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Section 188 of Companies Act: Related Party Transactions

July 2, 2026
Gaurav Vashistha
Company Law Compliance India
0

Table of Content

INTRODUCTION

In the normal course of business, a company may enter into transactions with people or entities that are closely connected to it, such as its directors, their relatives, holding companies, subsidiaries, associate companies, or businesses in which the directors have an interest (known as related party). Such transactions can include buying or selling goods, providing or receiving services, renting property, appointing a person to a position in the company, or entering other business arrangements. These transactions are not prohibited and are often necessary for conducting business efficiently.

However, because the parties involved are connected to the company, there is a possibility that decisions may be influenced in favor of the related party rather than in the best interest of the company. To prevent misuse and ensure fairness, transparency and accountability, the Companies Act, 2013 has prescribed certain rules for dealing with related party transactions.

Section 188 of the Companies Act, 2013 specifies the types of transactions that are covered, the approvals that may be required from the Board of Directors or shareholders, and the disclosures that need to be made. These provisions help ensure that transactions with related parties are carried out fairly and in the best interests of the company and its stakeholders.

SECTION 2(76) RELATED PARTIES

The related parties are defined under the Section 2(76) of the Companies Act 2013.

A Director or his relative
A Key Managerial Personnel (KMP) or his relative
A Firm in which a director, manager or his relative is a partner
A Private Company in which a director, manager or his relative is a member or director
A Public Company in which a director or manager is a director and, along with relatives, holds more than 2% share capital
A Company whose Board follows the instructions of the company’s director or manager
A Person whose instructions the company’s director or manager generally follows
Group Companies:
Holding, Subsidiary or Associate Company
Fellow Subsidiary
Investing Company or Venturer
Any other prescribed person

NOW, WHO IS RELATIVE?

The Section 2(77) of the Companies Act 2013 defines relatives as:

Members of the same Hindu Undivided Family (HUF)
Husband and Wife
A person is considered a relative of another person if he or she is:

Father (including stepfather)
Mother (including stepmother)
Son (including stepson)
Son’s wife
Daughter
Daughter’s husband
Brother (including stepbrother)
Sister (including stepsister)

SECTION 188 – RELATED PARTY TRANSACTIONS

The law says that a company shall not enter into certain contracts or arrangements with a related party without the prior consent of the Board of Directors. The section does not prohibit a company from entering transactions with related parties. However, to ensure transparency and prevent conflicts of interest, it requires the company to obtain the necessary approvals before entering specified contracts or arrangements.

The transactions covered under this section include:

(a) sale, purchase or supply of goods or materials;

(b) sale, disposal or purchase of property of any kind;

(d) availing or rendering of services;

(e) appointment of an agent for purchase or sale of goods, materials, services or property;

(f) appointment of a related party to any office or place of profit in the company, its subsidiary or associate company; and

(g) underwriting the subscription of any securities or derivatives of the company.

Further, the law also requires approval from the shareholders in certain cases. If the value of a related party transaction crosses the limits prescribed under Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014, the company must obtain prior approval of its shareholders by passing an Ordinary Resolution.

In simple terms, while smaller related party transactions can generally be approved by the Board of Directors, larger transactions having a significant financial impact on the company must also be placed before the shareholders for their approval. This ensures greater transparency and provides shareholders with an opportunity to review and approve important transactions involving related parties.

LIMITS AS PER RULE 15 OF THE COMPANIES (MEETINGS OF BOARD AND ITS POWERS) RULES, 2014, REQUIRING SHAREHOLDERS APPROVAL

The prior approval of the shareholders by way of an Ordinary Resolution is required where a Related Party Transaction exceeds the following limits:

Nature of Transaction	Threshold
Sale, purchase or supply of goods or materials	Exceeding 10% of the turnover of the company
Selling, buying or otherwise disposing of property of any kind	Exceeding 10% of the net worth of the company
Leasing of property of any kind	Exceeding 10% of the turnover of the company
Availing or rendering of any services	Exceeding 10% of the turnover of the company
Appointment of an agent for purchase or sale of goods, materials, services or property	Exceeding 10% of the turnover of the company
Appointment to any office or place of profit in the company, its subsidiary or associate company	Monthly remuneration exceeding ₹2.5 lakh
Remuneration for underwriting the subscription of any securities or derivatives thereof	Exceeding 1% of the net worth of the company

The turnover or net worth shall be calculated based on the audited financial statements for the preceding financial year.

EXCEPTIONS TO SECTION 188 APPROVAL REQUIREMENTS

Not every transaction with a related party requires approval under Section 188. The Companies Act, 2013 provides certain exceptions to reduce unnecessary compliance in genuine business transactions.

