Related party transactions Section 188 of the Companies Act, 2013 regulates are not banned. They are permitted, but only in sequence: disclose the interest, obtain the Board's consent by a resolution passed at a meeting, and where the value crosses the prescribed thresholds, obtain the members' prior approval by resolution with the related party abstaining. Miss a step and the contract is voidable, the interested directors must indemnify the company for any loss, and a penalty of twenty five lakh rupees in a listed company or five lakh rupees in any other company attaches to whoever authorised it.
Two carve-outs do most of the practical work. Nothing in Section 188(1) applies to transactions entered into in the ordinary course of business, other than transactions that are not on an arm's length basis. Almost every argument in a real board room is about whether a contract sits inside that exception.
What related party transactions Section 188 actually catches
Section 188(1) applies to seven categories of contract or arrangement with a related party:
- Sale, purchase or supply of any goods or materials.
- Selling or otherwise disposing of, or buying, property of any kind.
- Leasing of property of any kind.
- Availing or rendering of any services.
- Appointment of any agent for purchase or sale of goods, materials, services or property.
- The related party's appointment to any office or place of profit in the company, its subsidiary or its associate company.
- Underwriting the subscription of any securities or derivatives of the company.
Note what is absent. Loans to directors are dealt with separately under Section 185, and inter-corporate loans and investments under Section 186. A guarantee given for a related party is not automatically a Section 188 transaction. Getting the classification right at the outset decides which approval route the company must take.
Three different sections of the Companies Act, 2013 are in play, and the classification decides the route.
Section 188: seven categories
Sale, purchase or supply of goods, buying or disposing of property, leasing, availing or rendering services, appointing a purchase or sale agent, office or place of profit, and underwriting.
Section 185: director loans
Loans to directors are dealt with separately and do not travel through the Section 188 route, so the classification has to be settled before approval is sought.
Section 186: inter-corporate loans
Inter-corporate loans and investments sit here. A guarantee given for a related party is not automatically a Section 188 transaction either.
The Act defines "arm's length transaction" as a transaction between two related parties conducted as if they were unrelated, so that there is no conflict of interest. It does not define "ordinary course of business", which is why boards should record, in the minutes, why a transaction is within the company's usual line of activity and how the price was benchmarked.
Key takeaway. The ordinary course and arm's length exception is cumulative, not alternative. A transaction escapes Section 188(1) only if it is both in the ordinary course of business and on an arm's length basis. A market-priced deal outside the company's usual business still needs approval.
Who counts as a related party
Section 2(76) is broader than most founders assume. It covers a director or his relative; a key managerial person or his relative; a firm in which a director, manager or his relative is a partner; a private company in which a director or manager or his relative is a member or director; a public company in which a director or manager is a director and holds, with his relatives, more than two per cent of the paid-up share capital; any body corporate whose board or managing director is accustomed to act on the advice of a director or manager, and the person on whose advice a director or manager is accustomed to act, except professional advice; and holding, subsidiary, associate, fellow subsidiary, investing company and venturer relationships.
The practical trap in closely held companies is sub-clause (iv). A private company in which a director of your company, or that director's relative, is merely a member becomes a related party. Family holding vehicles, dormant companies from an earlier venture and a spouse's consultancy firm all routinely qualify.
Board approval, member approval and the Rule 15 thresholds
Every Section 188 transaction needs the consent of the Board given by a resolution passed at a meeting, not by circulation. Rule 15(1) of the Companies (Meetings of Board and its Powers) Rules, 2014 requires the agenda itself to disclose the related party's name and relationship, the nature and duration of the contract, its material terms and value, any advance paid or received, how the pricing was determined, and any other information relevant to the decision. Under Rule 15(2), an interested director must not be present at the meeting during discussion of that item, which is stricter than the general rule in Section 184(2) that an interested director must disclose his interest and not participate.
Prior approval of the members by resolution is additionally required where the value crosses the limits in Rule 15(3). Since the 2015 amendment the resolution required is an ordinary resolution, not a special resolution, and since the amendment notified on 18 November 2019 the absolute rupee caps that used to sit alongside the percentages have gone.
| Transaction under Section 188(1) | Threshold for prior member approval | Measured against |
|---|---|---|
| Sale, purchase or supply of goods or materials, directly or through an agent | Ten per cent or more | Turnover of the company |
| Selling, disposing of or buying property of any kind, directly or through an agent | Ten per cent or more | Net worth of the company |
| Leasing of property of any kind | Ten per cent or more | Turnover of the company |
| Availing or rendering of services, directly or through an agent | Ten per cent or more | Turnover of the company |
| Appointment to an office or place of profit in the company, its subsidiary or associate | Monthly remuneration exceeding two and a half lakh rupees | Remuneration |
| Underwriting the subscription of securities or derivatives | Remuneration exceeding one per cent | Net worth of the company |
Turnover and net worth are computed on the audited financial statements of the preceding financial year, so the test is applied against last year's numbers, not a projection. Two further reliefs matter. A member who is a related party cannot vote on the resolution, but that bar does not apply to a company in which ninety per cent or more of the members, in number, are relatives of promoters or are related parties. And no resolution under the first proviso is needed for transactions between a holding company and its wholly owned subsidiary whose accounts are consolidated and placed before the shareholders for approval.
