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 the related party cannot vote on. Skip a rung and the transaction becomes voidable, with the director liable to indemnify the company's loss.
Every related party transaction needs board approval by resolution at a meeting, with the interested director recused, and a shareholder ordinary resolution once the value crosses the Rule 15 thresholds — unless the deal is both in the ordinary course of business and at arm's length.
The bottom line
Always: board approval by resolution at a meeting, never by circulation. The interested director recuses from the discussion and the vote.
Where a committee exists: audit committee approval first. It can give omnibus approval for recurring transactions, valid one financial year.
Above the Rule 15 thresholds: a shareholder ordinary resolution, on which related parties cannot vote.
Exempt from approval: transactions in the ordinary course of business and at arm's length. Both, not either.
What counts as a related party transaction
A contract or arrangement between a company and a related party — broadly its directors and their relatives, its KMP, and group or associate entities, all defined in Section 2(76).
Section 188 covers seven transaction types, including the sale or purchase of goods, buying, selling or leasing property, availing or rendering services, appointing a related party to an office or place of profit, and underwriting the company's securities.
The approval ladder
| Level | When it applies |
|---|---|
| Audit Committee | Where the company has one (listed and 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, never by circular resolution |
| Shareholders (ordinary resolution) | When the value crosses the Rule 15(3) materiality thresholds — sale or purchase of goods above 10% of turnover, property above 10% of net worth, an office of profit above ₹2.5 lakh a month |
Each level is a checkpoint under Section 188(1) and Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014. Skipping one leaves a gap that can void the transaction later.
The exemption, and why both limbs matter
The proviso to Section 188(1) is the most important relief here. The approval requirements do not apply to a transaction that is both in the ordinary course of business and on an arm's length basis.
Both conditions must hold at once. A deal can be entirely routine but mispriced, which fails arm's length. It can be properly priced but extraordinary, which fails ordinary course. Either failure pulls it back into the approval net.
For listed companies, even exempt transactions still go through the audit committee and into AOC-2 disclosure. What makes an arm's length claim defensible two years later is a documented basis — a master service agreement, a transfer pricing study, comparable quotes — rather than an assertion in a board minute.
Recusal and disclosure of interest
Every director discloses their interests in Form MBP-1 at the first board meeting of each financial year, and again whenever an interest changes, under Section 184.
When a transaction they are interested in comes up, the director must declare the interest and abstain from both the discussion and the vote. A director who stays and votes, or who never disclosed at all, exposes themselves to penalty and renders the contract voidable. The duty to avoid conflicts sits underneath all of this.
AOC-2 and the register of contracts
Section 188(2) requires approved transactions to 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 arm's-length ones. Every transaction also goes into the Register of Contracts in Form MBP-4 under Section 189.
Disclosure is the second half of the regime. Approving correctly and then not disclosing is still a default.
What non-compliance costs
A transaction entered without the required approval is voidable at the option of the Board or the shareholders under Section 188(3), and the related party or 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 of up to 1 year, a fine, or both.
A worked example
A company wants to lease office space owned by Director D.
D has an MBP-1 disclosure on record. The rent is benchmarked against comparable market rates, which establishes arm's length. At the board meeting D declares the interest and recuses, and 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, does not vote. The transaction goes into the MBP-4 register and into AOC-2.
Every rung climbed, and the deal survives scrutiny.
Common mistakes
- Using a circular resolution. Board approval for a related party transaction must happen at a meeting.
- Letting the interested director vote, or simply stay in the room. They must declare and recuse.
- Claiming ordinary course and arm's length with nothing to evidence either.
- Missing the shareholder resolution above the thresholds, or letting the related party vote on it.
- Forgetting AOC-2 and MBP-4. Approval without disclosure is still a default.
A working routine
- Establish whether the counterparty is a related party under Section 2(76).
- Test the ordinary course and arm's length exemption, and document the basis.
- Route it through the audit committee where one exists, then the Board with the interested director recused.
- Above the Rule 15 thresholds, pass a shareholder ordinary resolution on which the related party does not vote.
- Record it in MBP-4 and disclose it in AOC-2 and the Board's Report.
- For a listed company, apply the stricter SEBI LODR overlay on top.
Frequently asked questions
Does every related party transaction need shareholder approval? No. Board approval is always required. Shareholder approval applies only once the value crosses the Rule 15 materiality thresholds.
What is the ordinary course and arm's length 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? No. They must declare the interest and abstain from the discussion and the vote.
Where are these transactions disclosed? In Form AOC-2, annexed to the Board's Report and AOC-4, and in the Register of Contracts in Form MBP-4.
What is the penalty for an improperly approved transaction? The transaction is voidable, and a director or employee in default faces ₹25 lakh in a listed company or ₹5 lakh in any other, plus indemnity for losses.
Can recurring transactions be pre-approved? Yes, where there is an audit committee. It can give omnibus approval for recurring transactions, valid for one financial year.
Primary sources
- Sections 188, including 188(1), (2), (3) and (5), 2(76), 184 and 189, Companies Act, 2013
- Rule 15, Companies (Meetings of Board and its Powers) Rules, 2014; Forms AOC-2, MBP-1 and MBP-4
- SEBI (LODR) Regulations, Regulation 23, for listed companies