Section 188 of CA 2013 : Section 188: Related Party Transactions

Explanation using Example

Imagine a company named "DreamDecor Pvt. Ltd." which specializes in interior design. The company plans to purchase high-quality furniture for its new office space. The best offer comes from "ComfyFurnishings Ltd.", which is owned by the brother of DreamDecor's managing director.

Under Section 188 of The Companies Act, 2013, DreamDecor Pvt. Ltd. cannot simply proceed with this purchase because it involves a related party. First, the Board of Directors must give their consent through a resolution at a board meeting. They must also ensure that the transaction is at an arm's length, meaning it's conducted as if ComfyFurnishings Ltd. and DreamDecor Pvt. Ltd. were unrelated parties.

If the paid-up share capital of DreamDecor Pvt. Ltd. exceeds a certain amount, or the value of the transaction is above a specified sum, the company must also obtain prior approval from its shareholders through a resolution. The managing director's brother, who is a related party, would not be allowed to vote on this resolution.

If DreamDecor's Board decides to proceed without following these steps and the shareholders do not ratify the contract within three months, the contract will be voidable. Additionally, if the purchase leads to a loss for DreamDecor, the directors involved may have to indemnify the company for this loss.

Lastly, if the directors or employees of DreamDecor violate these provisions, they could be subject to substantial penalties, especially if DreamDecor is a listed company.