Interests of Director and Related Party Transactions

UPDATE: on 30^th August 2013: Companies Bill 2012 became the Companies Act, 2013 (Act 18 of 2013).

DISCLOSURE OF INTEREST BY DIRECTOR (SECTION 184, SUB SECTION 1):

Every director shall disclose his concern or interest in any company or companies or bodies corporate, firms, or other association of individuals which shall include the shareholdings, in such manner as may be prescribed. Such disclosure shall be made on three particular point of time:

(i)           At the first meeting of the Board in which he participates as a director;

(ii)          At the first meeting of the Board in every financial year; and

(iii)         Whenever there is any change in the disclosures already made, then at the first Board meeting held after such change.

Interest in Contract (Section 184, Sub – Section 2):

Every director of a company who is in any way, whether directly or indirectly, concerned or interested in a contract or arrangement or proposed contract or arrangement entered into or to be entered into shell disclose the nature of his concern or interest at the meeting of the Board in which the contract or arrangement is discussed and shall not participate in such meeting.

In case of body Corporate:

(a)   in which such director or such director in association with any other director, holds more than two per cent shareholdings of that body corporate, or

(b) is a promoter, manager, Chief Executive Officer of that body corporate.

In case of firm or other entity in which, such director is a partner, owner or member.

A director, who is not so concerned or interested at the time of entering into such contract or arrangement, shall, disclose his concern or interest,

(a)   forthwith when he becomes concerned or interested, or

(b) at the first meeting of the Board held after he becomes so concerned or interested.

Contract Voidable and Director Punishable (Section 184, Sub – Section 3, 4):

A contract or arrangement entered into by the company without disclosure or with participation by a director who is concerned or interested in any way, directly or indirectly, in the contract or arrangement, shall be voidable at the option of the company.

If a director of the company contravenes the provisions of sub-section (1) or subsection (2), such director shall be punishable with imprisonment for a term which may extend to one year or with fine which shall not be less than fifty thousand rupees but which may extend to one lakh rupees, or with both.

Interest Define (Section 184, Sub – section 5):

This sub – section say, “Nothing in this Section shall apply to any contract or arrangement entered into or to be entered into between two companies where any of the directors of the one company or two or more of them together holds or hold not more than two per cent of the paid-up share capital in the other company.

Related Party (Section 2, clause 76):

“Related party”, with reference to a company, means—

(i)           a director or his relative;

(ii)          a key managerial personnel or his relative;

(iii)         a firm, in which a director, manager or his relative is a partner;

(iv)         a private company in which a director or manager is a member or director;

(v)          a public company in which a director or manager is a director or holds along with his relatives, more than two per cent. of its paid-up share capital;

(vi)         any body – corporate  whose Board of Directors, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager;

(vii)        person on whose advice, directions or instructions a director or manager is accustomed to act

(viii)       any company which is—

1. a holding, subsidiary or an associate company of such company; or
2. a subsidiary of a holding company to which it is also a subsidiary;
3. such other person as may be prescribed;

Relative (Section 2, Clause 77):

‘‘relative’’, with reference to any person, means anyone who is related to another, if—

(i)           they are members of a Hindu Undivided Family;

(ii)          they are husband and wife; or

(iii)         one person is related to the other in such manner as may be prescribed;

RELATED PARTY TRANSACTION (SECTION 188, SUB – SECTION 1)

No company shall enter into any contract or arrangement with a related party with respect to—

(a)  sale, purchase or supply of any goods or materials;

(b) selling or otherwise disposing of, or buying, property of any kind;

(c)  leasing of property of any kind;

(d)  availing or rendering of any services;

(e)  appointment of any agent for purchase or sale of goods, materials, services or property;

(f)   such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company; and

(g)  Underwriting the subscription of any securities or derivatives thereof, of the company.

These contracts may be contract with (a) consent of board (b) given by way of resolution (c) at a meeting of the Board and (d) subject to prescribed conditions.

No contract or arrangement, in the case of a company having a paid-up share capital of not less than such amount, or transactions not exceeding such sums, as may be prescribed, shall be entered into except with the prior approval of the company by a special resolution.

No member of the company shall vote on such special resolution, to approve any contract or arrangement which may be entered into by the company, if such member is a related party.

This sub-section shall apply to any transactions entered into by the company in its ordinary course of business other than transactions which are not on an arm’s length basis.

“Office or place of profit” means any office or place—

(a)  where such office or place is held by a director, if the director holding it receives from the company anything by way of remuneration over and above the remuneration to which he is entitled as director, by way of salary, fee, commission, perquisites, any rent-free accommodation, or otherwise;

(b) where such office or place is held by an individual other than a director or by any firm, private company or other body corporate, if the individual, firm, private company or body corporate holding it receives from the company anything by way of remuneration, salary, fee, commission, perquisites, any rent-free accommodation, or otherwise.

“Arm’s length transaction” means a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest.

Related Party Transaction in Board Report (Section 188, Sub – Section 2):

Every contract or arrangement entered into shall be referred to in the Board’s report to the shareholders along with the justification for entering into such contract or arrangement.

Contract Voidable, Director to Indemnify (Section 188, Sub – Section 3, 4):

Where any contract or arrangement is entered into by a director or any other employee, without obtaining the consent of the Board or approval by a special resolution in the general meeting and if it is not ratified by the Board or, as the case may be, by the shareholders at a meeting within three months from the date on which such contract or arrangement was entered into, such contract or arrangement shall be voidable at the option of the Board and if the contract or arrangement is with a related party to any director, or is authorised by any other director, the directors concerned shall indemnify the company against any loss incurred by it.

Please note, use of term “voidable at the option of the Board”, while in section 184, there is a use of term “voidable at the option of the Company”.

It shall be open to the company to proceed against a director or any other employee who had entered into such contract or arrangement in contravention of the provisions of this section for recovery of any loss sustained by it as a result of such contract or arrangement.

Punishment for Contravention (Section 188, Sub – Section 5):

Any director or any other employee of a company, who had entered into or authorized the contract or arrangement in violation of the provisions of this section shall,—

(a)  in case of listed company, be punishable with imprisonment for a term which may extend to one year or with fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees, or with both; and

(b) in case of any other company, be punishable with fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees.

These two sections are applicable to all companies one – person, private, private public and listed. Applicability of Section 188 raises some question in my mind. Private companies usually have all directors from same family and interested in same contracts. Further in case of all members are related parties, what will be possibilities for business?

Please note: this blog post is not a professional advice but general information about the subject covered here. I appreciate if readers share this post on social media with friends and colleagues.