Related Party Transactions under Section 188 of the Companies Act, 2013

Related Party Transactions under Section 188 of the Companies Act, 2013

If your company has ever bought raw material from a director's brother's firm, rented office space from a promoter, or hired a relative as a consultant, you have already brushed up against related party transaction rules — whether you realised it or not. Many founders and CFOs treat these deals as "just business," only to discover during an audit or a funding due diligence that the paperwork was never done properly.

This is one of those compliance areas that looks simple on the surface but trips up even well-run companies. The good news is that once you understand the framework under Section 188 of the Companies Act, 2013, it becomes a routine part of your board process rather than a source of last-minute panic. Let's break it down in plain language.

What is a Related Party Transaction

A related party transaction, in simple terms, is any contract or arrangement your company enters into with a "related party" — someone who is closely connected to the company through ownership, management, or family ties, and who could potentially influence the terms of the deal in their own favour.

The term "related party" is defined under Section 2(76) of the Companies Act, 2013, and it covers a fairly wide circle of people and entities, including:

• A director or key managerial personnel (KMP) of the company
• A relative of a director or KMP
• 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 and holds along with relatives more than the 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
• Any person on whose advice, directions, or instructions a director or manager is accustomed to act (excluding advice given in a purely professional capacity)
• Holding, subsidiary, and associate companies, and subsidiaries of holding companies (fellow subsidiaries)
• Investing companies or venturers of the company, as prescribed

Section 188 of the Companies Act then lists out the specific types of transactions that get caught under this framework when they happen with a related party. These include:

• 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 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 company, or associate company
• Underwriting the subscription of any securities or derivatives of the company

In practice, this touches far more transactions than people expect — intercompany loans, shared services arrangements, rent for a warehouse owned by a promoter's family, consultancy fees paid to a director's spouse, or even a group company's product being resold through your firm. If any of these involve a related party as defined above, Section 188 applies.

Why It Matters

You might wonder why the law bothers to regulate deals your own company chooses to enter into. The answer lies in protecting everyone who is not sitting at the table when the deal is negotiated.

• Risk of value extraction: Related parties, by definition, have influence over decision-making. Without checks, a director could push the company into a lopsided contract that benefits their own firm at the company's expense.
• Protecting minority shareholders: Shareholders who do not have management control rely on the law to ensure that insiders are not quietly siphoning off value through inflated purchase prices, underpriced sales, or unnecessary "consultancy" arrangements.
• Governance and transparency: Proper related party transaction handling is a core pillar of good corporate governance, and it is one of the first things investors, lenders, and rating agencies check before committing capital.
• Statutory audit and ROC scrutiny: Your statutory auditor is required to comment on related party transactions and their compliance with Section 188 in the audit report. The Registrar of Companies (ROC) can also flag non-disclosure or non-compliance during routine or investigation-based scrutiny.
• Reputational risk: Related party issues are often what surface in financial press coverage of corporate governance failures. Even a technically minor lapse can attract disproportionate attention if it becomes public.
• Penalty and personal liability for directors: Contravention of Section 188 does not just expose the company — officers in default, including the directors who approved or benefited from the transaction, can face personal consequences. The exact penalty figures have been revised over time, so always verify the current amounts under the Act with a professional before assuming a number.

Simply put, this is not a "check the box" compliance requirement. It exists because related party deals are exactly where governance tends to break down first.

When It Applies / Conditions

Here is where a lot of confusion happens, so let's simplify the layers of approval.

Board approval is always required. Every related party transaction covered under Section 188, regardless of size, needs the approval of the Board of Directors, passed at a validly convened board meeting. This is the baseline requirement that applies to every company, public or private, listed or unlisted.

