Related-party transactions: who signs off, and when

A related-party transaction under the Companies Act does not pass through one approval. It passes through up to three, in sequence, and each has its own threshold. Boards that treat it as a single decision are the ones that end up filing a rectification.

The three gates

Audit committee. Every related-party transaction needs prior approval of the audit committee, where the company is required to have one. Omnibus approval is available for repetitive transactions, but it has to be granted on specified criteria and reviewed.

Board. Transactions outside the ordinary course of business, or not at arm's length, require Board approval by resolution at a meeting — not by circulation. A director who is interested does not count towards quorum and does not vote.

Shareholders. Above the prescribed thresholds, prior approval of the members by resolution is required, and the related party cannot vote on it.

Where it goes wrong in practice

• Arm's length is asserted, not evidenced. "Ordinary course and at arm's length" is the exemption most relied on and the least documented. The file needs comparables, not a conclusion.
• The interested director stays in the room. Quorum is computed after excluding interested directors. A resolution passed without valid quorum is not a resolution.
• Omnibus approval is treated as permanent. It runs for the financial year and needs the criteria specified up front.
• Listed-company disclosure is forgotten. Where the company is listed, the SEBI listing obligations add their own approval and disclosure requirements on top of the Companies Act. Clearing one does not clear the other.

A workable internal process

The firms that get this right run a standing register rather than a case-by-case scramble.

• Maintain a live related-party register, refreshed at each quarter and on any change in directorship or shareholding
• Route every proposed transaction through a single checklist that asks, in order: is the counterparty a related party, is it in the ordinary course, is it at arm's length, which thresholds are crossed
• Put the arm's length evidence in the file at the time of the transaction, not at audit
• Calendar the omnibus approval renewal with the other annual approvals

The cost of the process is small. The cost of unwinding a transaction, or of a penalty proceeding that surfaces three years later during due diligence, is not.

The diligence angle

This is one of the first things a buyer's counsel tests. In a legal due diligence exercise, an unevidenced arm's length claim on a material related-party transaction is a red flag that affects price, indemnity and sometimes the deal itself. Keeping the register clean is cheaper than explaining it later.

This note is general information, not legal advice on any specific matter, and does not create a lawyer–client relationship. Seek independent advice on your own facts.