When The Company You're Buying From Is The Company You Own: Related Party Transactions Explained

When the Company You're Buying From Is the Company You Own: Related Party Transactions Explained

A Deal That Looks Fine on Paper

Imagine a mid-sized manufacturing company that needs packaging materials every month. It finds a supplier with competitive rates, reliable delivery, and a long working relationship with the purchase team. Nothing about the arrangement raises eyebrows — until someone notices that the supplier is a partnership firm where the company's managing director holds a 40% stake.

Nobody has necessarily done anything wrong. But the fact of that ownership overlap changes everything about how this transaction has to be handled, because the managing director now sits on both sides of the table — deciding, in effect, how much his own company should pay him.

This is the basic tension the Companies Act, 2013 manages whenever it deals with related party transactions, or RPTs. The law doesn't assume these deals are corrupt; it assumes they're risky by design, because the person approving the transaction and the person benefiting from it can be the same individual. Everything that follows — the approval chains, the audit committee's role, the penalties for skipping steps — exists to separate those two roles enough that shareholders can trust the outcome.

Who Actually Counts as "Related"

The definition, found in Section 2(76) of the Act, is broader than most people expect. It's not limited to a director's spouse or children. It reaches:

• Firms or private companies where a director, manager, or their relative holds a stake or position of influence
• Holding and subsidiary companies
• Entities that share common control through overlapping directors or investors

A company can find itself dealing with a "related party" through a chain of ownership two or three steps removed from anyone sitting in the boardroom.

Section 188 then narrows the focus to specific dealings that matter enough to regulate: buying or selling goods, leasing or transferring property, exchanging services with the related party, appointing a related party to a paid office within the company, and related-party involvement in underwriting the company's own securities. If a transaction falls into one of these buckets and involves a related party as defined above, Section 188 activates.

Getting Approval: A Two-Track System

Here's where the practical mechanics kick in, and where companies most often stumble — not through malice, but through assuming a lighter process applies than actually does.

Every board considering a qualifying RPT needs to pass a formal resolution at an actual board meeting — not by circulating papers for signature. That baseline applies whether the company is a small private firm or a listed giant.

Two things adjust that baseline, in opposite directions:

• The arm's-length exemption. If the transaction happens in the company's ordinary course of business and on terms comparable to what any unrelated party would get, it doesn't need to go through Section 188 at all. This gets misapplied constantly — boards assume a deal is arm's length because it "feels normal," without ever benchmarking it against market rates. That assumption tends to fall apart the moment a regulator or minority shareholder asks for proof.
• The shareholder-approval trigger. Once the transaction value crosses thresholds set out in the Companies (Meetings of Board and its Powers) Rules, 2014 — pegged to turnover, net worth, or a flat rupee ceiling depending on the transaction type — board approval alone isn't enough. Shareholders must also pass a resolution, and any shareholder who is a related party to that transaction is barred from voting on it.

Listed companies carry a second, heavier rulebook: Regulation 23 of SEBI's Listing Obligations and Disclosure Requirements Regulations. Since amendments effective from 2022 and refined further through 2024–2025, a transaction counts as "material" — triggering mandatory shareholder approval — once it crosses a scale-based threshold tied to annual consolidated turnover, capped at ?1,000 crore, whichever is lower. Every material RPT must first clear the audit committee, composed entirely of independent directors for this purpose, before disinterested shareholders approve it. Listed companies must also maintain a published RPT policy and disclose material transactions to stock exchanges within set timelines, then again in half-yearly filings and the annual report.

Section 188 and Regulation 23 are not interchangeable. An unlisted private company only answers to the Companies Act. A listed entity must satisfy both, and wherever they overlap, the stricter requirement wins.

Why the Board's Role Is the Whole Point

None of this machinery works if approval becomes a formality — a resolution passed because it's on the agenda, not because anyone actually questioned it. Section 177 requires listed companies, and certain other prescribed companies, to set up an audit committee specifically so that RPTs get reviewed by people without a personal stake before the full board ever votes.

A few habits separate boards that take genuine oversight seriously from ones that treat it as paperwork:

• Prove the arm's-length claim. Produce the comparison that justifies it — quotes from other vendors, market pricing data — not just "we've always worked with them."
• Interested directors step out. Anyone with a personal stake should leave the room for that discussion and abstain from the vote entirely, not just declare interest and stay seated.
• Disclose in the Board's Report. Section 134(3)(h) requires particulars of every related party contract, in the prescribed Form AOC-2, so shareholders reading the annual report can see what happened.
• Maintain the register. Under Section 189, a register of these contracts must be kept and made available for inspection — not buried until an auditor asks.

None of these steps is complicated alone. What makes them matter is that skipping any one quietly removes the independence the whole system depends on.

What It Costs to Get This Wrong

The consequences aren't abstract:

• Voidable contracts. Under Section 188(4), a contract signed in violation can be voided at the board's own discretion.
• Personal liability. If a director was the related party involved, that director personally owes the company for any resulting loss.
• Fines, not jail. The Companies (Amendment) Act, 2020 replaced imprisonment with a fine-only penalty structure for this violation — but the fines remain significant.
• Regulatory action for listed companies. SEBI has grown more aggressive about enforcing Regulation 23. In 2024, it acted against a group of companies — including a non-banking financial company — over related-party loans to borrowers with shaky finances, where the usual due diligence appeared to have been skipped.

What's notable about cases like this is that the transactions were often technically "approved" — a resolution existed somewhere — but the approval process had been hollowed out. The financial penalty is often the smaller cost; the larger one is the hit to investor confidence and the scrutiny that follows the board afterward.

The Short Version

If you're trying to hold the whole picture in your head at once, it comes down to this: related party transactions aren't banned, but they're deliberately made harder to wave through than ordinary business deals. Board approval is the floor, not the ceiling. Genuine arm's-length pricing is the only real exemption, and it has to be provable, not assumed. Cross a value threshold and shareholders — minus the ones with a stake in the deal — get a say too. Listed companies answer to SEBI on top of the Companies Act, and the two regimes don't substitute for each other. And when the process is skipped or hollowed out, the fallout lands on the company's finances, its directors personally, and its reputation, roughly in that order of speed.

Where This Leaves Boards

The underlying logic of RPT regulation isn't distrust of business relationships between connected parties — plenty of those are legitimate and even efficient. It's about making sure that when a decision-maker has something to gain, someone without that stake checks the math before the deal closes. That's a modest ask, but one a surprising number of companies still get wrong — usually not out of dishonesty, but out of treating disclosure and approval as paperwork rather than the actual safeguard it's meant to be. Boards that document, disclose, and genuinely question these transactions before signing spend far less time later explaining themselves to regulators or shareholders who noticed what the board didn't.