Shareholder approval kicks in under specific conditions. A related party transaction needs the additional approval of shareholders by an ordinary resolution when either of the following is true:

• The transaction is not in the ordinary course of business of the company, or
• The transaction is not on an arm's length basis (meaning the pricing or terms are not comparable to what an unrelated third party would agree to), or
• The transaction (or a series of transactions to be entered into) exceeds the thresholds prescribed under Rule 15 of the Companies (Meetings of Board and its Powers) Rules — these thresholds are periodically reviewed, so please verify the current limit applicable to your transaction type and company size with a professional rather than relying on any fixed figure.

The key exemption: if a transaction is both in the ordinary course of business and at arm's length price, it is exempt from the shareholder approval requirement under Section 188. Board approval (with proper disclosure) is still advisable and, in most reasonable governance practices, still obtained — but the higher bar of a shareholder resolution does not apply.

Voting restriction: if the related party is also a member (shareholder) of the company, that related party cannot vote on the resolution approving the transaction. This ensures the people with a conflict of interest do not get to approve their own deal.

Audit committee angle under Section 177: for listed companies and other companies where an audit committee is mandatorily constituted (as prescribed), all related party transactions — and any subsequent material modification — must first be approved by the audit committee before going to the board. The audit committee can also grant "omnibus approval" for repetitive or recurring transactions of a similar nature, subject to conditions prescribed under the applicable rules, which considerably eases the compliance burden for routine dealings.

Documents & Approvals Required

Getting the paperwork right is where most companies stumble. Here is what you typically need in place:

• Board resolution approving the transaction, with the interested director's disclosure of interest recorded as required under Section 184
• Disclosure of interest by the concerned director in the prescribed form/register, along with a general notice if applicable
• Audit committee approval or omnibus approval, where the company is required to constitute an audit committee under Section 177
• Notice to shareholders with an explanatory statement, if the matter is being placed before a general meeting — this statement must disclose material details such as the name of the related party, the nature of the relationship, the nature, duration, and material terms of the contract or arrangement, and the amount involved or likely to be involved
• Ordinary resolution passed by shareholders where required (special resolution is not the standard requirement here, but always double-check the current provision applicable to your fact pattern with a professional)
• Form MBP-1 — disclosure of interest by directors, filed with the company at the start of each financial year and whenever there is a change
• Form AOC-2 — a mandatory annexure to the board's report, disclosing particulars of contracts or arrangements with related parties under Section 188, whether or not shareholder approval was needed
• Contract register entries — maintained as required under Section 189, capturing details of every contract or arrangement in which directors are interested

Keep every one of these documents ready before, not after, the transaction is executed. Retrofitting compliance after the fact is far messier and riskier than doing it upfront.

Step-by-step Process & Forms

Here is a practical sequence most companies follow:

1. Identify whether the counterparty is a related party using the definition under Section 2(76) — check for direct relationships (director, KMP) as well as indirect ones (relatives, associate companies, entities where a director or relative holds an interest).
2. Assess whether the transaction is in the ordinary course of business and at arm's length — this usually requires comparing the proposed terms with market rates or third-party quotes, and documenting that comparison.
3. Place the matter before the audit committee, if your company is required to have one, for its approval or to seek omnibus approval for recurring transactions.
4. Place the matter before the Board of Directors, ensuring the interested director discloses their interest and does not participate in the discussion or vote on that specific agenda item.
5. If the transaction is not in the ordinary course, not at arm's length, or exceeds the prescribed threshold, convene a general meeting of shareholders with proper notice and an explanatory statement covering all material particulars.
6. Pass the ordinary resolution, with related party members who are shareholders abstaining from voting on that resolution.
7. Maintain the register of contracts in which directors are interested, under Section 189, typically in Form MBP-4.
8. Disclose the transaction in the board's report, attaching Form AOC-2 with full particulars of every related party contract entered into during the year, including those exempted from shareholder approval.
9. Let the statutory auditor review the transaction as part of the annual audit — auditors typically test related party transactions for proper identification, approval trail, and arm's-length justification.

Missing any single step in this chain — for example, forgetting to record the interested director's abstention, or skipping the explanatory statement details — can make the entire approval defective, even if the underlying commercial terms were completely fair.

