Related party transactions: when board approval is enough and when you need shareholders (Section 188)

Founders assume a quiet board nod covers dealings with their own consulting firm, a director's brother's premises, or a group company. Under Section 188 of the Companies Act, 2013, the difference between a clean file and a penalty of up to ₹25 lakh often comes down to one question they never asked: did this transaction cross a threshold that required a shareholder resolution, or could the board approve it alone?

Related party transactions (RPTs) are not illegal. Companies deal with directors, their relatives, holding companies and group entities every day. What the law polices is the process: who approves the transaction, whether it was disclosed, and whether it was priced honestly. Getting the approval route wrong is one of the most common — and most expensive — compliance failures in Indian private companies.

What the law actually requires

Section 188 read with Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014 sets up a two-tier approval structure for a defined list of transactions with a "related party" (as defined in Section 2(76) of the Act — this includes directors, their relatives, firms or private companies in which a director or relative is a partner/member/director, and holding, subsidiary and associate companies).

Tier 1 — Board approval by resolution. Every transaction listed in Section 188(1) — sale, purchase or supply of goods or materials; buying, selling or leasing property; availing or rendering of services; appointment of a related party to any office or place of profit; and underwriting the subscription of the company's securities — requires the consent of the Board of Directors given by a resolution at a board meeting. This cannot be done by circulation. Under Section 184, an interested director must disclose their interest and not participate in that agenda item — though a key private-company relaxation applies (see below).

Tier 2 — Prior approval of members by ordinary resolution. Where a transaction exceeds the monetary thresholds in Rule 15(3), board approval alone is not enough. The company must obtain prior approval of shareholders by an ordinary resolution (the Companies (Amendment) Act, 2015 relaxed this from a special resolution to an ordinary one). The current thresholds are:

• Sale, purchase or supply of goods or materials — 10% or more of turnover
• Selling, disposing of, or buying property of any kind — 10% or more of net worth
• Leasing of property of any kind — 10% or more of turnover
• Availing or rendering of any services — 10% or more of turnover
• Appointment to any office or place of profit in the company, subsidiary or associate — monthly remuneration exceeding ₹2,50,000
• Underwriting the subscription of securities — remuneration exceeding 1% of net worth

Turnover and net worth are taken from the audited financial statements of the immediately preceding financial year.

The two carve-outs that matter most. Section 188 does not apply to transactions entered into in the ordinary course of business that are at arm's length price (both conditions must be satisfied — "arm's length" means as if between unrelated parties with no conflict of interest). This is where most legitimate group trading sits. Second, for a transaction between a holding company and its wholly-owned subsidiary, an ordinary resolution passed by the holding company is sufficient — the WOS does not need a separate members' resolution.

Omnibus approval vs. per-deal approval

This is the distinction founders get wrong. Omnibus approval is a mechanism under Section 177(4) and Rule 6A whereby the Audit Committee approves a class of recurring related party transactions in advance for a financial year, rather than clearing each invoice one by one.

Omnibus approval is available only to companies that are required to constitute an Audit Committee under Section 177 — broadly, listed companies and certain larger public companies. Most small private limited companies do not have an Audit Committee, and therefore cannot use omnibus approval at all. For them, every threshold-crossing RPT goes through the per-deal route: board resolution, and members' ordinary resolution where limits are breached.

Where omnibus approval is available, Rule 6A caps it: the Audit Committee must specify criteria (name of the party, nature, period, maximum value), the approval is valid for one financial year and must be renewed, and transactions whose value is not foreseeable are capped at ₹1 crore per transaction. Omnibus approval cannot cover transactions concerning the sale or disposal of the company's undertaking, and cannot be used where the committee has not laid down criteria.

So the practical test is: Is this a one-off deal above a Rule 15 threshold? → per-deal board + shareholder approval. Is this a recurring, foreseeable class of transactions in a company that has an Audit Committee? → omnibus approval, renewed annually.

Practical implications — what happens when you get it wrong

The contract becomes voidable. Under Section 188(3), where an RPT is entered into without the required board or shareholder consent and is not ratified within three months, the contract is voidable at the option of the Board. If it is with a related party of a director, that director must indemnify the company for any loss.

