Can a Company Enter Into a Related-Party Transaction Without Shareholder Approval?

Introduction

Yes.

A company generally deals with the people it already knows well the promoters, relatives and the firms under their control. These types of related party transactions are legitimate, but they also carry an intrinsic risk that the weightage will move away from the company to the people who control it.

Discussing whether the company can enter into a related party transaction without approval of shareholders? Then the answer is yes, but this yes is neither absolute nor vague.

As per Indian law, Section 188 of the Companies Act, 2013, requires Board approval for covered transactions, while outlining the requirement to obtain prior approval of shareholders only while dealing with larger transactions and not for the ordinary course of business at arm's length.

By this, we can say that the law leaves a demarcated category of related party dealings to the Board alone.

This article outlines the circumstances in which shareholder approval can be bypassed, examines the consequences of non-compliance, and argues that in promoter-controlled companies, where the board itself is rarely independent, these exemptions weaken the safeguard the statute appears to promise.

Statutory Framework

The beginning point is to understand the term "related party". As per Section 2(76) of the Companies Act, 2013, this defines a “related party”. It includes directors and key managerial personnel and their relatives, firms and companies in which they hold specified interests, and holding, subsidiary and associate companies.

This section matters because the transactions caught by Section 188 are those between the company and any such person.

Section 188(1) lists the covered transactions:

• Sale, purchase or supply of goods or materials.

• Dealings in property.

• Leasing.

• Availing or rendering of services.

• Appointment to an office or place of profit.

• Underwriting of securities.

Concerning these, the core rule is, ordinary resolution is presented and the Board must pass it by give consent. Shareholder approval is not the common essential but an additional layer applicable only above the mentioned thresholds.

Section 188 also demarcates transactions in the ordinary course of business, provided they are on an arm's length basis.

The next Part examines how these provisions determine when shareholders are, and are not, consulted.

When Shareholder Approval Is and Isn’t Required

Three Situations

First, ordinary course and arm’s length transactions fall outside Section 188(1) altogether. The Act does not define “ordinary course of business”, so the Board largely decides what qualifies.

Second, transactions below the thresholds in Rule 15(3) of the 2014 Rules need only Board consent. Shareholder approval is required, for example, for goods exceeding teper centnt of turnover or property exceeding teper centnt of net worth.

Third, transactions between a holding company and its wholly owned subsidiary with consolidated accounts need no separate shareholder resolution.

The result is that the “no” in answer to the question is not an exception but a large part of the framework. Shareholders are consulted only on the largest and least ordinary transactions, and the Board, not the shareholders, decides which transactions fall outside that net.

Listed Companies: The Stronger Regime

Where a transaction crosses the Rule 15(3) thresholds, shareholder approval by resolution is required, and a member who is a related party may not vote.

This bar does not apply to private companies, under a Section 462 notification, or companies where ninety per cent or more of members are promoter relatives or related parties.

Companies required to have an audit committee also need its prior approval under Section 177(4)(iv).

Listed companies face Regulation 23 of the SEBI (LODR) Regulations, 2015:

• Audit committee approval for all related party transactions.

• Shareholder approval for material ones.

• Abstention by all related parties, whether or not party to the transaction.

The contrast is instructive. The Act asks shareholders to approve only transactions above the thresholds, and the voting bar then applies.

Regulation 23 combines an audit committee filter with a stronger abstention rule, but only for listed companies.

Critical Analysis: The Argument

A company that enters a related party transaction without the required approval still has remedies, but it depends largely on action after the event.

Under Section 188, a contract entered into without the required Board or shareholder approval can be ratified within three months of its execution.

If it is not ratified, it becomes voidable at the option of the Board or, as the case may be, the shareholders.

Where the contract is with a related party of a director, or was authorised by another director, the directors concerned must indemnify the company against any loss.

The company may also proceed against the director or employee who entered into the contract for recovery of its loss.

Section 188 also prescribes penalties. The Companies (Amendment) Act, 2020 replaced the imprisonment and ₹25,000 to ₹5 lakh fine with a flat penalty of ₹25 lakh for listed companies and ₹5 lakh for others.

It falls on the director or employee who entered into or authorised the contract.

Two features stand out:

1. The contract is voidable, not void, so third parties dealing in good faith are not left exposed.

2. Ratification allows an unapproved transaction to be cured after the fact, which weakens the preventive effect of the approval requirement.

Loopholes

The answer to the central question is therefore yes, and the more important issue is how much protection remains.

Three features of the framework suggest it is less than the statute appears to promise.

First, the Board is the real gatekeeper.

Most related party transactions never reach shareholders, because they fall below the thresholds or within the ordinary course exemption.

In promoter-controlled companies, the Board that decides which transactions qualify is promoter-nominated, so the exemption is applied by the same persons it should constrain.

Second, the voting bar is narrow.

It excludes only members who are themselves related parties, so other shareholders may still vote.

It does not apply to private companies or where ninety per cent or more of members are related. The residual electorate is often small and passive.

Third, ratification blurs prevention.

A transaction that misses approval can be corrected within three months by the same decision-makers who allowed it, so non-compliance carries a modest cost.

Regulation 23 shows that a stronger design is possible, since listed companies face audit committee scrutiny and a broader abstention rule.

Unlisted promoter-controlled companies, however large, enjoy no equivalent protection.

Reform That Can Be Made and Conclusion

Three reforms would address these weaknesses without burdening ordinary commercial dealings.