1. Transactions in the Ordinary Course of Business and at Arm’s Length Basis

The provisions of Section 188 do not apply where a transaction is entered into:

In the ordinary course of business; and
On an arm’s length basis.

An arm’s length transaction means a transaction conducted as if the parties were unrelated, so that there is no conflict of interest and the terms are fair and commercially reasonable.

2. Transactions Between Holding Company and Wholly Owned Subsidiary

The Shareholders’ approval is not required for transactions entered into 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 for approval.

3. Transactions Between Two Wholly Owned Subsidiaries

The Shareholders’ approval is also not required for transactions between two wholly owned subsidiaries of the same holding company, provided their accounts are consolidated with the holding company and presented before the shareholders at the general meeting.

Although certain related party transactions may qualify for exemption from the approval requirements under Section 188, many companies continue to place such transactions before the Board of Directors as a matter of good corporate governance and transparency. Obtaining Board approval helps create a proper record of the transaction, confirms that the terms have been reviewed by the directors, and reduces the risk of future disputes regarding the applicability of exemptions. Accordingly, while not always mandatory, seeking Board approval is often considered as a good compliance practice, particularly for significant or recurring related party transactions.

RATIFICATION OF TRANSACTIONS ENTERED WITHOUT APPROVAL

Section 188 recognizes that, in certain situations, a related party transaction may be entered into without obtaining the required approval of the Board of Directors or shareholders. In such cases, the transaction must be placed before the Board or shareholders, as applicable, for ratification within three months from the date on which the transaction was entered into.

Consequences of non-ratification

If the transaction is not ratified within the prescribed period of three months, the transaction becomes voidable at the option of the Board of Directors or the shareholders, as the case may be. This means that the company may choose to cancel or set aside the transaction.

PENALTY FOR CONTRAVENTION OF SECTION 188

The Companies Act, 2013 imposes monetary penalties on directors and employees who enter into or authorize a related party transaction without obtaining the approval required under Section 188.

In case of a violation of Section 188:

Listed Company: The concerned director or employee is liable to a penalty of ₹25 lakh.
Any Other Company: The concerned director or employee is liable to a penalty of ₹5 lakh.

These penalties are intended to ensure that related party transactions are undertaken transparently and in the best interests of the company.

CONCLUSION

The Related Party Transactions are a normal part of doing business and are often necessary for the efficient operation of a company. However, because these transactions involve people who may have a close connection with the company, there is always a possibility of a conflict of interest.

Section 188 of the Companies Act, 2013 does not prohibit companies from entering into transactions with related parties. Instead, it seeks to ensure that such transactions are carried out in a fair, transparent, and accountable manner. By obtaining the required approvals, maintaining proper documentation, and ensuring that transactions are conducted on reasonable terms, companies can avoid regulatory issues and protect the interests of all stakeholders.

In simple terms, whenever a company proposes to enter into a transaction with a related party, it should first check the three important things:

Who is the related party?
What is the nature of the transaction?
What approvals are required?

A careful review of these aspects can help the company remain compliant and avoid unnecessary penalties and disputes in the future.

Frequently Asked Questions

1. Does Section 188 apply to private companies as well as listed companies?

Yes. Section 188 applies to all companies registered under the Companies Act, 2013 — private limited, public unlisted, and listed companies alike. However, the penalty amount differs: listed companies face a higher penalty (₹25 lakh) compared to other companies (₹5 lakh) for non-compliance.

2. Can an interested director vote on a related party transaction at the Board meeting?

No. Under Section 188, a director who is interested in a related party transaction cannot participate in the discussion or vote on the resolution approving that transaction at the Board meeting. This restriction ensures the decision is taken impartially by disinterested directors.

3. Is disclosure of related party transactions required in the Board's Report?

Yes. Every company must disclose particulars of related party transactions in Form AOC-2, which is attached to the Board’s Report as required under Section 134(3)(h) read with Rule 8(2) of the Companies (Accounts) Rules, 2014. This disclosure applies even to transactions exempted under the arm’s length/ordinary course exception.

4. What is the difference between Section 188 and Section 177 in relation to related party transactions?

Section 177 requires the audit committee (in companies where one is mandatory) to approve or ratify related party transactions and review any modifications to previously approved RPTs. Section 188 deals separately with Board and shareholder approval requirements. In practice, both provisions often apply together — the Audit Committee’s approval is typically obtained before the transaction goes to the Board.

5. How is "arm's length basis" determined in practice for a related party transaction?

An arm’s length transaction is one priced and negotiated as if the parties had no relationship — using market rates, comparable third-party pricing, or independent valuation. Companies often maintain a Related Party Transaction Policy and supporting documentation (such as comparative quotations or valuation reports) to justify and evidence that a transaction was genuinely conducted at arm’s length, in case of scrutiny.