It is usual for business enterprises to be involved in business with their established professional and social connections. These firms can be significant shareholders, affiliate companies, or partially owned companies. The transactions can be related to sales, leases, loans, etc., referred to as related party transactions (RPT).
Though these transactions are legal, they turn destructive to the concerns of existing stockholders in case these are unreported.
Who is a Related Party?
Related party relates to the organizations or individuals that the company is connected with for the purpose of trade or business transaction. In alignment with the Indian Accounting Standards (AS-18), parties are considered connected if one party is able to affect the other in making a financial or operating decision in a specified reporting period of time.
Related parties may include:
- A director and their family members
- key managerial staff or their relatives
- A business or private firm where a manager, director, family member, or director is a partner
- If a director and his/her relatives own more than 2% of the fully paid capital in a public company
- Any corporate entity where the management or director has considerable influence
- A holding, subsidiary, or affiliated business of that business
- A business that serves as the holding company’s subsidiary
What are Related Party Transactions?
Related Party Transactions (RPTs) are the business transactions engaged in with the related parties. It is expected from businesses to utilize their in-hand resources and engage in transactions with existing networks. The majority of these transactions make economic and operational perspectives, offering the interests of the directors/managers, and the companies tend to align. Engaging with the related firm is sometimes the only viable choice.
Related party transactions are governed by various laws. This occurs due to such transactions possess the risk of partiality. when the linked party may be given preference in a transaction by the promoter or important people. The interests of the stockholders can be harmed.
For instance, a business may rent a building from a director’s family member. and pay more than what the market will bear. may charge the affiliated business a fee for services that is far more than their worth. These frequently come from the funds of stockholders.
RPTs must be closely examined in order to maintain sound company governance and avoid legal ramifications.
In what ways are RPTs regulated?
The Companies Act, 2013 primarily governs related party transactions. The Act does not restrict RPTs but outlines some protective measures. It is stated in Section 188 that any related party transaction must be revealed in the board report to the shareholder. And ought to be validated (according to the Act’s specified threshold limitations).
Transactions needed approval of Board of Directors | Transactions needed approval of Board of Directors |
Any material or items sold, bought, or supplied, either directly or through an agent | 10% or more of the business’s total revenue. |
Property sales or purchases | 10% or more of the business’s total value |
Using or providing any service, either directly or by a representative. | 10% or more of the business’s total revenue |
Appointment of a related party to any position or profit center inside the business or its subsidiary. | The salary passes Rs. 250000 per month. |
Underwriting of the company’s derivatives or securities | 1% or more of the net worth of the company. |
The consequence of irregularities in compliance
Failure to comply with the criteria stated in the Companies Act can make the transaction invalid.
In case the related party transaction’s contract/agreement has not been approved by the board of directors or the shareholders, this specific agreement is subject to cancellation by the board/shareholders.
Any director who approved the transaction is obligated to compensate the business for any damages.
In order to recoup any losses resulting from RPTs, the corporation may take legal action against the director or the employee.
Such a director or employee is accountable for:
- up to a year in jail,
- A fine of between Rs. 2,500 and Rs. 5 lakhs
- or both
Questions to Understand your ability
Q1.) What’s the real deal behind Related Party Transactions (RPTs)?
A) To jack up profits using outside players
B) To do business with people you already know
C) To stir up competition in the market
D) To slash down company debts
Q2.) Who can be tagged as a related party in a company?
A) Your biggest rival in the market
B) A director’s family member
C) Some random government official
D) A random employee who works in HR
Q3.) According to the Companies Act, 2013, when do RPTs need board approval?
A) If it’s more than 5% of company revenue
B) If it crosses 10% of total revenue
C) If it’s below Rs. 1 lakh
D) If it’s the director’s personal deal
Q4.) What happens if the board doesn’t approve a related party transaction?
A) The transaction magically becomes legal
B) The board or shareholders can cancel it
C) The company has to notify the government
D) The CEO has to sign off on it
Q5.) If directors mess up and fail to follow the rules for RPTs, what’s the punishment?
A) A slap on the wrist with a Rs. 1,000 fine
B) Up to a year in jail and a fine between Rs. 2,500 and Rs. 5 lakh
C) A warning from the company
D) A pay cut
Conclusion
In conclusion, related party transactions (RPTs) are common in business but must be carefully regulated to prevent potential harm to shareholder interests. The Companies Act, 2013 provides guidelines for such transactions, ensuring transparency and proper approval. Failure to comply with these regulations can lead to the cancellation of agreements and legal penalties for the responsible directors or employees. Companies must ensure adherence to these rules for sound governance and to avoid financial repercussions.
FAQ's
RPTs are basically business deals between a company and people or organizations it’s connected to, like directors, their families, or affiliate companies. Simple, right?
Think directors, their families, key staff, anyone with more than 2% share, or businesses where the company has some control. It’s all about connections.
Yeah, RPTs are legal, but if they go unreported, they can mess up things for shareholders. They need to be kept in check.
If you don’t report it, the deal’s basically a bust. Worse, directors could face penalties or the deal could be nullified.
Any transaction that crosses a certain threshold. Buying property, huge service contracts, or high-salary appointments all need approval. No escape.
Ignore the rules, and the director could be looking at jail time, fines, or both. Not worth it, right?
When they hit 10% of the company’s revenue or involve big salaries, like above Rs. 250,000 a month. These things need a green light.
If the board doesn’t approve, it’s game over. The deal gets canceled, and the director’s on the hook for damages.
