Section 188 of the Companies Act, 2013 is often read as a ban on dealing with related parties. It is not. It sets out an approval and disclosure process for seven kinds of contracts with related parties, and it takes transactions that are both in the ordinary course of business and on an arm's length basis out of that process altogether. For finance teams, company secretaries and auditors, the work is to identify the related party, classify the contract, test the two exception conditions separately, and then apply the Board, shareholder and reporting steps that remain.
The statutory text is in the Companies Act, 2013 published by the Ministry of Corporate Affairs, with the thresholds in Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014. The Institute of Company Secretaries of India explains the procedure in its Guidance Note on Related Party Transactions (Revised Edition, January 2023).
Who counts as a related party
The definition is in section 2(76). As summarised in the ICSI Guidance Note, it includes:
- a director or key managerial personnel (KMP), or a relative of either;
- a firm in which a director, manager or their relative is a partner;
- a private company in which a director or manager or their relative is a member or director;
- a public company in which a director or manager is a director and holds, along with relatives, more than 2% of the paid-up share capital;
- a body corporate whose Board or managing director acts on the advice or instructions of a director or manager, other than advice given in a professional capacity;
- a person on whose advice a director or manager is accustomed to act, again excluding professional advice;
- a holding, subsidiary or associate company, and other persons that may be prescribed.
Listed entities apply a wider definition under the SEBI Listing Regulations. The ICSI Guidance Note records that from 1 April 2022 it covers promoter and promoter group members and shareholders holding 20% or more, reduced to 10% from 1 April 2023. This article deals with the Companies Act route; a listed company has to satisfy both sets of rules.
The seven categories covered by section 188(1)
Section 188(1) applies to a contract or arrangement with a related party for:
- sale, purchase or supply of any goods or materials;
- selling or otherwise disposing of, or buying, property of any kind;
- leasing of property of any kind;
- availing or rendering of any services;
- appointment of any agent for purchase or sale of goods, materials, services or property;
- the related party's appointment to any office or place of profit in the company, its subsidiary or associate company;
- underwriting the subscription of any securities or derivatives of the company.
Start with the nature of the contract, not the ledger head. A recurring management-service charge, a lease of a director's premises, a procurement arrangement or an appointment of a director's relative can all fall under section 188 even though they look routine.
An "office or place of profit" means an office held by a director for which he gets anything beyond his remuneration as director, or an office held by any other person for which he receives salary, fee, commission, perquisites or rent-free accommodation.
The exception: ordinary course and arm's length together
A proviso to section 188(1) says nothing in the sub-section applies to a transaction entered into in the ordinary course of business that is also on an arm's length basis. Both conditions must be met.
The Act explains an arm's length transaction as one "between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest". Ordinary course is a separate question of fact: is this activity normal for the company's business, judged by its operations, frequency, objects and industry practice?
A transaction can be priced at market and still be outside the ordinary course, for example a one-off sale of surplus land by a trading company to a director's firm. A routine purchase can be in the ordinary course but priced on preferential terms. Either failure removes the exception, and the full approval route then applies.
Companies that have an audit committee should also keep section 177 in mind. The ICSI Guidance Note points out that the audit committee approves related party transactions under section 177 even where section 188 does not require Board or shareholder approval. The ICSI presentation on related party transactions notes that the audit committee may grant omnibus approval, valid for one financial year.
Board approval and what the agenda must contain
Where the exception does not apply, the contract needs the consent of the Board by a resolution passed at a meeting of the Board. Rule 15(1) requires the agenda of that meeting to disclose:
- the name of the related party and the nature of the relationship;
- the nature, duration and particulars of the contract or arrangement;
- the material terms, including the value, if any;
- any advance paid or received;
- the manner of determining the pricing and other commercial terms, and whether all relevant factors were considered;
- any other information relevant for the Board to decide.
Under Rule 15(2), a director interested in the contract must not be present during the discussion on that resolution.
When shareholders must approve
If the contract crosses the limits in Rule 15(3), the company also needs the prior approval of its members by resolution. The limits have been percentage-only since the Companies (Meetings of Board and its Powers) Second Amendment Rules, 2019, which took effect on 18 November 2019 and removed the earlier rupee caps of Rs 100 crore and Rs 50 crore.
| Category | Members' approval needed when the transaction |
|---|---|
| Sale, purchase or supply of goods or materials | amounts to 10% or more of turnover |
| Selling, disposing of or buying property | amounts to 10% or more of net worth |
| Leasing of property | amounts to 10% or more of turnover |
| Availing or rendering services | amounts to 10% or more of turnover |
| Appointment to office or place of profit | carries monthly remuneration above Rs 2.5 lakh |
| Underwriting of securities | carries remuneration above 1% of net worth |
Two explanations to Rule 15(3) decide how the test is run. Turnover and net worth are taken from the audited financial statements of the preceding financial year. The limits apply to a transaction individually or taken together with earlier transactions with that party during the financial year.
