Every company, at some point, enters into transactions with people or entities that are closely connected to it. A director awarding a supply contract to a firm owned by a relative. A company leasing office space from its promoter's family trust. These are everyday business decisions, but when the parties involved share a relationship of influence, the law demands scrutiny. This is exactly what related party transactions 188 under the Companies Act, 2013 addresses.
Section 188 exists to protect the interests of minority shareholders and ensure that insiders don't exploit their position for personal benefit. It lays down a structured approval framework that companies must follow before entering into specified transactions with related parties. The provision applies to every company registered in India, whether private or public, though the extent of compliance varies based on the nature and size of the transaction.
For CFOs, auditors, directors, and compliance teams, understanding section 188 compliance rules isn't optional. It is a core governance requirement. Non-compliance can lead to penalties, imprisonment, and even voiding of contracts. Whether you run a mid-sized company or manage compliance for a private limited company, this guide walks you through every aspect of Section 188 that matters.
Who is a Related Party Under the Companies Act
Before examining the transactions, it is important to understand who qualifies as a related party. Section 2(76) of the Companies Act, 2013 provides a comprehensive definition. A related party includes any director or key managerial personnel (KMP) of the company, or their relatives. It also covers any firm, private company, or body corporate in which a director or manager is a member, director, or holds more than 2% of the paid-up share capital.
The definition extends to the holding company, subsidiary company, and associate company of the entity in question. Any person on whose advice or instructions a director or manager is accustomed to act is also treated as a related party. For listed companies, the definition is broader and includes additional categories prescribed by SEBI under the LODR Regulations.
Consider a practical scenario. If your company's Managing Director owns 5% in another private company, and your company enters into a transaction with that entity, it is a related party transaction. The connection need not be direct. Relatives as defined under Section 2(77), including spouse, father, mother, son, daughter, and siblings, also trigger the related party classification.
Types of Transactions Covered Under Section 188
Section 188 doesn't cover every transaction with a related party. It specifically lists certain categories of transactions that require compliance. Understanding these categories helps you identify which dealings fall within the regulatory net.
| Transaction Type | Description |
| Sale, purchase or supply of goods or materials | Any trading transaction between the company and a related party |
| Selling or disposing of property | Transfer of any kind of property, movable or immovable |
| Leasing of property | Taking or granting lease of any property or asset |
| Availing or rendering of services | Professional, technical, or any other services exchanged |
| Appointment to office or place of profit | Appointing a related party to a remunerative position in the company |
| Remuneration for underwriting | Payment for underwriting subscription of securities |
Each of these categories triggers a compliance obligation. The question is not whether the transaction is beneficial or fair. The question is whether the proper approval process was followed. Even a genuinely arm's length deal requires compliance if it falls within these categories and crosses the prescribed thresholds.
Approval Process: Board Resolution and Special Resolution
The approval mechanism under Section 188 operates at two levels. Every related party transaction that falls within the specified categories requires prior approval of the Board of Directors through a resolution passed at a duly convened board meeting.
Board Approval
The Board must approve the transaction before the company enters into it. The interested director, meaning the director who is related to the other party, must not participate in the discussion or vote on the resolution. This is a strict requirement. If the interested director votes, the resolution becomes voidable at the option of the Board or shareholders.
Shareholder Approval Through Special Resolution
In certain cases, the transaction must also receive shareholder approval through a special resolution. This requirement applies when the transaction exceeds the thresholds prescribed under Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014. For instance, if the sale, purchase, or supply of goods exceeds 10% of the company's turnover, a special resolution becomes mandatory. Similarly, if the leasing of property exceeds 10% of net worth or if remuneration for appointment to office exceeds Rs 2.5 lakhs per month, shareholder approval is required. Companies must ensure that their annual compliance filings accurately reflect all approved related party transactions.
Prescribed Thresholds for Special Resolution
| Transaction Category | Threshold for Special Resolution |
| Sale, purchase, supply of goods/materials | Exceeds 10% of turnover |
| Selling or disposing of property | Exceeds 10% of net worth |
| Leasing of property | Exceeds 10% of net worth or 10% of turnover |
| Availing or rendering services | Exceeds 10% of turnover |
| Appointment to office of profit | Monthly remuneration exceeds Rs 2.5 lakhs |
An important procedural detail applies here. Related parties cannot vote on the special resolution approving the transaction. This restriction ensures that the decision rests with disinterested shareholders, reinforcing the governance purpose of the provision.
