Related Party Transactions: Governance and Disclosure

Introduction:

Related party transactions are ordinary business arrangements with an extraordinary capacity for misuse. A company may buy goods from a promoter-controlled entity, lease office space from a director's partnership firm, or appoint a relative of a key managerial person to a position carrying financial benefit. None of this is automatically suspect. The concern begins when influence distorts judgment and value begins to move on terms that an unrelated party would never have accepted.

That is why the law does not ban related party transactions. It regulates them. The object is not to paralyse commercial activity within corporate groups, but to ensure that insider dealings are tested against standards of fairness, disclosure, and institutional scrutiny. This becomes especially significant in India, where concentrated ownership and promoter influence continue to shape decision-making in many companies.

Section 188 of the Companies Act, 2013, read with the Companies (Meetings of Board and its Powers) Rules, 2014, proceeds on that logic. The framework tries to strike a balance. Companies need room to transact efficiently with affiliates and group entities. At the same time, the law must guard against the extraction of private benefit from corporate assets at the expense of minority shareholders and the company itself.

Understanding Related Party Transactions:

The expression “related party” is defined in Section 2(76) of the Companies Act, 2013. The definition is wide and intentionally so. It extends beyond directors and key managerial personnel and includes their relatives, firms in which such persons are partners, private companies in which they are members or directors, certain public companies, holding companies, subsidiaries, associate companies, and other bodies corporate connected through control or influence.

This breadth reflects a practical legislative choice. Conflicts of interest do not arise only through direct shareholding. They often operate through family ties, management overlap, layered ownership structures, or informal influence within business groups. If the definition were narrow, the law would miss the very arrangements through which preferential treatment is most likely to occur.

Section 188 then identifies the transactions that attract special scrutiny. These include the sale, purchase, or supply of goods or materials; the buying or selling of property; leasing of property; availing or rendering of services; appointment of agents; appointment to any office or place of profit; and underwriting of securities or derivatives thereof. These are not minor internal matters. They are transactions through which corporate value can be shifted, directly or indirectly, to connected persons.

The legislative idea behind regulation is therefore quite simple. A related party transaction is not objectionable merely because the parties know each other. It becomes problematic when the relationship affects pricing, bargaining power, timing, or disclosure. The law steps in because ordinary market discipline is weaker when both sides of the transaction are linked.

The Section 188 Framework:

Section 188 is the operative provision at the heart of the Companies Act regime on related party transactions. It requires prior consent of the Board for specified contracts or arrangements entered into with related parties. In practice, that requirement matters because it converts what might otherwise be treated as a management decision into a matter of formal corporate oversight.

The rule on interested directors is one of the clearest governance safeguards in the section. Where a director is concerned or interested in the proposed transaction, that director must disclose the interest and cannot participate in the meeting on the item in question. The principle is familiar. A person should not help approve a contract from which he or she stands to benefit.

Board approval, however, is only meaningful if the Board actually asks difficult questions. Directors are expected to test the commercial rationale of the transaction, examine how the price has been arrived at, compare the proposal with market alternatives, and assess whether the arrangement genuinely serves the company's interest. A resolution passed without inquiry may satisfy form. It does not satisfy governance.

The most litigated and most relied upon exception is the one for transactions in the ordinary course of business and on an arm's length basis. That exception recognises commercial reality. Companies cannot be expected to take shareholder approvals for every routine supply arrangement or service contract within a group where the terms are genuinely market-based. But the exception also creates room for misuse because both limbs of the test are intensely factual.

What counts as the ordinary course of business depends on the nature of the company, its past practice, the industry, and the surrounding circumstances. The arm's length requirement is equally demanding. A company must be able to show, with some credible material, that the pricing and terms broadly resemble what would have been agreed with an unrelated counterparty. That is often harder than companies first assume.

Material Transactions and Shareholder Oversight:

Board scrutiny is only the first gate. Once a related party transaction crosses the prescribed thresholds under Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014, shareholder approval becomes necessary. This reflects an obvious point: when the financial size of the transaction becomes significant, the issue is no longer merely managerial. It becomes a question of ownership oversight.

The logic behind shareholder involvement is sound. In promoter-driven companies, the Board may not always operate with complete distance from the persons who stand to benefit. Bringing the matter before shareholders introduces a wider body of review and compels the company to explain the commercial basis of the deal more openly. That explanation itself performs a disciplining function.

The voting restrictions on related parties are equally important. If a related party could vote to approve its own transaction, the safeguard would be hollow. Disinterested shareholder approval exists precisely because company law recognises that a majority influenced by self-interest is not the same thing as an independent corporate judgment.

There is also a signaling effect here. Once a transaction requires shareholder approval, management knows it will be read not just by directors and in-house teams, but by investors, proxy advisers, auditors, and sometimes the market itself. That changes behaviour. At least, it is supposed to.

Disclosure and Transparency Requirements:

No governance system can work in darkness. Related party transactions are regulated not only through approvals but also through disclosure obligations that allow shareholders and regulators to understand who is dealing with the company, on what terms, and at what scale.