Worked example: cumulative purchases
Assume a company's audited turnover for the preceding year is Rs 180 crore. Its 10% threshold for goods is Rs 18 crore. In April it agrees to buy packaging worth Rs 12 crore from a firm in which a director is a partner. In October it agrees a further Rs 7 crore. The cumulative value becomes Rs 19 crore, which crosses Rs 18 crore. If the purchases are not both in the ordinary course and at arm's length, the October contract needs members' approval before it is entered into, not only Board approval.
Worked example: property and place of profit
The same company has a net worth of Rs 60 crore. A purchase of a building from a director's relative for Rs 6 crore or more (10% of net worth) needs members' approval. Separately, appointing the managing director's son as a manager at Rs 2.8 lakh a month crosses the Rs 2.5 lakh limit for an office or place of profit, while a salary of Rs 2.2 lakh would need Board approval only, unless the ordinary course and arm's length exception applies.
Voting restrictions and exemptions
A member who is a related party must not vote on the resolution approving the contract. MCA General Circular No. 30/2014 dated 17 July 2014 clarified that a member is treated as a related party for this purpose only with reference to the contract for which the resolution is being passed. The same circular said contracts that were valid under the earlier law did not need fresh approval until the end of their original term, but any modification from 1 April 2014 had to comply with section 188, and that compromises, arrangements and amalgamations do not attract section 188.
The voting restriction does not apply to a company in which 90% or more of the members, in number, are relatives of promoters or are related parties. The shareholder-approval requirement also does not apply to transactions between a holding company and its wholly owned subsidiary whose accounts are consolidated with the holding company and placed before the shareholders at the general meeting.
Board's report, ratification and penalties
Section 188(2) requires every contract entered into under sub-section (1) to be referred to in the Board's report, with the justification for entering into it. The ICSI Guidance Note refers to Form AOC-2 for this disclosure.
A contract entered into by a director or employee without the required Board or members' approval is not automatically void. Under section 188(3), if it is not ratified by the Board or the members, as the case may be, within three months from the date it was entered into, it becomes voidable at the option of the Board or the members. If the contract is with a related party to any director, or is authorised by any other director, the directors concerned must indemnify the company for any loss. Section 188(4) lets the company proceed against a director or employee who entered into or authorised the contract to recover its loss.
Section 188(5), as amended by the Companies (Amendment) Act, 2020, replaced imprisonment and fines with fixed penalties on the director or employee who entered into or authorised the contract in violation of the section:
- Rs 25 lakh in the case of a listed company;
- Rs 5 lakh in the case of any other company.
Section 188 compliance checklist
- Identify the counterparty. Check the section 2(76) definition, and for a listed company the SEBI definition as well. Record the relationship.
- Classify the contract. Map it to one of the seven categories.
- Test the exception in two parts. Write down why the activity is in the ordinary course and, separately, what supports arm's length pricing: comparable quotations, historical rates with unrelated parties, market data or a valuation.
- Take audit committee approval where the company has one, and decide whether an omnibus approval for the year suits repetitive transactions.
- Prepare the Board agenda with every Rule 15(1) item. Keep the interested director out of the discussion.
- Run the Rule 15(3) test on the preceding year's audited turnover or net worth, adding up all transactions with the same party during the year.
- Obtain members' approval before execution where the limits are crossed, and exclude related-party members from voting unless the 90% exemption applies.
- Diarise the three-month ratification window for any contract executed without approval.
- Disclose in the Board's report (Form AOC-2) and in the related party note to the financial statements.
Mistakes that recur in reviews
- Assuming every related party transaction needs shareholder approval.
- Treating a transaction as exempt because it is commercially useful, without evidence on both tests.
- Treating ordinary course and arm's length as one test.
- Applying the old Rs 100 crore or Rs 50 crore caps that were removed in November 2019.
- Checking each purchase order alone instead of the running total for the year.
- Taking approval but not keeping the pricing evidence and commercial justification that support it.
Updated on 27 September 2026: retitled; added the section 2(76) definition, Rule 15(1) agenda items, the current Rule 15(3) thresholds with worked examples, MCA Circular 30/2014 points, ratification and the 2020 penalty amounts.
