Understanding Materiality in Related Party Transactions of Private Companies

Private companies frequently grapple with one recurring interpretational issue under the Companies Act 2013: what exactly is “material” for the purpose of disclosing related party transactions (RPTs) in Form AOC-2, especially in Part 2 relating to transactions at arm’s length and in the ordinary course of business.

The statutory framework under Section 188 and Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014 is very specific where it deals with approval thresholds. However, that framework does not answer the separate and equally important question of materiality for disclosure in Form AOC-2 in the case of unlisted and private companies.

This article unpacks the legal position, distinguishes the approval regime from the disclosure regime, and sets out a practical approach that private companies can adopt to deal with the materiality requirement under Form AOC-2.

1. Statutory Framework Relevant to Private Company RPTs

Before analysing “materiality”, it is essential to map the key legal provisions applicable to related party transactions and their disclosure in the Board’s Report.

1.1 Core Provisions Under the Companies Act 2013

  • Section 188(1)
    Requires prior consent of the Board of Directors, by resolution passed at a Board meeting, before entering into specified categories of contracts or arrangements with a related party.

  • First proviso to Section 188(1)
    Mandates prior approval of members by ordinary resolution where the transaction value exceeds the monetary limits notified under Rule 15(3).

  • Second proviso to Section 188(1)
    Prohibits a related-party member from voting on such resolutions.

    This proviso does not apply to private companies due to a specific MCA exemption (discussed later).

  • Third and fourth provisos to Section 188(1)
    Carve out an exemption from Board/shareholder approval for transactions that are:

    • in the ordinary course of business, and
    • at an arm’s length basis.

  • Rule 15(3) of the Companies (Meetings of Board and its Powers) Rules, 2014
    Prescribes monetary limits that determine when shareholder approval by ordinary resolution is compulsory for specified RPT categories.

  • Section 2(76)
    Defines “related party” for the purposes of Section 188 (subject to certain exemptions for private companies, discussed separately).

  • Section 134(3)(h)
    Requires the Board’s Report to include particulars of every contract or arrangement with related parties referred to in Section 188(1), in Form AOC-2, along with justification for entering into such contracts.

  • Rule 8(2) of the Companies (Accounts) Rules, 2014
    This is the enabling rule under which Form AOC-2 is prescribed.

  • Form AOC-2
    The prescribed format through which details of related party contracts/arrangements are disclosed in the Board’s Report. It has:

    • Part 1 – for contracts/arrangements not at arm’s length (with no materiality qualifier), and
    • Part 2 – for “material” contracts or arrangements or transactions at arm’s length basis in the ordinary course of business.

  • MCA Notification G.S.R. 464(E) dated 5 June 2015 (as amended by G.S.R. 583(E) dated 13 June 2017)
    Provides certain relaxations for private companies in relation to Section 188.

  • Section 134(8)
    Prescribes the penalty for contravention of Section 134, which includes defaults or deficiencies in the Board’s Report and hence in Form AOC-2 disclosures.

  • Section 188(5)
    Sets out the penalty for contravention of Section 188 itself, i.e., entering into related party transactions without following the prescribed approval process.

1.2 SEBI LODR Reference – Only for Contrast

  • Regulation 23 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (SEBI LODR)
    Contains a definition of material related party transactions, but only for listed entities. It does not extend to unlisted or private companies and is cited here purely to highlight the contrast and the absence of such a definition under the Companies Act 2013 for private/unlisted companies.

2. Extracts that Trigger the Materiality Question

Certain key statutory and form-based extracts show where the confusion around “materiality” arises for private companies.

2.1 Ordinary Course and Arm’s Length Exception

The third proviso to Section 188(1) in effect states that the procedural requirements of Section 188(1) (Board/members’ approval) do not apply to transactions:

  • undertaken in the ordinary course of business, and
  • that are on an arm’s length basis.

Thus, such transactions can be entered into without following the Section 188 approval pipeline, irrespective of their size.

2.2 Disclosure in the Board’s Report via Form AOC-2

Section 134(3)(h) requires the Board’s Report to contain:

particulars of every contract or arrangement with related parties referred to in sub-section (1) of section 188 in the prescribed form (Form AOC-2).

Form AOC-2 then bifurcates reporting as follows:

  • Part 1 – Details of contracts/arrangements not at arm’s length. Here, there is no concept of materiality; all such transactions are reportable.
  • Part 2 – Heading states:

    “Details of material contracts or arrangement or transactions at arm’s length basis.”

This is the first and only place in the Companies Act framework dealing with unlisted companies where the word “material” is introduced in relation to RPT disclosures.

Critically:

Neither the Act nor the rules (including Rule 8(2)) provide any definition of “material” for this purpose in the context of a private or unlisted company.

The result: the materiality filter in Part 2 of Form AOC-2 is left undefined at the statutory level for private companies.

3. Two Distinct Compliance Tracks: Approval vs Disclosure

For a private company, related party transaction compliance actually flows through two entirely separate tracks.