Navigating the Statutory and Compliance Landscape of Related Party Transactions

Business decisions and transactions are guided by the natural persons that control or manage the company. The involvement of natural persons in finalisation of such business endeavours pave way for transactions that are suspicious in nature, catering to the ulterior motives of the parties related to the persons whose opinion influenced the decisions. Companies often engage in business with parties that are directly or indirectly associated with them, such as its promoters, shareholders, and sister companies.

In order to ensure that such transactions are not detrimental to the other stakeholders in the company, Indian law has provided for regulation of such related party transactions by requiring the companies to undergo certain procedural compliances prior to undertaking the transaction. This Article discusses the procedural requirements laid down by the Companies Act, 2023 ("Act") and the Securities Exchange Board of India (Listing Obligation and Disclosure Requirement) Regulations, 2015 ("LODR Regulations") in this regard. 

A related party ("RP") is defined as a party who, with reference to the company, is inter alia either (i) its 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; or (iv) a public company in which a director or manager is a director and holds along with his relatives, more than two per cent of its paid-up share capital [Section 2(76) of the Act].

The LODR Regulations further expand on this definition of RPs, with respect to listed companies, as (i) a party falling under the definition of a RP under the provisions of the applicable accounting standards; (ii) any person or entity forming a part of the promoter or promoter group of the listed entity, or any person or any entity holding equity shares (a) of 20% or more, or (b) of 10% or more, with effect from April 1, 2023, in the listed entity, either directly or on a beneficial interest basis as provided under Section 89 of the Act, at any time, during the immediate preceding financial year [Regulation 2(zb) of the LODR Regulations].

Related party transactions ("RPT") are not explicitly defined under the Act. However, transactions pertaining to (i) the sale, purchase or supply of any goods or materials, (ii) availing or rendering of any services, or (iii) underwriting the subscription of any securities or derivatives of the company are considered to be RPTs [Section 188 of the Act]. With respect to listed companies, the LODR Regulations define RPTs as transactions involving a transfer of resources, services or obligations between: (i) a listed entity or any of its subsidiaries on one hand and a related party of the listed entity or any of its subsidiaries on the other hand; or (ii) a listed entity or any of its subsidiaries on one hand, and any other person or entity on the other hand, the purpose and effect of which is to benefit a related party of the listed entity or any of its subsidiaries, with effect from April 1, 2023; regardless of whether a price is charged [Regulation 2(zc) of the LODR Regulation].

All companies are required to obtain the consent of the Board of Directors for RPTs, in accordance with the due procedure [As detailed in Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014]. No member of the company who is a RP for the purposes of that transaction may vote on resolution approving any contract or arrangement that relates to such transaction. Further, the LODR Regulations require listed entities to comply with additional disclosure and approval requirements for RPTs. Under the LODR Regulations, all companies that engage in RPTs are required to: (i) create a policy for determining the materiality of RPTs and for dealing with such RPTs, containing clear threshold limits duly approved by the board of directors [Regulation 23(1) of the LODR Regulations]; (ii) acquire the approval of the audit committee [Regulation 23(2) of the LODR Regulations]; and (iii) include the RPTs in the company’s annual report. The report must contain details of all RPTs entered into during the year, the policy on RPTs adopted by the company, the business rationale for entering into the RPT and the comparative market price of the RPT [Schedule V of the LODR Regulations].

Additionally, for material RPTs, the company is required to obtain consent from the shareholders of the listed entity [Regulation 23(4) of the LODR Regulations]. If the transaction entered into, either individually or upon consolidation with previous transactions during a financial year, exceeds 10% of the annual consolidated turnover of the listed entity as per the last audited financial statements of the listed entity, it is considered a material RPT [Regulation 23(2)(b) of the LODR Regulations]. Further, RPTs involving payments made to a RP with respect to brand usage or royalty shall be considered material if the transaction(s) entered into, either individually or taken together with previous transactions during a financial year, exceed 5% of the annual consolidated turnover of the listed entity as per the last audited financial statements of the listed entity [Regulation 23(1A) of the LODR Regulations].

Certain RPTs are exempted from the aforementioned requirements. Transactions entered into between two government companies, and transactions entered into between a holding company and its wholly owned subsidiary, whose accounts are consolidated with such holding company and placed before the shareholders at the general meeting for approval, are not required to obtain approval from the audit committee [Regulation 23(5) of the LODR Regulations].

The Securities and Exchange Board of India (""SEBI"), taking note of the insufficiency of the records generally produced before an audit committee prior to a company engaging in RPT, issued a circular [SEBI Circular numbered SEBI/HO/CFD/CMD1/CIR/P/2021/662] mandating certain minimum disclosures ("Circular"). However, disclosures were also inadequate due to the increasing complexity of transactions, the group companies' growth, and the use of unrelated intermediaries. Subsequently, the SEBI mandated the Industry Standard Forum to formulate a comprehensive module on the minimum disclosures required to effectively oversee RPTs ("Guidance Note"). This Guidance Note, notified on February 14, 2025, details minimum information to be provided by a listed entity to its audit committee and shareholders for the approval of RPTs. This Guidance Note has recently come into effect on April 1, 2025.

The newly mandated RPT disclosures require the audit committee to carry out a higher standard of due diligence prior to the approval of any RPTs. The Guidance Note provides for the distinct categories in which the information pertaining to the RPT is to be disclosed to the audit committee, including erstwhile absent requirements such as detailed disclosure format for company balance sheets and profit and loss accounts. These updated requirements remove any ambiguity with regard to the disclosure format that a company is required to follow when requesting for approval of RPTs.

While the evolving regulatory requirement further reduce the possibility of an entity engaging in transactions that unduly benefit it promoter or directors, they also introduce a new practical challenge to the approval process of such RPTs. Most listed companies have only four to six audit committee meetings in a year, with four focused on approving quarterly financial results, as mandated for listed companies [Regulation 18(2)(a) of the LODR Regulations]. This provides for a very narrow window during which RPTs may be effectively evaluated by the audit committee. Further, the LODR Regulations require that the audit committee consists only of independent directors. As a matter of general practice, independent directors are a part of audit committees for multiple different listed companies. This further reduces the probability of the audit committee convening for a period of time that is adequate to handle the volume of information provided by the company. It is yet to be seen whether these challenges will hinder the application of the additional safeguards set up by the Guidance Note.

About the authors: Akanksha Dua is a Partner and Natasha Matange is an Associate at Obhan & Associates.

Disclaimer: The opinions expressed in this article are those of the author(s). The opinions presented do not necessarily reflect the views of Bar & Bench.

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