Related Party Transactions Under Section 188: What Actually Needs Approval

A closely-held company pays rent to a director's other firm for its office space, buys raw material from a supplier owned by a promoter's relative, or hires a director's spouse as a marketing consultant. On the ground, these deals often get treated like any other vendor relationship: a purchase order, an invoice, a payment. Under company law, they're not. The moment the counterparty is a 'related party' as the Act defines it, the transaction falls under Section 188, and depending on its size, it needs board approval, shareholder approval, or both, before it happens, not after. Companies that treat this as year-end audit paperwork are usually the ones an auditor flags, because by then the transaction has already gone through unapproved.

Who Actually Counts as a 'Related Party'

The definition is wider than most people assume, and it doesn't require a formal ownership stake to apply. It covers a company's directors and key managerial personnel and their relatives, any firm in which a director, manager, or relative is a partner, any private company where a director or manager is a director or member, and any public company where a director or manager holds shares along with relatives above a prescribed threshold. It also covers holding, subsidiary, and associate companies, fellow subsidiaries of the same parent, and any person whose advice a director or manager is accustomed to act on, unless that influence is purely professional. In a closely-held company, this net catches far more than the obvious related entities, including the small vendor or consultancy run by a founder's sibling or spouse.

Which Transactions Need Approval, and From Whom

Section 188 lists specific categories: sale, purchase, or supply of goods or materials; buying, selling, or leasing property; availing or rendering services; appointing a related party to an office or place of profit; and underwriting the company's securities. Any transaction in one of these categories with a related party needs prior board approval, passed as a resolution at a meeting, with an interested director in a public company stepping back from discussing and voting on that item. Once a transaction crosses the materiality thresholds set under the rules, board approval alone isn't enough: it also needs shareholder approval by ordinary resolution, and a member who is itself the related party can't vote on that resolution either, except where the company is a wholly owned subsidiary, where approval by the holding company's own resolution is treated as sufficient.

Private companies get a real relaxation here, and it's easy to miss. Under a specific exemption available to them, an interested director may participate in the board's discussion and vote after disclosing their interest, rather than stepping back the way a public company director must, and a related-party shareholder isn't barred from voting on the shareholder resolution either. None of this removes the underlying requirement to get board and, above the threshold, shareholder approval. What's relaxed is only who's allowed to cast a vote when that approval is being given, which matters in a closely-held company where the interested party might be the only person who really understands the deal.

The exact percentages and rupee figures behind these thresholds sit in the rules framed under the Act rather than in Section 188 itself, and they get revised from time to time, so it's worth confirming the currently applicable figures with your CA rather than assuming they're fixed for good. What doesn't change is the structure: cross the threshold, and shareholder approval joins board approval as a requirement, not a replacement for it.

The Arm's Length and Ordinary Course Exemptions

Section 188 carries one significant carve-out: a transaction entered into in the ordinary course of business and at arm's length doesn't need board or shareholder approval under this section at all. Both conditions have to be genuinely true together, not just one. A related-party purchase priced like a third-party deal, but for an activity the company doesn't normally engage in, isn't ordinary course just because the price was fair. Equally, a transaction that's part of the company's regular business but priced more generously than an unrelated party would ever agree to isn't arm's length just because the activity is routine. Neither condition is something a company gets to simply declare. Auditors expect to see it demonstrated: pricing comparable to deals with unrelated parties, and a pattern of activity that genuinely matches what the company does as a matter of course, not a one-off dressed up to look routine.

Disclosure Doesn't Stop Once a Transaction Is Exempt

Even a transaction that clears the arm's length and ordinary course exemption doesn't disappear from scrutiny. Every related party transaction, approved, exempted, or in between, needs to be disclosed in the board's report through Form AOC-2, covering the relationship, the duration and salient terms of the arrangement, and the amounts involved. This becomes part of the public record once the annual filing goes through, so a transaction that skipped Section 188 approval because it genuinely qualified for the exemption is still visible to anyone who looks. Applicable accounting standards separately require related party balances to be disclosed in the notes to the financial statements too, which is why auditors review the two together, not as unconnected checklists.

Why This Keeps Coming Up in Audits and Governance Reviews

Related party transactions are a recurring flashpoint precisely because they're common and rarely malicious, which makes them easy to under-document. A founder's company genuinely might share office space with another business the founder also owns, or route a service through a relative's firm because that relative is good at the job, and the transaction itself is often perfectly legitimate. What auditors, minority shareholders, and investors actually check for is whether the approval process was followed and the pricing can be defended as fair, not whether a related party was involved at all, since related-party dealing isn't prohibited on its own. It's one of the more common observations in audits of founder-run and family-owned companies, and it shows up just as often in shareholder disputes, where a minority shareholder alleging that value was quietly siphoned out through undocumented related-party deals is a familiar pattern in oppression and mismanagement complaints. Treating approval and documentation as part of doing the deal, not a formality to backfill later, is what keeps a legitimate arrangement from looking like something worse.