188 . Related party transactions
1. 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:—
a. sale, purchase or supply of any goods or materials;
b. selling or otherwise disposing of, or buying, property of any kind;
c. leasing of property of any kind;
d. availing or rendering of any services;
e. appointment of any agent for purchase or sale of goods, materials, services or property;
f. such related party's appointment to any office or place of profit in the company, its subsidiary company or associate company; and Related party transactions.
g. underwriting the subscription of any securities or derivatives thereof, of the company:
Provided that: no contract or arrangement, in the case of a company having a paid-up share capital of not less than such amount, or transactions not exceeding such sums, as may be prescribed, shall be entered into except with the prior approval of the company by a special resolution:
Provided further that: no member of the company shall vote on such special resolution, to approve any contract or arrangement which may be entered into by the company, if such member is a related party:
Provided also that nothing in this sub-section shall apply to any transactions entered into by the company in its ordinary course of business other than transactions which are not on an arm's length basis.
Explanation.- — In this sub-section,
a. the expression “office or place of profit“ means any office or place”
i. where such office or place is held by a director, if the director holding it receives from the company anything by way of remuneration over and above the remuneration to which he is entitled as director, by way of salary, fee, commission, perquisites, any rent-free accommodation, or otherwise;
ii. where such office or place is held by an individual other than a director or by any firm, private company or other body corporate, if the individual, firm, private company or body corporate holding it receives from the company anything by way of remuneration, salary, fee, commission, perquisites, any rent-free accommodation, or otherwise;
b. the expression "arm“ s length transaction" means a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest.
2. Every contract or arrangement entered into under sub-section (1 ) shall be referred to in the Board's report to the shareholders along with the justification for entering into such contract or arrangement.
3. Where any contract or arrangement is entered into by a director or any other employee, without obtaining the consent of the Board or approval by a special resolution in the general meeting under sub-section (1 ) and if it is not ratified by the Board or, as the case may be, by the shareholders at a meeting within three months from the date on which such contract or arrangement was entered into, such contract or arrangement shall be voidable at the option of the Board and if the contract or arrangement is with a related party to any director, or is authorised by any other director, the directors concerned shall indemnify the company against any loss incurred by it.
4. Without prejudice to anything contained in sub-section (3 ), it shall be open to the company to proceed against a director or any other employee who had entered into such contract or arrangement in contravention of the provisions of this section for recovery of any loss sustained by it as a result of such contract or arrangement.
5. 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 punishable with imprisonment for a term which may extend to one year or with fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees, or with both; and
ii. in case of any other company, be punishable with fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees.
Legal Commentary & Landmark Judgments: Section 188
Section 188 governs Related Party Transactions (RPT), establishing Audit Committee scrutiny, board consent, shareholder approvals without interested parties voting, and the critical 'ordinary course of business and arm's length' statutory exception.
Sub-section (3) provides that non-ratified transactions are voidable at the option of the Board/company, and defaulting directors must indemnify the company against any loss.
Section 188 is the most litigated and heavily scrutinized corporate governance provision in India. Corporate counsel must rigorously satisfy the two-prong test of the third proviso: proving both that the transaction is in the 'ordinary course of business' AND on an 'arm's length basis' (supported by benchmarking studies and independent transfer pricing documentation). Disqualified related-party shareholders cannot vote on Section 188 resolutions, eliminating promoter self-approval.