Related Party Transactions in a Private Limited Company: What Every Board Must Get Right

Related Party Transactions can quietly expose a private limited company to serious governance risk.

They often begin as routine business decisions, office rent paid to a promoter entity, shared services within a group, or inter-company financial support. But without the necessary approvals, pricing discipline, and documentation, these transactions can quickly become compliance failures under the Companies Act, 2013.

This guide explains how private companies should structure, approve, and govern Related Party Transactions (RPTs) to remain compliant while retaining business flexibility.

Key Takeaways

• Related Party Transactions are allowed, but only with discipline
  Private limited companies can enter into RPTs freely, provided the pricing is fair, the terms are transparent, and approvals are in accordance with Section 188 of the Companies Act, 2013.
• Arm’s length pricing is the single most important safeguard
  Transactions conducted in the ordinary course of business and at arm’s length usually do not require special approvals. Poor pricing immediately triggers compliance and governance risk.
• Approval failures create personal and corporate liability
  Unapproved RPTs can become voidable, attract financial penalties, and expose directors to indemnity obligations and reputational damage.
• Strong RPT governance strengthens investor and lender confidence
  Clear documentation, timely disclosures, and structured approvals reduce due diligence friction and support long-term scalability and capital raising.

What Is a Related Party Transaction?

A Related Party Transaction (RPT) is any arrangement between a company and its related parties. These include directors, key managerial personnel, their relatives, holding or subsidiary companies, and entities where such persons exercise significant influence or control.

In private limited companies, RPTs are common. Ownership and management often overlap. As a result, transactions such as rentals, loans, service agreements, cost sharing, or guarantees frequently involve related parties.

Because of this overlap, regulators focus not on whether RPTs exist, but on how they are executed. Understanding the legal implications of a private limited company helps directors appreciate their governance responsibilities, particularly regarding related-party dealings.

Why RPT Governance Matters for Private Companies

Private companies may not face public market scrutiny. Yet, weak governance around RPTs creates real risk.

Poorly structured RPTs can harm minority shareholders. They can also raise red flags during lender audits, investor due diligence, or regulatory inspections. In extreme cases, they expose directors to personal liability.

Strong RPT governance protects the company. It also builds credibility with banks, investors, and regulators. Most importantly, it prevents future disputes and costly compliance corrections.

The Arm’s Length Rule: Your First Compliance Test

The arm’s length principle is the foundation of RPT compliance.

It requires that transactions with related parties be conducted on terms comparable to those offered to unrelated third parties under similar conditions. Pricing, tenure, payment terms, and risk allocation must reflect market reality.

Companies typically rely on market benchmarks, third-party quotations, industry standards, or independent valuation reports. Professional business valuation services and an understanding of various business valuation methods are essential for establishing fair market value in complex transactions.

Where exact comparables are unavailable, clear commercial justification becomes essential. This is particularly important for specialised services or unique arrangements, such as when companies engage consultancy agreements with related parties.

If a transaction fails the arm’s length test, it immediately triggers higher approval requirements.

Identify Related Parties Before You Transact

Effective compliance begins before the transaction is signed.

Directors and key managerial personnel must disclose their interests in other entities and any changes to those interests. These disclosures allow the company to identify related parties early and assess compliance requirements in advance.

Maintaining an updated internal register of related parties is not optional. It is a critical governance tool that prevents accidental non-compliance.

Section 188 Approval Framework Explained

Section 188 of the Companies Act, 2013, governs approval requirements for RPTs. The approval level depends on the transaction’s structure.

Board Approval Is Mandatory When:

The transaction is not in the ordinary course of business, or
The transaction is not at arm’s length.

In such cases, prior Board approval is required. Interested directors must disclose their interest and abstain from discussion and voting.

Shareholder Approval Is Required When:

The transaction value exceeds the prescribed thresholds

Approval must be obtained through an ordinary resolution. Related parties are not permitted to vote on the resolution.

This layered approval framework ensures objectivity and shareholder protection.

Managing Recurring Related Party Transactions

Many private companies engage in recurring RPTs such as rentals, shared services, or group support arrangements. Approving each transaction separately can be inefficient.

A practical approach is to execute consolidated agreements with predefined commercial terms and monetary limits. These arrangements should be reviewed periodically by the Board.

This method preserves operational efficiency while maintaining regulatory discipline.

What If an RPT Is Done Without Approval?

Unapproved RPTs create immediate governance exposure.

Under Section 188, such transactions become voidable at the Board’s option. Directors or related parties may be required to indemnify the company for losses. Delays in corrective action increase regulatory and reputational risk.

Prompt ratification, supported by proper justification and documentation, significantly reduces potential fallout.

Practical Exemptions You Should Know

Not every transaction requires special approvals.

Transactions with wholly owned subsidiaries, uniform employee benefits, and corporate actions applicable equally to all shareholders are generally excluded. These exemptions prevent unnecessary compliance burden while keeping the focus on material risks.

Consequences of Non-Compliance Under Section 188

Failure to comply with Section 188 has real consequences.

For private limited companies, penalties can range from ₹25,000 to ₹5,00,000. Transactions may be invalidated. Directors may face personal liability. More importantly, non-compliance damages trust with lenders and investors.

The cost of fixing RPT failures is always higher than the cost of getting them right up front. Companies receiving income tax notices often find that poorly documented RPTs attract additional scrutiny from tax authorities.

Disclosure and Ongoing Monitoring Are Non-Negotiable

All covered RPTs must be disclosed in the Board’s Report along with proper justification. Approved limits must be monitored continuously.

Ongoing oversight ensures audit readiness and prevents threshold breaches. It also demonstrates a strong governance culture to external stakeholders.

The Strategic Value of Strong RPT Governance

RPT compliance is not just a legal requirement. It is a strategic advantage.

Companies with clear RPT frameworks face fewer issues during funding rounds, audits, and exits. Governance discipline signals maturity, reduces friction, and supports long-term scalability.

Private companies that invest in RPT governance today avoid regulatory stress tomorrow.

Final Takeaway

Related Party Transactions are inevitable in private limited companies. Governance failures are not.

By applying the arm’s length principle, identifying related parties early, following Section 188 approval norms, and maintaining transparent documentation, companies can execute RPTs confidently and compliantly.

Strong RPT governance protects directors, safeguards shareholders, and strengthens the company’s foundation for growth.