First, define "ordinary course of business", or have the Ministry of Corporate Affairs issue guidance on frequency, nature and scale.

Second, apply a majority-of-minority vote above a higher threshold to large unlisted companies, and take back the private company exemption from the voting bar for them. Section 177 already requires audit committee approval where a committee shall exist.

Third, require independent valuation for important transactions depending on the arm's length exemption.

Conclusion

In conclusion, a company can enter into a related party transaction without shareholder approval, and the Companies Act, 2013 permits this across a wide category of dealings.

The law's preference for Board-level control is defensible where the Board is independent, but in promoter-controlled companies that condition generally fails.

The exemptions, the limited reach of the voting bar and the availability of ratification together leave shareholders with less protection than the statute suggests.

Specific reform, not a covering ban, would get back the balance.

Key Takeaways

 1.⁠ ⁠Shareholder approval is not mandatory for every Related Party Transaction (RPT). A company can enter into certain related-party transactions without shareholder approval under Section 188 of the Companies Act, 2013.

 2.⁠ ⁠Board approval is the general requirement. Transactions covered under Section 188(1) generally require the consent of the Board of Directors through a resolution at a Board meeting

 3.⁠ ⁠Ordinary course and arm's length transactions are exempt. Transactions satisfying both conditions fall outside the approval requirements of Section 188(1).

 4.⁠ ⁠Thresholds determine shareholder involvement. Shareholder approval through an ordinary resolution becomes necessary when transactions cross the prescribed limits under Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014.

 5.⁠ ⁠Listed companies face stricter compliance. Regulation 23 of SEBI (LODR) Regulations, 2015 provides additional safeguards, including audit committee scrutiny and shareholder approval for material related-party transactions.

 6.⁠ ⁠Related-party shareholders generally cannot vote. The Companies Act and SEBI regulations contain voting restrictions, subject to applicable exemptions.

 7.⁠ ⁠Non-compliance can have serious consequences. An unauthorised transaction may become voidable, and the responsible directors or employees may face penalties and liability for losses.

 8.⁠ ⁠Ratification is possible, but it is not a substitute for proper approval. Section 188 provides a three-month ratification mechanism for certain unauthorised transactions.

 9.⁠ ⁠Promoter-controlled companies raise governance concerns. Where the Board lacks independence, exemptions and Board-level decision-making may weaken shareholder protection.

10.⁠ ⁠Reforms are necessary. Clearer definitions, stronger minority shareholder protection and independent valuation can improve transparency and accountability.

FREQUENTLY ASKED QUESTIONS (FAQs)

Q1. Can a company enter into a Related Party Transaction without shareholder approval?

Yes. Under Section 188 of the Companies Act, 2013, shareholder approval is not mandatory for every related-party transaction. Certain transactions can be approved at the Board level, while transactions falling within specified exemptions may not require approval under Section 188(1).

Q2. What is a Related Party Transaction under Indian company law?

A Related Party Transaction is a contract or arrangement between a company and a related party. Section 2(76) of the Companies Act, 2013 defines related parties and includes directors, key managerial personnel, their relatives and certain associated companies and firms.

Q3. Which provision governs Related Party Transactions in India?

Section 188 of the Companies Act, 2013 is the principal provision governing specified related-party transactions. It must be read with Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014.

Q4. When is shareholder approval not required for a Related Party Transaction?

Shareholder approval is generally not required under Section 188(1) in the following circumstances:

- The transaction is in the ordinary course of business and conducted at arm's length.

- The transaction does not cross the prescribed shareholder-approval thresholds.

- The transaction qualifies for the specific holding company and wholly owned subsidiary exemption.

Q5. What does an arm's length transaction mean?

An arm's length transaction is one in which related parties deal with each other as if they were independent parties, without a conflict of interest and on commercially comparable terms.

Q6. What happens when a Related Party Transaction crosses the prescribed thresholds?

Prior approval of shareholders through a resolution is required under the first proviso to Section 188(1), read with Rule 15(3). The relevant thresholds depend on the nature and value of the transaction.

Q7. Can a related party shareholder vote on the approval resolution?

Generally, no. The second proviso to Section 188(1) prohibits a related-party member from voting on the resolution approving the transaction. However, statutory and notified exemptions apply, including the specified 90% membership exception.

Q8. Are listed companies subject to stricter rules?

Yes. Listed companies must also comply with Regulation 23 of the SEBI (LODR) Regulations, 2015. This includes prior audit committee approval and shareholder approval for material related-party transactions, subject to applicable exemptions.

Q9. What happens if a company enters into a Related Party Transaction without obtaining the required approval?

Under Section 188(3), the transaction may be ratified within three months. If it is not ratified within that period, it becomes voidable at the option of the Board or shareholders, as applicable. The responsible directors may also have to indemnify the company against losses.

Q10. What penalties are prescribed for violating Section 188?

Under Section 188(5), a director or employee who enters into or authorises a contract in violation of the provision is liable to:

- Listed company: ₹25 lakh penalty.

- Other companies: ₹5 lakh penalty.

Q11. Does Section 188 apply to every transaction between a company and its related party?

No. Section 188 applies to the specified categories of contracts and arrangements listed in subsection (1). Other applicable provisions, including Section 177 and SEBI regulations, may impose additional requirements.

Q12. Why are Related Party Transactions a corporate governance concern?

They create a possibility that promoters or controlling persons may use their influence to benefit themselves or their associated entities at the company's expense. This can undermine minority shareholder interests, transparency and accountability.

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