Cost, Fees & Penalties 2026

The actual cost of compliance here is usually modest compared to the risk of getting it wrong. Typical cost components include:

• Documentation and drafting charges for board resolutions, explanatory statements, and notices — professional fees vary depending on transaction complexity and whether a shareholder meeting is involved
• Arm's-length benchmarking support — if a transaction's pricing needs to be justified against market comparables, you may need a valuation or benchmarking exercise, which adds to professional fees depending on scope
• Contract register and MBP-1/MBP-4 maintenance — usually bundled into a company's annual compliance retainer with its CS or CA firm
• Form AOC-2 preparation and board report integration — typically part of the annual filing and board report compilation exercise

On the penalty side, the Companies Act prescribes consequences for contravention of Section 188 for both the company and every officer in default, including possible fines. However, since these amounts have been revised multiple times through amendments, please verify the current applicable penalty figures under the Act with a professional before relying on any specific number.

Beyond the direct monetary penalty, the real cost of non-compliance can be more damaging:

• The transaction can be voidable at the option of the Board or, where the transaction is with a related party of a director, at the option of the shareholders, if it was entered into without the required approval
• The director or employee responsible may be required to indemnify the company for any loss it suffers as a result of the transaction
• Ratification difficulties: if the transaction is not ratified within a prescribed period by the Board or shareholders (as applicable), the related party may also be required to reverse the benefit obtained, in addition to facing the other consequences

This is precisely why getting the approval process right the first time is far cheaper than trying to fix it after an auditor or the ROC raises a query.

Timeline

Related party transaction approvals move at different speeds depending on the layer of approval required.

• Board approval can typically happen within the same board meeting where the transaction is discussed, provided the disclosures under Section 184 have already been made and the interested director is excluded from voting.
• Audit committee approval or omnibus approval, where applicable, is usually built into the company's quarterly or annual board and committee calendar, and omnibus approvals are often renewed on an annual basis to cover recurring transactions without needing fresh approval each time.
• Shareholder approval requires a general meeting, and the standard notice period for an AGM or EGM is typically 21 clear days, though this can be shortened with the consent of the requisite majority of members entitled to vote, where permitted. Because notice period rules and consent thresholds can change and depend on your company's specific circumstances, it is best to verify the exact number of days applicable to your situation with a professional before finalising your meeting calendar.

Building related party transaction approvals into your regular board and AGM calendar — rather than treating each one as a one-off exercise — saves significant time and stress.

Related Party Transactions vs Ordinary Third-Party Transactions — Key Distinctions

It helps to see the two side by side to understand exactly what extra compliance related party status brings:

• Approval layers: An ordinary third-party transaction generally needs only routine internal approval as per the company's own delegation of authority. A related party transaction needs board approval as a baseline, and potentially audit committee and shareholder approval depending on the nature and size of the deal.
• Disclosure requirements: Third-party transactions with unrelated vendors do not require specific disclosure in the board's report. Related party transactions must be disclosed through Form AOC-2 as an annexure to the board's report, regardless of whether shareholder approval was needed.
• Arm's-length test applicability: For an ordinary third-party deal, pricing is assumed to be market-driven since there is no relationship influencing it. For a related party deal, the company must actively demonstrate and, ideally, document that pricing is at arm's length if it wants to claim the exemption from shareholder approval.
• Audit scrutiny level: Statutory auditors typically apply a much higher level of scrutiny to related party transactions, often verifying the approval trail, the arm's-length basis, and the accuracy of Form AOC-2 disclosures, whereas ordinary transactions are tested through general substantive audit procedures.
• Voting restrictions: There is no voting restriction concept for ordinary third-party transactions. For related party transactions, both the interested director (at the board level) and the related party shareholder (at the general meeting level) are barred from participating in the relevant vote.

