Corporate affairs ministry's warning—related-party violations attract penalties

New Delhi: The ministry of corporate affairs has reminded business promoters of the penalties for not following an arms-length approach in transactions involving company directors, executives, relatives and firms linked to such persons.
Emphasising the importance of adhering to guidelines covering related-party transactions to ensure transparency, fairness, and long-term sustainability of businesses, the ministry said such deals are prone to conflicts of interest.
The ministry's reminder comes amid ongoing proceedings against executives of Gensol Engineering Ltd for alleged diversion of funds to various related parties in violation of rules under the Companies Act.
The National Company Law Tribunal (NCLT) last week allowed the Central government to attach the bank accounts and lockers of Gensol Engineering, its 10 subsidiaries, and several individuals after investigations by multiple agencies and regulators revealed systemic fraud, Mint reported on 28 May.
The ministry stated in its newsletter for April released over the weekend that the company law prescribes penalties for directors or employees who violate provisions regarding related-party transactions.
'In a listed company, they could face a penalty of ₹ 25 lakh. For other companies, penalty is of ₹ 5 lakh,' the ministry said.
As per the Companies Act, the consent of a company's board of directors is required for any contract or arrangement with a related party for any sale or purchase of goods and property, leasing of property, availing of services, or appointing agents for such transactions. Also, subscribing to the shares of a related-party entity requires board approval.
However, related-party transactions that happen in the ordinary course of business and are on an arms-length basis do not need board approval, as per law.
Related-party transactions remain in the focus of regulatory authorities because erring businesses and promoters tend to use this route to divert funds raised for specific purposes to privately held entities linked to or controlled by them. Such illicit fund transfers short-circuit the normal functioning of a company.
Given the role of related-party transactions in corporate scandals, audit watchdog National Financial Reporting Authority (NFRA) keeps special focus on how religiously statutory auditors of a company check such transactions before giving an opinion on the affairs of the company.
The ministry's newsletter stated that the legal provisions in the Companies Act on related-party transactions seek to ensure such deals do not undermine investor confidence or the integrity of the financial system.
'Ultimately, these provisions reflect the growing importance of robust governance practices that align with global best practices, contributing to the long-term sustainability and growth of companies in India,' the ministry said in its newsletter.

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