Section 188 approval process-AAOL rule

In case a company is unlisted/public company, I will check the AAOL thumb rule which determines the approval process:

a. A: Audit committee, Is the company covered under section 177(1)?

b A: Is the transaction at Arm's length price?

c. O: Is the transaction in ordinary course of business?

d. L: Is the transaction superseding the limits?

Before moving with the rule, are we aware of what is meant by consent of the Board?

As seen in Walchandnagar Industries Ltd. V. Ratanchand khimchand motishaw [1953] 23 Comp. Cas. 343 (Bom.), ‘Consent’ as occurring in section 297(1) of the 1956 Act [Corresponding to section 188(1) of the 2013 Act] implies a knowledge of the necessary facts and materials which leads to the consent.

a.????? A: Audit committee,

The ‘A” in rule states the following:

“Is the company required to have Audit Committee (covered under section 177(1))?”

If the company is required to constitute Audit Committee, then all related party transactions irrespective of the fact whether or not it is in ordinary course of business and arm’s length price, we are required to get the Audit committee approvals.

(Note:

a.the companies covered under section 177(1) is covered in schedule 1,Part A of this article)

b.Omnibus approval for related party transactions on annual basis is covered in schedule 1,Part B.)

Now for a company not covered under section 177(1), if the transaction is in ordinary course of business and at arm’s length price, no Board approval is needed except the omnibus approval at the start of the year given by Board instead of audit committee and additional omnibus approvals if any.

Now the next question in the rule is: A: Is the transaction at Arm's length price?

(Note:- An in-depth research on the Arm’s length pricing is already published with the link given in comments below)

O: Is the transaction in ordinary course of business?

How do we determine what is in ordinary course of business?

As a Company secretary, what would your answer be?

(hint: Which documents deals with the objects of the company?)

Yes, you guessed it right, It is the Memorandum of Association.

However, have your read the judgement in of M/s. Bharti Televentures Ltd. v. Addl./Jt. Commissioner of Income Tax [ITA 1395/2006, ITA 1656/2010]?

i. it was held that the Memorandum and Articles of Association is not conclusive for deciding whether an activity is in the ordinary course of business of the company.

ii.? Frequency of the activity is sought to be highlighted. It should be a continuous activity carried out in a normal organised manner.

But if I write an activity in my object clause so it is in ordinary course right?

In Seksaria Biswan Sugar Factory v. Commissioner of Income Tax [AIR 1950 Bom 200] Judgement:

i.? the Hon'ble High Court decided that the amount lent by the company to a third party will not be in the ordinary course of business.

ii.The Court observed that just because an activity is included in the Memorandum of Association, the activity per se does not become an activity in the ordinary course of business of the company.

So, in terms of RPT: Few variables need to be looked at like:

• Whether the activity is covered in the objects clause of the Memorandum of Association?
• Whether the activity is in furtherance of the business?
• Whether the activity is normal or otherwise routine for the particular business (i.e. activities like advertising, staff training, etc.)?
• Whether the activity is repetitive/frequent?
• Whether the income, if any, earned from such activity/transaction is treated as business income in the company’s books of account?
• Whether the transactions are common in the particular industry?
• Whether there is any historical practice to conduct such activities?
• The financial scale of the activity with regard to the operations of the business.
• Revenue generated by the activity.
• Resources committed to the activity.

Conclusion for Ordinary course of business:

1.Moa should be referred however not a conclusive proof.

2.Audit committee may also be referred.

3. Company’s policy on transactions.

4. Guidelines if any framed by Audit Committee.

5. In case of company not covered under section 177[1] then the same shall be referred to Board of Directors instead of audit committee.

L: Is the transaction superseding the limits?

Last but most importantly, If the material limits are breached/exceeded then we would need to take shareholder approval.

But what are these material limits under companies Act?

The limits are as follows:

Schedule 1 part A:

a.????? Section 177(1): The Board of Directors of 5[every listed public company] and such other class or classes of companies, as may be prescribed, shall constitute an Audit Committee.

b.????? Rule 6 of The Companies (Meetings of Board and its Powers) Rules, 2014: The Board of directors of every listed public company and a company covered under rule 4 of the Companies (Appointment and Qualification of Directors) Rules, 2014 shall constitute an ‘Audit Committee’, and a ‘Nomination and Remuneration Committee of the Board’.

c.?Rule 4(1) of The Companies (Appointment and Qualifications of Directors) Rules, 2014:

1)] The following class or classes of companies shall have at least two directors as independent directors -

(i) the Public Companies having paid up share capital of ten crore rupees or more; or

(ii) the Public Companies having turnover of one hundred crore rupees or more; or

(iii) the Public Companies which have, in aggregate, outstanding loans, debentures and deposits, exceeding fifty crore rupees:

?

Rule 4(2) The following classes of unlisted public company shall not be covered under sub-rule (1), namely: -.

(a) a joint venture;

(b) a wholly owned subsidiary; and

(c) a dormant company as defined under section 455 of the Act.

Schedule 1 part B:

Rule 6A of the Companies (Meetings of Board and its Powers) Rules, 2014.

Omnibus approval for related party transactions on annual basis.-

All related party transactions shall require approval of the Audit Committee and the Audit Committee may make omnibus approval for related party transactions proposed to be entered into by the company subject to the following conditions, namely: -

(1) The Audit Committee shall, after obtaining approval of the Board of Directors, specify the criteria for making the omnibus approval which shall include the following, namely:-

(a) maximum value of the transactions, in aggregate, which can be allowed under the omnibus route in a year;

(b) the maximum value per transaction which can be allowed;

(c) extent and manner of disclosures to be made to the Audit Committee at the time of seeking omnibus approval;

(d) review, at such intervals as the Audit Committee may deem fit, related party

transaction entered into by the company pursuant to each of the omnibus approval made.

(e) transactions which cannot be subject to the omnibus approval by the Audit Committee.

(2) The Audit Committee shall consider the following factors while specifying the criteria for making omnibus approval, namely: –

(a) repetitiveness of the transactions (in past or in future);

(b) justification for the need of omnibus approval.

(3) The Audit Committee shall satisfy itself for transactions of repetitive nature and that the company.

(4) The omnibus approval shall contain or indicate the following: –

(a) name of the related parties:

(b) nature and duration of the transaction;

(c) maximum amount of transaction that can be entered into;

(d) the indicative base price or current contracted price and the formula for variation in the price, if any; and

(e) any other information relevant or important for the Audit Committee to take a decision on the proposed transaction:

Provided that where the need for related party transaction cannot be foreseen and aforesaid details are not available, audit committee may make omnibus approval for such transactions subject to their value not exceeding rupees one crore per transaction.

(5) Omnibus approval shall be valid for a period not exceeding one financial year and shall require fresh approval after the expiry of such financial year.

(6) Omnibus approval shall not be made for transactions in respect of selling or disposing of the undertaking of the company .

(7) Any other conditions as the Audit Committee may deem fit.

With warm regards,

Keep Smiling,

Saeed Shaikh.

Footnotes & credits

1.https://www.mca.gov.in/content/mca/global

2.https://www.mca.gov.in/content/mca/global/en/acts-rules/ebooks.html

3.https://www.icsi.edu/

Credits:

1.A huge amount of credit goes to Mrunal and Juhi for taking out the time from a quarter ending week to explain me the concepts in depth and clearing my same doubts again too!