Common Mistakes

Even experienced finance teams get tripped up on related party compliance. Watch out for these recurring issues:

• Not identifying the related party correctly, especially indirect relationships — for instance, missing that a vendor company is actually controlled by a director's relative, or overlooking that an associate company qualifies as a related party even without direct director overlap.
• Claiming "arm's length" without proper benchmarking or valuation support — simply asserting that pricing is fair is not enough; you need comparable market data, quotations, or a documented rationale to back the claim if it is ever questioned.
• Interested directors voting when they should have abstained — this is one of the most common defects found during due diligence and can render the board approval invalid.
• Missing or incomplete Form AOC-2 disclosure — some companies file the form but leave out material details like the exact nature of the relationship or the amount involved, which defeats the purpose of the disclosure.
• No omnibus approval process for recurring transactions, leading to repeated ad-hoc approvals (or worse, no approvals at all) for transactions that happen every month, such as rent payments to a promoter-owned entity or regular purchases from a group company.
• Not maintaining the Section 189 register of contracts in which directors are interested, which is a separate and often forgotten requirement from the board resolution itself.
• Inadequate explanatory statements in shareholder meeting notices — leaving out the name of the related party, the precise nature of the relationship, or the material terms, which can make the shareholder resolution vulnerable to challenge.
• Treating group company transactions casually just because "it's all one business," without realising that holding-subsidiary-associate transactions are squarely covered under the related party framework.
• Ignoring the cumulative effect of smaller transactions — several smaller deals with the same related party over a year can together cross the prescribed threshold, and companies sometimes fail to track this cumulative exposure.
• Delaying disclosure until year-end — waiting until the board report is being finalised to compile related party details, instead of tracking and approving transactions as they happen through the year, often leads to gaps and last-minute scrambling.

FAQ

Who counts as a related party under the Companies Act?

A related party includes directors, key managerial personnel, and their relatives, as well as firms and private companies where they hold an interest, holding/subsidiary/associate companies, and certain other connected entities as defined under Section 2(76). The definition is broader than most people expect and includes several indirect relationships.

Is board approval always needed for a related party transaction?

Yes, board approval is the baseline requirement for every related party transaction covered under Section 188, irrespective of the transaction's size or whether it is in the ordinary course of business. Higher approvals like shareholder resolution apply only in specific conditions on top of this.

What does "arm's length" pricing actually mean?

Arm's length means the transaction is priced and structured as if it were between two unrelated, independent parties negotiating in their own commercial interest, with no special favour given because of the relationship. Companies typically support this claim with market comparisons, third-party quotations, or a documented pricing rationale.

What happens if a related party transaction is not disclosed?

Non-disclosure can expose the company and officers in default to penalties under the Act, and the transaction itself can be treated as voidable at the option of the board or shareholders. It also invites adverse remarks from the statutory auditor and increased scrutiny from the Registrar of Companies.

Can a related party shareholder vote on the resolution approving their own transaction?

No. If the related party is also a member of the company, they are barred from voting on the ordinary resolution approving that specific transaction at the general meeting. This restriction exists specifically to prevent conflicted parties from approving their own deals.

Does Section 188 apply to private companies too?

Yes, Section 188 applies to private companies as well as public companies. While certain other governance provisions have limited exemptions for private companies, the related party transaction framework under Section 188 broadly continues to apply, so private companies should not assume they are exempt.

What is an omnibus approval and why does it help?

An omnibus approval is a one-time approval given by the audit committee (where applicable) covering a category of recurring related party transactions for a defined period, usually reviewed annually, instead of requiring a fresh approval for every single instance. It significantly reduces the compliance burden for routine, repetitive dealings like rent, regular purchases, or shared services.

What are the consequences of violating Section 188?

Consequences can include penalties on the company and every officer in default, the transaction being rendered voidable at the option of the board or shareholders, and the responsible director or employee potentially having to indemnify the company for any resulting loss. Because exact penalty figures have changed over time through amendments, it is important to verify the current position with a professional rather than assume a fixed number.

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