Related party transactions under the Companies Act, 2013 are often misunderstood as transactions that are automatically prohibited. Section 188 does not impose a blanket ban. Instead, it creates an approval and disclosure framework for specified contracts or arrangements with related parties, while also carving out an important exception for transactions that are both in the ordinary course of business and on an arm's length basis.
For finance teams, company secretaries and auditors, the practical task is to identify the related party, classify the transaction, test the ordinary-course and arm's-length conditions, and then determine which approvals and disclosures apply. The statutory starting point is section 188 of the Companies Act, 2013 on India Code.
Which transactions are covered by section 188?
Section 188(1) lists seven broad categories: sale, purchase or supply of goods or materials; buying or selling property; leasing property; availing or rendering services; appointment of an agent for purchase or sale of goods, materials, services or property; appointment of a related party to an office or place of profit in the company, subsidiary or associate; and underwriting the subscription of securities or derivatives of the company.
This means the analysis should begin with the nature of the contract, not merely with the accounting ledger description. A recurring management-service charge, property lease, procurement arrangement or appointment can fall within section 188 even though it looks commercially routine.
Board approval: the basic rule
For a covered section 188 transaction, the provision generally requires consent of the Board of Directors by a resolution at a meeting of the Board, subject to the prescribed conditions. Transactions crossing prescribed limits can also require prior approval of the company by resolution. The detailed rules sit alongside section 188; India Code lists the Companies (Meetings of Board and its Powers) Rules, 2014 and subsequent amendments under the section, while MCA also hosts the Companies (Meetings of Board and its Powers) Rules, 2014.
Because prescribed monetary tests can change, teams should apply the version of the rules effective for the transaction date rather than relying on an old internal checklist.
The ordinary-course and arm's-length exception
One of the most important provisos to section 188 says the approval framework in subsection (1) does not apply to transactions entered into in the ordinary course of business where the transaction is also on an arm's length basis. Both conditions matter.
Section 188 explains an arm's length transaction as one between two related parties conducted as if they were unrelated, so that there is no conflict of interest. Ordinary course is a separate factual question: whether the activity is normal for the company's business, viewed in light of its operations, frequency, objects, industry practice and surrounding facts.
A transaction can therefore be at market price but still fall outside the ordinary course, or be routine in nature but priced on non-arm's-length terms. Either failure can take the transaction outside the exception.
Practical example
Assume a manufacturing company regularly purchases packaging material as part of its normal operations. A director-linked entity offers the same material. The finance team should first confirm whether the supplier is a related party under the Act, then document why packaging procurement is in the ordinary course, and separately support arm's-length pricing using comparable quotations, historical pricing, market data or another reasonable benchmark.
If the evidence supports both tests, the ordinary-course and arm's-length exception may be relevant. If the price is preferential without commercial justification, or the arrangement is unusual for the company's normal operations, the team should not assume the exception merely because the purchase has a business purpose.
Shareholder voting and important exceptions
Where shareholder approval is required under the first proviso to section 188(1), the Act contains restrictions on voting by a member who is a related party in the context of the contract or arrangement. The statute also contains specific exceptions, including one relating to companies in which ninety per cent or more members in number are relatives of promoters or related parties, and another for specified transactions between a holding company and its wholly owned subsidiary where the subsidiary's accounts are consolidated and placed before shareholders.
MCA's General Circular No. 30/2014 on related party transactions also clarifies that, for the voting restriction, related party is considered with reference to the particular contract or arrangement being approved.
Board's report and record-keeping
Section 188(2) requires contracts or arrangements entered into under subsection (1) to be referred to in the Board's report to shareholders along with justification for entering into them. Related-party compliance should therefore not stop at obtaining an approval.
A defensible file should normally connect the related-party identification, transaction classification, approval analysis, pricing support, ordinary-course assessment, relevant resolutions and financial-statement or Board-report disclosures. This also makes the audit trail easier to review.
Practical section 188 checklist
- Identify the counterparty: verify whether it falls within the Act's related-party definition and document the relationship.
- Classify the transaction: map the arrangement to the categories listed in section 188(1).
- Test both exception conditions: document ordinary course and arm's length separately.
- Check the current prescribed rules: if the exception does not apply, test the transaction against the approval requirements and current thresholds.
- Obtain approvals before execution where required: do not treat later paperwork as a substitute for timely governance.
- Document pricing: retain comparable quotations, valuation support, transfer-pricing material or other evidence appropriate to the transaction.
- Complete disclosures: review the Board's report, financial statements and registers or records that apply to the company.
Common mistakes to avoid
- Assuming every related-party transaction needs shareholder approval.
- Assuming a transaction is exempt simply because it is commercially useful to the company.
- Treating ordinary course and arm's length as the same test.
- Using an old monetary-threshold checklist without checking the current rules.
- Obtaining an approval but failing to retain the commercial justification and pricing evidence.
Key takeaway
Section 188 is best handled as a decision process rather than a yes-or-no prohibition. Identify the related party, classify the transaction, test ordinary course and arm's length independently, then apply the current approval and disclosure requirements. Good documentation is as important as the approval itself because it shows why the company concluded that a transaction was exempt or why a particular governance route was followed.