Exemptions for Private Limited Companies
One of the most frequently asked questions concerns whether private limited companies need to comply with Section 188 at all. The answer is nuanced. The requirement for shareholder approval through a special resolution has been exempted for private limited companies through a notification issued under Section 462 of the Companies Act. However, board approval is still mandatory for all companies, including private limited ones. This means that even if your private limited company doesn't need to pass a special resolution, the board must still approve the transaction, and the interested director must abstain from voting.
This exemption is a relief for smaller companies where the promoter, director, and majority shareholder are often the same person. However, it does not remove the disclosure obligations or the requirement to maintain proper records. Companies should document every board approval with a detailed agenda, explanatory statement, and minutes capturing the abstention of the interested director.
Disclosure Requirements and Form AOC-2
Transparency is the underlying principle behind Section 188 compliance rules. Every listed company must disclose details of all related party transactions in its annual report using Form AOC-2, which is annexed to the Board's Report. This form captures two categories of information.
The first part covers transactions entered into pursuant to the company's policy on related party transactions, which are on an arm's length basis. The second part details transactions that are not on arm's length terms. For each transaction, the form requires disclosure of the name of the related party, the nature of the relationship, the nature and duration of the transaction, the salient terms, the amount involved, and the justification for entering into it.
Even for private companies that are not mandated to file AOC-2, maintaining internal documentation is strongly recommended. Auditors regularly verify related party disclosures during statutory audits, and any gaps can lead to qualifications in the audit report. Companies that maintain proper accounting records and compliance systems are better prepared for audit scrutiny.
Penalties for Non-Compliance
The consequences of violating Section 188 are significant. If a related party transaction is entered into without the required board or shareholder approval, the transaction is voidable at the option of the Board of Directors. The company can ratify the contract within three months from the date on which the transaction was brought to the notice of the Board.
If the transaction is not ratified within three months, the director or related party who entered into the contract must indemnify the company against any loss arising from such a transaction. Beyond this, the company can proceed against the director or any other person who was party to the contract to recover any profit made by that person.
| Violation | Consequence |
| Transaction without board approval | Voidable at option of Board. Must be ratified within 3 months. |
| Failure to ratify within 3 months | Director/related party must indemnify the company for losses. |
| Director who authorised without approval | Fine of Rs 25,000 to Rs 5 lakhs. |
| Related party who contracted without approval | Imprisonment up to 1 year, or fine up to Rs 25 lakhs, or both. |
These penalties are not theoretical. The Ministry of Corporate Affairs has been increasingly active in enforcement, and auditors are required to report non-compliance with Section 188 in their audit reports under CARO 2020.
Role of the Audit Committee
For companies that are required to constitute an Audit Committee under Section 177, every related party transaction must first be placed before the Audit Committee for its prior approval. This is an additional layer of oversight that applies to all listed companies and prescribed classes of unlisted companies. The Audit Committee reviews the terms of the transaction, assesses whether it is on arm's length basis, and provides its recommendation to the Board. For companies that are scaling operations and may need to transition to a public company structure, understanding the Audit Committee's role in RPT governance becomes essential early on.
The Audit Committee can also grant omnibus approval for repetitive transactions that are expected to recur during a financial year. This omnibus approval must specify the name of the related party, nature and period of the transaction, maximum amount, and the basis on which the arm's length price is determined. The committee must review such omnibus approvals on a quarterly basis.
Conclusion
Related party transactions 188 is one of the most critical governance provisions under Indian company law. It creates a structured framework that balances commercial flexibility with the need to protect minority shareholders from potential abuse. Whether your company is entering into a supply arrangement with a promoter-linked entity or leasing property from a director's relative, the section 188 compliance rules require proper board approval, threshold-based shareholder approval, and transparent disclosure. Getting this right isn't just about avoiding penalties. It builds credibility with auditors, investors, and regulators. If you need professional support with business registration and compliance, working with experienced chartered accountants ensures that your governance framework stays robust and audit-ready.
