[Opinion] Regulatory Crackdown | Company and Its Directors Fined for Unapproved Related Party Transactions

Prof R Balakrishnan – [2024] 159 taxmann.com 768 (Article)

1. A brief about this case

This is a case where M/s Kudos Finance and Investments Private Limited had entered into transactions with related parties without obtaining the board approval as required under the provisions of the Companies Act 2013. As per the provisions of the Companies Act 2013, the whole concept of related party transactions has been capsulated/covered in a single section i.e. section 188 which combined the different sections of the earlier Act of 1956 and also contains many new provisions within the scope of related party transactions. As per the provisions of the Companies Act 2013 read with Companies (Meetings of Board and its Powers) Rules 2014, there are certain mandatory compliance requirements for Audit Committee approval for those related party transactions and the Acts and Rules have detailed provisions for dealing with related parties and the transactions entered between them. Audit Committee has been provided with a lot of roles and responsibilities under the provisions of the Companies Act 2013 including approval of related party transactions amongst many other things.

In this case, the directors and company had failed to obtain the approval of the board for entering into contracts with related party (in this case with the chief executive officer –one of the board members of the company) and entered with him the transactions. This was disclosed in the AoC-2 form one of the annexure to the board report without mentioning the date of board resolution where such contract was approved. This being a violation of section 188 of the Companies Act 2013, the company and the officers were liable for penal action under section 134(8) of the Companies Act 2013 and accordingly the Adjudication officer initiated the penal actions and levied penalty of Rs. 2.00 lakh on company and its directors. Let us go through this case in details in order to understand the provisions of the Companies Act 2013 read with the relevant rules and consequences of default/non-compliance.

2. Relevant provisions of the Companies Act 2013 relating to this case

Section 188(1)(f) of the Companies Act 2013 provides that “Except with the consent of the board of directors given by a resolution at a meeting of the board and subject to such conditions as may be prescribed, no company shall enter into any contract or arrangement with a related party with respect to”. (I) such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company.

3. Penal provisions for default/non-compliance

Section 188(5) of the Companies Act 2013 provides that “Any director or any other employee of a company, who had entered into or authorized the contract or arrangement in violation of the provisions of this section shall, —

(i) in case of listed company, be liable to a penalty of twenty-five lakh rupees and

(ii) in case of any other company, be liable to a penalty of five lakh rupees.

4. Consequences of default/violation – action from the Regulator

To understand the consequences of any default/non-compliances relating to section 188 of the of the Companies Act 2013 relating to the procedural aspects to be followed on related party transactions, let us go through the decided case law on this matter decided by the Registrar of Companies of Pune on 9th February 2024 in respect of M/s. Kudos Finance and Investments Private Limited.

5. The relevant case law on this matter

We shall go through the adjudication order by the Registrar of Companies, Pune bearing no. RoCP/ADJ/188/23-24/KUDOS/8(i)/B/2846 to 2851 in the matter of M/s. Kudos Finance and Investments Private Limited. – adjudication of penalties under Section 454(3) read with section 188 of the Companies Act 2013

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