Under the Companies Act, particulars of contracts or arrangements with related parties are required to be disclosed in the Board's Report in the prescribed form. This is not a clerical exercise. A proper disclosure gives shareholders visibility into transactions that may affect the direction of corporate decision-making and allows them to judge whether the company is dealing fairly with insider-connected entities.

Financial statement disclosures add another layer. Accounting standards require companies to disclose related party relationships and the transactions entered into with them. For investors and creditors, such disclosures often reveal more than the bare legal filing does. Patterns matter. A cluster of recurring high-value transactions with promoter-linked entities may say a great deal about how a company is actually being run.

Listed entities face a stricter environment. Securities regulation, particularly through the SEBI framework, has steadily moved toward deeper and more frequent disclosure of related party transactions. That shift reflects market reality. Investors increasingly treat governance quality as part of value assessment, and related party dealings remain one of the first places where governance stress tends to show up.

Practical Governance Issues:

The legal framework appears neat on paper. Practice is messier. The first difficulty is identification. Companies often operate through layered structures, cross-holdings, nominee relationships, and informal influence networks. By the time the legal team is asked to review a transaction, commercial teams may already have advanced negotiations without recognising that the counterparty is related.

Promoter-controlled companies present the sharpest version of the problem. The same individual may appear in multiple capacities at once: shareholder, director, guarantor, lender, customer, or supplier through another entity. In that setting, the line between legitimate business efficiency and private advantage can become blurred very quickly. Formal compliance alone does not always capture the real risk.

Documentation is another recurring weakness. Many companies remember to obtain the approval. Fewer maintain a convincing record explaining why the terms are fair, how comparables were chosen, or why the transaction falls within the ordinary course of business. When scrutiny comes later, and it often comes later, the absence of a paper trail becomes the real compliance problem.

Audit committees matter greatly here. When they function well, they act as the first serious checkpoint against management convenience and promoter influence. When they do not, the entire approval structure weakens. A passive audit committee can turn a statutory safeguard into a procedural ritual.

Indian corporate practice shows this repeatedly. Governance failures in the RPT space rarely arise because there is no legal rule on the subject. They arise because the rule is treated as a filing requirement rather than as a discipline of decision-making. That difference is crucial.

Critical Analysis:

The current framework has real strengths. It does not proceed on the simplistic assumption that all related party transactions are tainted. Instead, it accepts commercial necessity while demanding oversight where the possibility of abuse is strongest. That is a sensible starting point.

It also uses layered controls rather than a single approval trigger. Board scrutiny, interested director restrictions, shareholder approval beyond thresholds, audit committee review, and disclosure obligations together create a system of overlapping checks. If one layer fails, another may still catch the problem. For Indian corporate structures, that layered design is valuable.

Still, the framework is not without limits. The arm's length standard is conceptually appealing but often difficult to apply in real transactions, especially where the subject matter is unique or where meaningful market comparable are unavailable. Companies are then left to justify a standard that sounds precise in theory but becomes contestable in practice.

Independence is another weak point. The law can require independent directors and active audit committees, but it cannot by itself manufacture institutional courage. In companies dominated by promoters or controlling groups, formal independence may coexist with practical reluctance. That is where governance frameworks often begin to thin out.

There is a further problem of structuring. Transactions can be split, timed, or layered across entities in ways that technically avoid thresholds while preserving the same underlying economic effect. Regulators have become more attentive to substance over form, and rightly so, but enforcement still depends heavily on disclosure quality and the willingness to interrogate what lies behind the paperwork.

That said, the direction of regulation is unmistakable. Disclosure expectations are rising. Audit committees are being asked to do more than endorse management explanations. Investors, especially in listed companies, are less willing than before to treat related party transactions as routine internal matters. The law is moving toward closer scrutiny not because every related party transaction is suspect, but because too many abusive ones have historically passed under the label of business convenience.

Conclusion:

The regulation of related party transactions is really an attempt to answer a hard corporate law question: how far should the law trust insider judgment when insiders themselves may benefit from the transaction? Section 188 does not resolve that tension completely, and perhaps no statutory provision can. What it does offer is a structure through which companies are required to pause, disclose, justify, and seek approval before value moves through connected channels.

Whether that structure works depends less on drafting and more on conduct inside the company. A Board that asks sharp questions, an audit committee that insists on evidence, and management that treats transparency as a governance obligation rather than a compliance burden can make the framework work well. Without that institutional seriousness, even a carefully drafted regime will struggle.

For that reason, the present framework should be seen as necessary but not self-executing. It gives companies enough commercial room to function, yet places visible checks where conflicts are most acute. The balance is broadly defensible. Its success, however, still turns on whether corporate actors respect the spirit of the law and not merely its procedural surface.

Author: Shriyansh Tiwari, in case of any queries please contact/write back to us via email to chhavi@khuranaandkhurana.com or at  Khurana & Khurana, Advocates and IP Attorney.