The approval sequence, step by step
- Map the counterparty against Section 2(76) before negotiating. Maintain a standing related party list and refresh it whenever a director, key managerial person or shareholding changes.
- Classify the transaction. Decide whether it falls in one of the seven categories, and separately whether Section 185 or Section 186 applies instead.
- Test the exception. Record whether the transaction is in the ordinary course of business and whether pricing is at arm's length, supported by comparable quotes, a valuation, a transfer pricing study or a benchmarking note.
- Obtain audit committee approval where the company has one. Section 177(4)(iv) requires the audit committee to approve related party transactions and any subsequent modification, and permits omnibus approval on prescribed conditions.
- Circulate a compliant agenda under Rule 15(1) and pass the Board resolution at a duly convened meeting, with the interested director absent for that item.
- Where the Rule 15(3) thresholds are crossed, convene a general meeting. The explanatory statement must set out the related party's name, the related director or key managerial person, the nature of the relationship, and the material terms and monetary value.
- Execute the contract only after the approvals are in place. Prior approval means prior.
- Record and report. Enter the contract in the register of contracts under Section 189, and disclose the transaction with the justification for entering into it in the Board's report, as required by Section 188(2) and Section 134(3)(h) in the prescribed form.
Common mistake. Signing first and ratifying later. Section 188(3) allows ratification within three months, but only by the Board or the shareholders as the case may be, and it is a rescue, not a plan. If ratification does not happen in time the contract is voidable at the option of the Board or the shareholders, and the directors concerned must indemnify the company against any loss.
Listed companies: SEBI LODR Regulation 23 and the 2025 recalibration
A listed entity has to satisfy Section 188 and, separately, Regulation 23 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, which is wider in every direction. All related party transactions and subsequent material modifications need prior approval of the audit committee, and material related party transactions need prior approval of shareholders, with related parties not voting.
The materiality test changed at the end of 2025. The SEBI (Listing Obligations and Disclosure Requirements) (Fifth Amendment) Regulations, 2025, notified on 19 November 2025, replaced the flat test of one thousand crore rupees or ten per cent of annual consolidated turnover, whichever is lower, with a scale-based table in the newly inserted Schedule XII. The Regulation 23 and Schedule XII changes took effect on the thirtieth day from publication in the Official Gazette.
| Consolidated turnover of the listed entity | Materiality threshold under Schedule XII |
|---|---|
| Up to twenty thousand crore rupees | Ten per cent of annual consolidated turnover |
| More than twenty thousand crore and up to forty thousand crore rupees | Two thousand crore rupees plus five per cent of turnover above twenty thousand crore |
| More than forty thousand crore rupees | Three thousand crore rupees plus two and a half per cent of turnover above forty thousand crore, or five thousand crore rupees, whichever is lower |
The same amendment tightened the subsidiary route. A related party transaction above one crore rupees, individually or aggregated across the financial year, to which a subsidiary of the listed entity is a party but the listed entity is not, now needs prior approval of the listed entity's audit committee if it exceeds the lower of ten per cent of the subsidiary's annual standalone turnover or the Schedule XII threshold. Omnibus shareholder approvals for material transactions granted at an annual general meeting are valid until the next annual general meeting, and those granted at any other general meeting are valid for no more than a year.
What happens when it goes wrong
The consequences run on four tracks and are cumulative. Under Section 188(3) the contract is voidable at the option of the Board or the shareholders if consent was not obtained and it is not ratified within three months, and the interested directors must indemnify the company. Under Section 188(4) the company may separately proceed against the director or employee to recover the loss actually suffered. Under Section 188(5) the person who entered into or authorised the transaction faces the penalty noted above. And under Section 184(3), a contract entered into without disclosure of interest, or with an interested director participating, is voidable at the option of the company, with a penalty of one lakh rupees on that director under Section 184(4).
Those four tracks, side by side, are what a default actually costs.
Section 188(3): voidable
The contract is voidable at the option of the Board or the shareholders where consent was not obtained and it is not ratified within three months, and interested directors must indemnify the company.
Section 188(4): recovery
The company may separately proceed against the director or employee to recover the loss it has actually suffered from the transaction.
