Section 188 of the Companies Act, 2013, discusses related party transactions and the requirement to seek approval of the shareholders by way of a special resolution. The provision specifically restricts members from casting their vote on such special resolutions if such member is a related party. As the definition of a ‘related party’ within the Companies Act is very wide, a blanket ban on all such persons would be unfair as they might not be a related party with reference to the contract or arrangement for which the said special resolution is being passed.
The Ministry of Corporate Affairs issued General Circular 30/2014 on 17th July 2014 which provides some clarity in this regard. ‘Related party’ has to be construed with reference only to the contract or arrangement for which the said special resolution is being passed.
Though the intent of the clarification seems to be to cover only those related parties who are involved in the relevant contract or transaction, the language of the Circular can lead to further confusion. Firstly, there is no definition for related party with reference to a contract or arrangement. The Act merely contains a general definition with reference to the company. Secondly, the circular does not envisage a situation where the majority shareholder of a company can enter into contracts with the company after diluting his shareholding to other related parties. This will make it easier for him to ensure a successful special resolution as he will only be barred from exercising voting rights to the extent of his diluted shareholding.
The circular provides further clarifications on two other matters. Firstly, it is now established that the requirement of obtaining approval through special resolution is not applicable to compromises, arrangements and corporate amalgamations. Secondly, contracts which have already come into effect prior to the enactment of Section 188 will not require fresh approval till the expiry of the original term of such contracts. However, any further modification in such contracts should fulfil the requirement of Section 188.