When s.188 applies
Section 188 covers seven kinds of contract or arrangement with a related party, as defined in s.2(76). A transaction that is both in the ordinary course of business and at arm's length is outside s.188 entirely. Both conditions must hold, and the company should keep evidence of each, such as a pricing comparison, benchmarking, or a valuation. If either fails, the board must approve the contract by resolution at a meeting, not by circulation (Rule 15(1)), and the interested director must stay out of the discussion (s.184(2)).
When members must also approve: Rule 15(3)
| Transaction | Ordinary resolution needed if it reaches |
|---|---|
| Sale, purchase or supply of goods or materials | 10% or more of turnover |
| Selling, disposing of or buying property of any kind | 10% or more of net worth |
| Leasing of property of any kind | 10% or more of turnover |
| Availing or rendering of services | 10% or more of turnover |
| Appointing an agent for any of the above | The threshold of the underlying transaction |
| Office or place of profit | Monthly remuneration above ₹2.5 lakh |
| Underwriting remuneration | More than 1% of net worth |
Turnover and net worth come from the audited financial statements of the preceding year. The limits apply to a single transaction or to transactions taken together during the year.
Who cannot vote
A member who is a related party in the context of the contract cannot vote on the resolution. This bar does not apply to a private company (exemption notification of 5 June 2015). It also does not apply where 90% or more of the members, by number, are relatives of promoters or related parties. Transactions between a holding company and its wholly owned subsidiary whose accounts are consolidated need no members' resolution.
Records and disclosure
Enter every such contract in the register in MBP-4 (s.189). Disclose contracts that are not at arm's length, and material ones at arm's length, in Form AOC-2 with the board's report. A contract entered without approval can be ratified by the board or members within three months; otherwise it is voidable at the board's option (s.188(3)). Listed companies follow the stricter Regulation 23 of LODR instead; see the SME LODR toolkit.
Common questions
If a transaction is at arm's length but not in the ordinary course of business, does s.188 apply?
Yes. The exemption needs both conditions together. A one-off sale of a factory to a director's company at market value still needs board approval, and members' approval if it reaches 10% of net worth.
Does the audit committee approve all related party transactions?
In a company with an audit committee, every related party transaction, including ordinary-course arm's length ones, needs its prior approval or omnibus approval under s.177(4)(iv) and Rule 6A.
Which year's turnover is used?
The turnover or net worth in the audited financial statements of the preceding financial year.
Can related party members vote in a private company?
Yes. The second proviso to s.188(1), which bars related party members from voting, does not apply to private companies under the 2015 exemption notification.