APPOINTMENT OF DIRECTOR'S RELATIVE AND EXEMPTION FROM APPROVAL UNDER SECTION 314 OF COMPANIES ACT, 1956

[Dr. Sanjiv Agarwal]

According to sub-section (1A) of Section 314, where a relative of a director or a firm in which such relative is a partner holds any office or place of profit under the company or a subsidiary thereof having been appointed to such office or place before such director becomes a director of the company, the provisions of sub-section (1) shall not apply i.e, no special resolution required to be passed for such appointment.

As per sub-section (1B) of Section 314 of the Companies Act, 1956, prior consent of the company by way of passing special resolution in the general meeting and also approval of the Central Government would be required if a relative of director hold office or place of profit carrying total remuneration payable in respect of such office or place of profit exceeding the prescribed sum i.e 2,50,000/- per month.

As per DCA Circular No 14/75[8/12/314(1B)/75-CL-V] dated 05.06.1975, the exemption under Section 314(1A) shall apply to Section 314(1B) as well. Accordingly, no prior approval of members in general meeting by passing special resolution and no approval of the Central Government shall be required in case payments to the relative of director exceeds 250000/- per month and also where such relative was appointed at the office or place of profit before the director is appointed as director in the company.

Thus exemption provided in sub-section 1(A) will continue to be available even in case the payments to such relative exceed the prescribed limit of Rs.50000/- per month as the sub-section (1A) starts with the word “nothing in sub-section (1) shall apply”.

Further, as per Section 297 of the Companies Act, 1956, the consent of the Board of directors of the company will be required by way of passing resolution at the Board meeting. Generally, the consent of the Board is required prior the contract is entered into or within three months from the date on which the contract is entered into otherwise, the contract shall be voidable at the option of the board.

Limit of Rs. 50000 and reimbursement of expenses

The limit of Rs.50000/- for the purpose of Section 314(1) shall includes fixed reimbursements but no taxes as the word “total monthly remuneration” has been used in the said section. It is not only the remuneration on monthly basis, but remuneration paid in any other mode should also be taken into account for the purpose of the ceiling limits prescribed under sub-section 1 of Section 314 of the Companies Act, 1956. The High Court in the case of Ravindra Kumar Sanghal v Auto Lamps Ltd, 1983 (10) TMI 196 - HIGH COURT OF DELHI, held that, the payment of bonus, reimbursement in lieu of privileged leave not availed, employer’s contribution to provident fund, reimbursement of medical expenses etc, cannot be treated as monthly payments. Therefore, any amount in the nature of non-recurring or non-regular payment shall not be taken for the purpose of calculating “total monthly remuneration”.

Payments made to relative of the director and related party transaction

As per AS-18 and ASI 21 issued in this regard, non-executive directors are not treated as key managerial personnel and as such any transaction with them or with their relative shall not be treated as related party transaction. Therefore, as such, payment made to relative  of any  non-executive director may not be treated as related party transaction as per AS-18. However, the payments made to the relative of non-executive director may be regarded as related party transaction, only when it can be demonstrated that the non-executive director of the company exercises significant influence or control over the activities of reporting enterprise.

Even though disclosure requirement as laid out in the AS-18 is not to be followed as the director is non-executive, however, such transaction will continue to be related party transaction in terms of Companies Act, 2013 as well as Companies Act, 1956 and as such disclosure requirement as set out in the respective sections of the Act’s are to be followed. Further, sub-section 3A of Section 211 of the Companies Act, 1956 provides that, every profit and loss account and balance sheet of company shall comply with accounting standards. Therefore, to ensure greater transparency, the disclosure requirement as set out in the AS-18 may be followed.

Implications of continuity of contracts under new provisions of the Companies Act, 2013

As per Section 188 of the Companies Act, 2013, contract with related party in respect to appointment of the related party to any office or place of profit in the company requires prior approval of the Board by way resolution passed at the Board meeting. Such provision was not provided in the Section 297 of the erstwhile Companies Act, 1956. Where relative  of the non-executive director is appointed at place of profit in the company even before such director was appointed as the director in the company, for which no approval from Board or passing of any resolution was required at the time of appointment. Therefore, it could be considered as a proper compliance if the Board of directors in the Board meeting held after such director become director in the company ratifies the contract with the relative party by passing resolution at Board meeting. However, for subsequent renewal of the contract with the relative of the director will require prior consent of the Board.

However, if such transaction with the relative is on arm’s length basis i.e the fees given for its services are not excessive and is reasonable as per the general practice in the industry, in such case, nothing provided in sub-section 1 of Section 188 of the Companies Act, 2013 shall apply i.e Board consent shall not be required for such contracts.

The company is required to report all such contracts/ transactions entered with the related parties in its Board report with the proper justification for entering into such contracts. The company is also required to maintain the registers under section 189 of the Companies Act, 2013 having all the particulars of the contracts or arrangements entered into by the company in which directors or key managerial personnel of the company are interested. The related parties transactions are also require to reported in the “notes to accounts” which are integral part of the financial statements of an entity. 

Since section 188 of the Companies Act, 2013 is not applicable as of now, and till the time the said section gets notified, Sections 297 and 314 of the erstwhile Companies Act, 1956 shall apply. Therefore, it would be proper compliance if the consent of Board is taken for renewing the contract with the related party in the Board meeting by way of passing resolution and after then the company passes special resolution in the general meeting held after the date the relative holds the office or place of profit and renewed the contracts with the related party, even though as per sub-section 1A of Section 314 of the Companies Act, 1956, the said contract does not require approval of shareholders in general meeting.

Further, instead of general punishment, specific punishment has now been provided in Section 188 of the Companies Act, 2013 in case of contravention of provisions related to related party transaction. In case of default, any Director or other employee of a company, who has authorized the contract or arrangement in violation of the provisions of the section be punishable with imprisonment for a term which may extend to 1 year or with fine which shall not be less than Rs. 25000/- but which may extend to Rs. 5,00,000/- or with both.