When a company deals with its own directors, their relatives, or group entities, the law assumes a conflict and demands a paper trail — board approval at minimum, audit-committee and shareholder approval as the value climbs. The one escape is a genuine arm's-length deal in the ordinary course.
The rule: board approval for every RPT; shareholder ordinary resolution once it crosses the Rule 15 thresholds.
A company leases its office from premises owned by one of its directors. Routine, sensible — and squarely a related-party transaction. It needs board approval with that director recused, rent benchmarked to market, and, if the value crosses the threshold, a shareholder resolution on which the related party can't vote. Skip a rung on that ladder and the transaction can be rendered voidable, with the director liable to indemnify the company's loss. RPT rules exist precisely because related-party deals are where minority shareholders are most easily shortchanged.
BOTTOM LINE
- Always: Board approval by resolution at a meeting (no circular resolutions); the interested director recuses from discussion and vote.
- Where a committee exists: Audit Committee approval first (it can give omnibus approval for recurring RPTs).
- Above Rule 15 thresholds: a shareholder ordinary resolution — related parties can't vote on it.
- Exempt from approval: transactions in the ordinary course of business AND at arm's length (both required).
What is a related party transaction?
Governs this section: Section 188 & Section 2(76), Companies Act, 2013
A related party transaction is a contract or arrangement between a company and a related party — broadly, its directors and their relatives, KMP, and group/associate entities (defined in Section 2(76)). Section 188 covers seven transaction types, including sale/purchase of goods, buying/selling/leasing property, availing/rendering services, appointing a related party to an office or place of profit, and underwriting the company's securities.
The approval ladder
Governs this section: Section 188(1) & Rule 15, Companies (Meetings of Board and its Powers) Rules, 2014
Approvals stack as the stakes rise:
| Level | When it applies |
|---|---|
| Audit Committee | Where the company has one (listed + prescribed public companies) — for every RPT; may grant omnibus approval for recurring RPTs, valid one financial year |
| Board | For every RPT — by resolution at a duly convened meeting (no circular resolutions) |
| Shareholders (ordinary resolution) | When the value crosses the Rule 15(3) materiality thresholds (e.g., sale/purchase of goods above 10% of turnover; property above 10% of net worth; office of profit above ₹2.5 lakh/month) |
Each level is a checkpoint — skipping one creates a gap that can void the transaction.
The arm's-length-and-ordinary-course exemption
Governs this section: proviso to Section 188(1)
The single most important relief: Section 188's approval requirements don't apply to a transaction that is both in the ordinary course of business and on an arm's length basis. Both conditions must hold simultaneously — a deal can be routine but mispriced (not arm's length), or arm's-length but extraordinary (not ordinary course), and either failure pulls it back into the approval net. For listed companies, even exempt RPTs still go through the audit committee and AOC-2 disclosure. A documented basis — a master service agreement, a transfer-pricing study — is what makes the "arm's length" claim defensible later.
Interested-director recusal and disclosure
Governs this section: Section 184 & MBP-1
Every director discloses their interests via Form MBP-1 at the first board meeting of each financial year (and on any change). When an RPT in which they're interested comes up, the director must declare the interest and abstain from both the discussion and the vote. A director who stays and votes — or doesn't disclose at all under Section 184 — exposes themselves to penalty and renders the contract voidable.
AOC-2 and the RPT register
Governs this section: Section 188(2) & Section 189
Approved RPTs must be disclosed in the Board's Report, with a justification, through Form AOC-2 (an annexure to AOC-4) — which separates non-arm's-length transactions from the arm's-length ones. Every RPT is also entered in the Register of Contracts (Form MBP-4) under Section 189. Transparency is the back-half of the regime: approve it correctly, then disclose it visibly.
What does non-compliance cost?
Governs this section: Section 188(3)–(5)
PENALTY — Section 188
An RPT entered without required approval is voidable at the Board's or shareholders' option, and the related party/director must indemnify the company for any loss. On penalties, a director or employee in default faces ₹25 lakh in a listed company and ₹5 lakh in any other company. Non-disclosure of interest under Section 184 separately carries imprisonment up to 1 year and/or a fine.
Worked example
Mini-case — leasing from a director
A company wants to lease office space owned by Director D. Steps: D files/has an MBP-1 disclosure on record; the rent is benchmarked to comparable market rates (arm's length). At the board meeting, D declares interest and recuses; the remaining directors approve. Because the annual lease value crosses 10% of net worth (the Rule 15 threshold for property), the company also passes a shareholder ordinary resolution — on which D, as the related party, doesn't vote. The transaction goes into the MBP-4 register and AOC-2. Every rung climbed; the deal is clean.
Common mistakes
- Using a circular resolution for an RPT. Board approval must be at a meeting.
- Letting the interested director vote (or stay in the room). They must declare and recuse.
- Claiming "ordinary course + arm's length" without documentation. Both must hold and be evidenced.
- Missing the shareholder resolution above thresholds — and letting the related party vote on it.
- Forgetting AOC-2 / MBP-4. Approval without disclosure is still a default.
Checklist
- Identify whether the counterparty is a related party under Section 2(76).
- Test the ordinary-course + arm's-length exemption (document the basis).
- Route through the Audit Committee (where one exists); then the Board, with the interested director recused.
- If above the Rule 15 thresholds, pass a shareholder ordinary resolution (related party doesn't vote).
- Record it in MBP-4 and disclose in AOC-2 / Board's Report.
- For listed companies, apply the stricter SEBI LODR overlay (audit committee for all RPTs, material-RPT shareholder approval).
FAQ
Does every related party transaction need shareholder approval? No. Board approval is always needed; shareholder approval only when the value crosses the Rule 15 materiality thresholds.
What's the arm's-length-and-ordinary-course exemption? A transaction that is both at arm's length and in the ordinary course of business is exempt from Section 188's approval requirements (both conditions must hold).
Can the interested director vote on an RPT? No. They must declare their interest and abstain from the discussion and the vote.
Where are RPTs disclosed? In Form AOC-2 (annexure to the Board's Report/AOC-4) and the Register of Contracts (MBP-4).
What's the penalty for an improperly approved RPT? The transaction is voidable; a director/employee in default faces ₹25 lakh (listed) or ₹5 lakh (other companies), plus indemnity for losses.
Primary sources
- Section 188 (incl. 188(1),(2),(3),(5)), Section 2(76), Section 184 & Section 189, Companies Act, 2013
- Rule 15, Companies (Meetings of Board and its Powers) Rules, 2014; Forms AOC-2, MBP-1, MBP-4
- SEBI (LODR) Regulations, Reg. 23 — for listed companies
Disclaimer: This article is general information on a fast-changing area of company law, current at the time of writing. It is not legal or professional advice for any specific company. Verify the position against the live MCA rules and consult your company secretary.