Section 188(5): penalty
Twenty five lakh rupees in the case of a listed company and five lakh rupees in any other company, on the person who entered into or authorised the transaction.
Section 184(3) and (4)
A contract made without disclosure of interest, or with an interested director participating, is voidable at the company's option, with a penalty of one lakh rupees on that director.
In closely held companies the real exposure is not the penalty. It is the minority shareholder petition. Related party dealings that move value out at soft prices are the commonest factual foundation for proceedings under Sections 241 and 242, discussed in our article on oppression and mismanagement before the NCLT. Where pricing was never benchmarked and the approval trail is thin, the company has no answer to the allegation.
Deadline warning. Ratification under Section 188(3) has to happen within three months of the date the contract or arrangement was entered into. There is no provision for condonation of that period, so a transaction discovered during the annual audit in the following year cannot be cured by a late ratification.
Documentation, costs and timelines
The paperwork that survives scrutiny is short but specific: a current related party list, a disclosure of interest by each director under Section 184(1) in Form MBP-1, the Rule 15(1) agenda note, minutes recording the interested director's absence, the benchmarking or valuation support, the register of contracts under Section 189 in Form MBP-4, and the disclosure in the Board's report under Section 134(3)(h).
Costs for an unlisted company are driven by professional time rather than statutory fees: drafting the policy and agenda notes, a company secretary's certification, and, where pricing is contested, an independent valuation, which is usually the largest line item and varies widely with the asset. Timelines are governed by the meeting calendar rather than by any regulator: allow at least seven clear days for the Board meeting notice and twenty one clear days for a general meeting called in the ordinary way, so a transaction needing member approval realistically takes four to six weeks from decision to signature. These are indicative ranges and depend on the company's articles and circumstances.
A practitioner's note
The most useful discipline for a closely held company is to run the related party list as a live document rather than an annual formality. Most Section 188 defaults that surface in due diligence are not deliberate. A director acquired shares in a supplier, or a son-in-law's firm started invoicing the company, nobody updated the list, and the transaction went through the ordinary purchase process without reaching the Board. The second discipline is to write the arm's length reasoning down at the time, in two or three lines in the minutes, with comparables attached. Reconstructing it three years later in front of a buyer's counsel is far harder than recording it on the day. Related themes are covered in our notes on shareholders agreement clauses and legal due diligence in mergers, and our work in this area is described on the corporate and commercial law page.
Related guides and where to get help
- Director Disqualification Under Section 164: Causes and Cure
- ESOPs in an Indian Startup: The Legal Issues Founders Miss
- Are Non-Compete Clauses Enforceable in India?
Frequently Asked Questions
Does every transaction with a related party need shareholder approval?
No. Board approval by resolution at a meeting is always needed for the seven categories in Section 188(1). Member approval by ordinary resolution is needed only where the value crosses the Rule 15(3) thresholds.
Is a special resolution required under Section 188?
Not since the Companies (Amendment) Act, 2015 substituted the word "resolution" for "special resolution" in the first proviso to Section 188(1). An ordinary resolution suffices, with related party members abstaining.
Can the related party shareholder vote on the resolution?
No, the second proviso to Section 188(1) bars it. The bar does not apply to a company in which ninety per cent or more members, in number, are relatives of promoters or are related parties.
Do transactions between a holding company and its wholly owned subsidiary need approval?
The requirement of a members' resolution does not apply to transactions between a holding company and a wholly owned subsidiary whose accounts are consolidated with the holding company and placed before the shareholders at the general meeting for approval.
What is the penalty for breaching Section 188?
Under Section 188(5), a director or employee who entered into or authorised the transaction in violation is liable to a penalty of twenty five lakh rupees in the case of a listed company and five lakh rupees in the case of any other company.
Can an unapproved related party contract be saved?
Only by ratification by the Board or the shareholders within three months of the date the contract was entered into. After that the contract is voidable at their option and the directors concerned must indemnify the company for any loss.
How do I show a transaction is at arm's length?
By contemporaneous evidence: comparable quotations, published price lists, an independent valuation, a transfer pricing benchmarking study, or the pricing the company charges unrelated customers for the same thing, recorded in the Board minutes.
What changed for listed companies at the end of 2025?
The SEBI LODR Fifth Amendment Regulations, 2025 replaced the flat materiality threshold in Regulation 23(1) with the scale-based Schedule XII, capped at five thousand crore rupees, and tightened audit committee approval for transactions of subsidiaries above one crore rupees.
Are loans to a director covered by Section 188?
No. Loans, guarantees and security for directors and persons in whom a director is interested fall under Section 185, and inter-corporate loans and investments under Section 186, each with its own approval requirements.
This article is general information about the law and is not legal advice. Whether a particular transaction requires Board or shareholder approval depends on the company's numbers, its articles and the facts of the transaction.