Personal monetary penalties under Section 188(5). Any director or employee who authorises a non-compliant transaction is liable to a penalty of up to ₹25 lakh in the case of a listed company and up to ₹5 lakh in the case of any other company (including private companies). This is a penalty on the individual, not just the company.

MCA21 v3 flags the mismatch automatically. The company's related party transactions must be disclosed in Form AOC-2 (attached to the Board's Report under Section 134(3)(h) and Rule 8(2)) and reflected in the notes to accounts filed with AOC-4. MCA21 v3's straight-through processing and the linkage between AOC-4, the auditor's report and the board's report mean an RPT that appears in the financials but has no corresponding AOC-2 disclosure or resolution reference is exactly the kind of inconsistency that surfaces in scrutiny. Auditors are separately required to report on RPTs under CARO 2020.

The private-company relaxation founders should know. By MCA notification dated 5 June 2015, the second proviso to Section 188(1) — which bars a member who is a related party from voting on the resolution — does not apply to private companies. In a private limited company, a shareholder who is a related party may vote on the ordinary resolution approving the transaction. This is a genuine relaxation, but it does not remove the requirement to pass the resolution where a threshold is crossed.

A worked example: where the threshold bites

Assume a private limited company with turnover of ₹8 crore and net worth of ₹3 crore, using last year's audited figures.

• The company buys packaging materials worth ₹60 lakh a year from a firm in which a director's brother is a partner. That is 7.5% of turnover — below the 10% goods threshold. A board resolution is enough (and the interested director's disclosure of interest must be minuted), unless the purchase is in the ordinary course of business at arm's length, in which case Section 188 does not apply at all.
• The same company then leases a warehouse owned by a director for ₹1 crore a year. That is 12.5% of turnover — above the 10% leasing threshold. Now the company needs a board resolution and a prior members' ordinary resolution, plus AOC-2 disclosure.
• The company also appoints the director's spouse to a management role at ₹3 lakh per month. Because monthly remuneration exceeds ₹2,50,000, this "office or place of profit" appointment also needs a members' ordinary resolution regardless of the percentage tests.

Notice that two separate transactions with the same related party can sit on opposite sides of the line. The thresholds are tested transaction-by-transaction, not on the aggregate relationship — which is exactly why a transaction-level screening habit matters more than a general sense that "we don't do much with related parties."

A further trap: transactions must be looked at on a per-financial-year basis. Splitting one ₹1 crore lease into two ₹50 lakh agreements to stay under a threshold will not survive scrutiny — the substance of the arrangement, not its paperwork, decides whether shareholder approval was needed.

Step-by-step: what to do

• Map your related parties first. List every director, their relatives (as defined in Section 2(77) and the Rules), and every firm/company in which they hold an interest. You cannot screen transactions you have not mapped.
• Classify each transaction. For every dealing with a related party, ask: (a) Is it in the ordinary course of business and at arm's length? If yes to both, Section 188 approval is not required — but document the arm's-length basis. If not, proceed.
• Check the Rule 15 threshold. Calculate the transaction value against the 10% turnover / 10% net worth / ₹2.5 lakh-per-month tests using last year's audited figures. Below threshold → board resolution suffices. At or above → board resolution plus prior members' ordinary resolution.
• Convene a board meeting (not approval by circulation). Record the interested director's disclosure of interest under Section 184, and note their non-participation in that agenda item in the minutes.
• Pass the members' ordinary resolution before the transaction where a threshold is crossed. "Prior approval" means before entering the contract, not after.
• Disclose in AOC-2 and attach it to the Board's Report; ensure the notes to accounts in AOC-4 are consistent.
• If you have an Audit Committee, put recurring RPTs through an omnibus approval at the start of the financial year and diarise its renewal.

For a compliance audit of your company, visit pvtltd.co

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See Also

• Lending Between Your Own Group Companies: Section 185 or Section 186? What the Companies Act Actually Requires
• "We charge our UK parent whatever is convenient": What arm's-length pricing actually requires
• Leaving Form AOC-2 blank: What the Companies Act actually requires for related-party disclosure

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