions with related parties involving:

• Sale, purchase, or supply of any goods or materials.
• Selling or otherwise disposing of, or buying, property of any kind.
• Leasing of property of any kind.
• Availing or rendering of any services.
• Appointment of any agent for the purchase or sale of goods, materials, services, or property.
• Appointment of a related party to any office or place of profit in the company, its subsidiary, or associate company.
• Underwriting the subscription of any securities or derivatives of the company.

Ordinary employment relationships, statutory dues, and transactions that do not fall within these specific categories are outside the direct scope of Section 188, though they may still attract disclosure requirements elsewhere (such as in the financial statements under applicable accounting standards).

The Arm's Length and Ordinary Course Exception

This is the most important carve-out in the section. Transactions entered into by the company in its ordinary course of business AND on an arm's length basis are exempt from the specific board/shareholder approval requirements of Section 188 (though they still need to be identified, tracked, and disclosed).

Both conditions must be satisfied together:

• Ordinary course of business — the transaction is of a kind the company regularly and normally undertakes as part of its business, not a one-off or unusual arrangement.
• Arm's length basis — the transaction is conducted as if between two unrelated parties, with no favourable terms flowing from the relationship, and is broadly comparable to prevailing market terms.

Many companies wrongly assume that simply because a transaction is "business as usual" it is automatically exempt — both limbs need to be independently satisfied and, ideally, documented (through comparable pricing benchmarks, market quotes, or valuation support) so the exemption can be defended if questioned later by an auditor or the ROC.

Approval Process: Board vs Shareholders

Board Approval

Every related party transaction that is *not* covered by the ordinary-course-and-arm's-length exemption requires prior approval of the Board of Directors at a meeting (not by circular resolution, in most cases involving related parties). The interested director must disclose their interest and not participate in the discussion or voting on that specific agenda item.

Shareholder Approval

Where the transaction value crosses prescribed thresholds under the applicable rules (these thresholds are calculated with reference to turnover, net worth, or absolute transaction value depending on the category of transaction, and are periodically fine-tuned — always confirm current limits before assuming a transaction is within board-only territory), the company must additionally obtain prior approval by an ordinary resolution of the shareholders. For this shareholder vote, any member who is a related party to the specific transaction (or interested in the contract) is barred from voting, ensuring the decision is made by unrelated/disinterested shareholders. Certain categories of private companies enjoy relaxations on this member-voting restriction, but this should be verified against current exemption notifications rather than assumed.

Omnibus Approval

For companies that enter into recurring related-party dealings (e.g., ongoing intra-group service arrangements), the Audit Committee (where applicable) may grant omnibus approval for a class of transactions, subject to criteria such as maximum value per transaction and periodic review, rather than requiring case-by-case approval for every instance.

Register and Disclosures

• Every company must maintain a Register of Contracts or Arrangements in which Directors are Interested, commonly maintained in Form MBP-4, recording particulars of related party contracts and arrangements under Section 188 (and connected provisions such as Section 184).
• The Board's Report must disclose particulars of every contract or arrangement entered into with related parties under Section 188(1), including those not at arm's length or not in the ordinary course, generally in the prescribed format (commonly referenced as Form AOC-2).
• Financial statement notes (under applicable Accounting Standards / Ind AS on related party disclosures) require separate disclosure of related party balances and transactions, which is a distinct but overlapping requirement from the Section 188 approval trail.
• Audit committees, where constituted, are also required to approve or ratify related party transactions as part of their statutory mandate, layering an additional review step for companies where an audit committee is mandatory.

Fees and Practical Costs (2026, Indicative)

Section 188 itself does not attract a distinct government filing fee for board or shareholder approval — the cost lies in governance and documentation: drafting board/audit committee resolutions, preparing the explanatory statement for the shareholder resolution (where required), benchmarking arm's-length pricing, and maintaining the MBP-4 register correctly. Where a special resolution or e-form filing is triggered as part of a broader restructuring involving related parties, standard MCA filing fees for the relevant form apply. Professional support for setting up a related-party compliance framework — identifying related parties, documenting the exemption analysis, structuring omnibus approvals, and preparing AOC-2 disclosures — is typically charged as a fixed governance retainer or per-transaction advisory fee; get an itemised quote rather than assuming a flat industry rate, since scope varies widely by group complexity.

