Related Party Transactions Under Section 188: A Founder Plain-English Guide

What Section 188 does

Section 188 of the Companies Act, 2013 deals with contracts and arrangements between a company and a related party covering specified categories, including sale or purchase of goods or materials, selling or otherwise disposing of property, leasing of property, availing or rendering of services, and appointment to any office or place of profit in the company.

It is important to read it as procedural rather than prohibitory. The section does not say a company may not deal with people connected to its directors. It says such dealings go through a defined approval process, with disclosure, and in some cases shareholder approval, depending on the transaction and the thresholds prescribed.

The transactions founders actually run into

• Paying a consultancy or services company owned by a founder or a founder relative.
• Taking office premises on lease from a director, a relative, or an entity they control.
• Employing a founder spouse, sibling or parent in the company.
• Buying equipment or services from a business connected to a director.
• Group arrangements where two companies share founders and one invoices the other.

Why it matters even when the deal is fair

Most of these transactions are entirely reasonable. A founder who owns a design studio doing the company branding at market rates is not doing anything improper. The difficulty is that the fairness is asserted rather than documented, and a later reader has no way to distinguish it from a transaction that was not at arm length.

That later reader is usually an investor or an acquirer. Related-party dealings are a standard diligence line item, and unpapered ones become questions, then schedules, then conditions. The remedy at that stage is retrospective documentation under time pressure, which is both expensive and less convincing than doing it contemporaneously.

Loans and guarantees are a separate question

Sections 185 and 186 address different ground. Section 185 restricts a company advancing loans, giving guarantees or providing security in connection with a loan to its directors or entities in which they are interested, subject to prescribed exceptions. Section 186 caps and conditions loans and investments made by a company.

Founders frequently move money between a company and themselves informally in the early years, and these are the provisions that make that a live issue rather than a bookkeeping detail. A director current account with an unexplained balance is a common diligence finding, and it is worth understanding the position before it becomes one.

Practical hygiene

• Maintain a register of related parties, including relatives and entities they control, and keep it current as the board changes.
• Disclose interests at board meetings and record the disclosure in the minutes.
• Follow the applicable approval process for the transaction and threshold rather than assuming board approval is always sufficient.
• Paper the transaction itself with an ordinary written agreement at market terms.
• Keep evidence of why the terms are market, such as comparable quotes, since that is what a later reader will ask for.