Timeline for Approval

• Identifying and flagging a related party transaction: should ideally happen at the deal-structuring stage, before commercial terms are finalised.
• Board approval: obtained at the next duly convened board meeting; urgent transactions may require convening a special meeting.
• Shareholder approval (if triggered): requires issuing notice for a general meeting with the explanatory statement, generally allowing the standard notice period (commonly 21 clear days, subject to shorter-notice provisions in limited circumstances).
• Ratification window: transactions entered into without prior approval (in narrow, specified circumstances) may be placed for ratification within three months of the date on which the transaction was entered into, though this is not a substitute for prior approval and carries its own risk if ratification is refused.

Penalties and Common Pitfalls

• Entering into an RPT without board or shareholder approval where required can render the transaction voidable at the option of the Board or shareholders, and the director/employee who authorised it may be required to indemnify the company for any loss.
• Listed companies face additional consequences and disclosure obligations under SEBI's Listing Regulations, layered on top of the Companies Act requirements.
• Officers in default for contravention of Section 188 can face penal consequences under the Act, and repeated defaults can attract adjudication proceedings by the ROC.
• Misclassifying a transaction as "arm's length" without supporting benchmarking documentation is a frequent audit finding — the burden of demonstrating arm's length pricing rests with the company.
• Interested directors participating in the board vote on their own related-party matter is a basic but surprisingly common lapse that can vitiate the approval.
• Failing to maintain or update the MBP-4 register is flagged during secretarial audits and ROC inspections as a standalone compliance gap even when the underlying transaction was otherwise properly approved.
• Ignoring RPTs during fundraising due diligence prep — investors routinely ask for the full RPT history and approval trail, and gaps here slow down or complicate term sheet negotiations.

FAQs

Does Section 188 apply to private limited companies?

Yes. While certain relaxations exist for specified classes of private companies (such as on member-voting restrictions for interested shareholders in limited scenarios), the core requirement to identify, approve, and disclose related party transactions applies to private companies as much as public ones.

Is a transaction between a company and its wholly-owned subsidiary a related party transaction?

Generally yes, since subsidiaries fall within the definition of related party — though certain categories of transactions between a holding company and its wholly-owned subsidiary may enjoy specific relaxations from the shareholder-approval requirement (the resolution passed by the holding company being treated as sufficient in some cases). This should be checked carefully against the current exemption before assuming automatic exclusion.

What documentation proves a transaction is at "arm's length"?

There is no single prescribed format, but common supporting evidence includes comparable third-party quotations, independent valuation reports, market rate benchmarks, or a documented rationale showing the terms mirror what an unrelated party would receive.

Can an interested director vote at the board meeting approving the RPT?

No. The interested director must disclose the nature of their interest and must not participate in the discussion or vote on that specific resolution.

What happens if a related party transaction is entered into without the required approval?

The contract can be voidable at the option of the Board (or, if involving a director, the company may also proceed against the director), and the director or employee responsible may be liable to indemnify the company for any resulting loss, in addition to potential penal consequences.

Is there a monetary threshold below which Section 188 does not apply at all?

The ordinary-course-and-arm's-length exemption applies regardless of value, but for transactions that fall outside that exemption, prescribed value thresholds determine whether shareholder approval (in addition to board approval) is triggered — these thresholds vary by transaction category and are set out in the applicable rules, so they should be checked before assuming board approval alone suffices.

How does Section 188 interact with Section 184 (disclosure of director's interest)?

Section 184 requires directors to generally disclose their interest in any company, firm, or body corporate at the start of each financial year and whenever there is a change; Section 188 builds on that disclosure by governing the specific approval process for transactions with those disclosed related parties. Both provisions are tracked together in the Register under Form MBP-4.

Do related party transactions need to be reported to shareholders even if board-approved and exempt?

Yes, in substance — while exempt (ordinary course, arm's length) transactions do not need prior shareholder approval, all material related party transactions are still expected to be disclosed in the financial statement notes and, where not at arm's length or not in the ordinary course, specifically in the Board's Report.

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