पाठशाला Pathshala · नियम Niyam, Law and compliance · Lesson 20 · Build

Related-party transactions and the founder’s conflicts of interest

The founder’s other company, the co-founder’s spouse on payroll, the office rented from family. All legal, all common, and all invalid if the board and shareholders did not approve them the way the Companies Act asks.

Pathshala, The Founder Library · 11 October 2026 · 7 min read

Two fishermen in silhouette on a small boat at sunset, with the Mumbai skyline behind them. — Photograph: Stockified · Pexels

In the third week of due diligence a Series A investor’s lawyers send a list. The company’s office is leased from a trust run by the founder’s father. The design work goes to a studio owned by the co-founder’s wife. The founder draws a salary as a director and another as a consultant through his own LLP. None of it is hidden and none of it is unusual. None of it was approved by the board, and the term sheet now has a new condition precedent.

Indian company law does not forbid a founder from doing business with the company. It requires that the business be visible, approved by people who are not on both sides of it, and priced as it would be between strangers. This lesson explains who counts as a related party, which transactions need which approval under the Companies Act, the exemption most founders can use and how to prove it, and how to repair a transaction that was signed without the paperwork.

Who counts as a related party

Section 2(76) of the Companies Act 2013 defines a related party, with reference to a company, in nine clauses. The people: a director or his relative, and a key managerial person or his relative. The businesses: a firm in which a director, manager or their relative is a partner; a private company in which a director or manager is a member or director; a public company in which a director or manager is a director, or holds with relatives more than two per cent of its paid-up capital. The group: any holding, subsidiary or associate company, and a fellow subsidiary. And the shadows: a body corporate whose board habitually acts on a director’s instructions, and any person on whose instructions a director habitually acts, unless the advice is given in a professional capacity.

A relative under section 2(77) includes a husband or wife, members of a Hindu undivided family, and the further relations the rules prescribe. For a founder the practical list is short and personal: the spouse and the immediate family the rules name, every company or LLP the founder or a co-founder owns or directs, and any family vehicle that holds shares. Write it down, and have the company secretary check the family names against the rules. A conflict that nobody listed is the conflict that surprises the investor.

The seven contracts and the two approvals

Section 188(1) names seven kinds of contract or arrangement with a related party: the sale, purchase or supply of goods or materials; selling or buying property of any kind; leasing property of any kind; availing or rendering services; appointing an agent for buying or selling; a related party’s appointment to any office or place of profit in the company; and underwriting the company’s securities. Each needs the consent of the board by a resolution at a meeting. Not a circular resolution, not an email: a meeting, with the terms in front of the directors.

A close-up of a rope tied in a knot, in black and white. — Every tie on the section 2(76) list is lawful. The Act asks only that it be visible and approved by people who are not on both ends of it. Photograph: Claudio Mota · Pexels

Above prescribed thresholds the company’s prior approval by resolution of the shareholders is needed as well. The thresholds sit in rule 15(3) of the Companies (Meetings of Board and its Powers) Rules 2014. The amendment notified as G.S.R. 857(E) on 18 November 2019 set leasing at ten per cent or more of turnover and removed the old rupee caps on goods, property and services, so those are now measured against turnover or net worth alone. An appointment to an office or place of profit crosses the line at a monthly remuneration above ₹2.5 lakh, and underwriting at more than one per cent of net worth, as the annotated rule text shows; turnover and net worth are taken from the audited financial statements of the preceding year. A co-founder’s spouse employed at ₹3 lakh a month is a shareholder resolution, not an HR decision.

The Act bars related-party members from voting on that resolution. For a private company, the 2015 exemption in G.S.R. 464(E) lifts the bar, provided the company has not defaulted in filing its financial statements and annual returns. That proviso is one more reason to keep the filings current: a company that is late with its annual return can find that its founders may not vote on their own arrangements.

The exemption most founders can use, and how to prove it

The third proviso to section 188(1) says nothing in it applies to transactions in the company’s ordinary course of business other than those not on an arm’s length basis. Both limbs must hold. Ordinary course means the kind of transaction the company does routinely in running its business: a software company buying cloud credits from a reseller its director owns may qualify; the same company buying the director’s flat does not. Arm’s length means terms an unrelated party, dealing freely, would accept.

The exemption is a defence, and defences need evidence. For each related-party contract the company relies on it for, keep three things in the file: a note of why the transaction is in the ordinary course, with two or three examples of similar contracts with strangers; the pricing evidence, which is a rate card, competing quotes or a valuation; and the board minute noting the transaction even though approval was not strictly needed. An investor’s lawyer who finds the file closes the question in an afternoon. One who finds nothing assumes the worst, and the [due diligence lesson](/library/due-diligence-data-room-that-closes-round) explains what that does to the timeline.

The law does not stop a founder dealing with the company. It asks that strangers could have struck the same deal, and that someone else approved it.

Disclosure, the interested director and the board’s report

Section 188 tells the company what to approve. Section 184 tells the director what to say. Every director must disclose his concern or interest in other companies, firms and bodies corporate, including shareholdings, at the first board meeting he attends as a director, at the first board meeting of every financial year, and whenever the disclosure changes. When the board considers a contract with a body corporate in which the director, alone or with another director, holds more than two per cent, or with a firm in which the director is a partner, owner or member, the director must disclose the nature of the interest at that meeting and not participate in it. A contract entered without that disclosure, or with the interested director taking part, is voidable at the option of the company.

Section 188(2) then requires every related-party contract to be referred to in the board’s report to shareholders, with the justification for entering into it. Write the justification at the time of the board meeting, not at year end from memory: the business reason, the alternatives considered, and why these terms are fair.

Walk any arrangement through the tree below. It starts with the question diligence starts with: has it already happened?

When the deal is already signed

Most founders meet section 188 after the fact. The repair is in section 188(3): a contract entered into without the board’s consent or the shareholders’ approval can be ratified by the board or, as the case may be, the shareholders at a meeting within three months of the date it was entered into. If it is not ratified in time, the contract becomes voidable, and where it was with a director’s related party or authorised by another director, the directors concerned must indemnify the company against any loss. Section 188(4) lets the company proceed against the director or employee who entered into it to recover that loss, and section 188(5) adds penalties.

For contracts older than three months the clean path is to approve them afresh, prospectively, at a meeting that follows the full procedure, often by terminating and re-entering on documented arm’s length terms. A lease that has run for two years is easier to re-paper than to defend. Tell the investor what you found and what you did. Lawyers forgive a fixed problem far more readily than a discovered one.

The April register and the quarterly check

At the first board meeting of every financial year, collect a fresh interest disclosure from every director and update a one-page related-party register: each person and entity on the section 2(76) list, the contracts the company has with each, the approval each received, the date, the value so far this year and the threshold it is measured against. Every quarter, before the board meeting, the finance lead runs the ledger against the register and flags any payment to a listed party that has no approval behind it, and any contract heading towards a rule 15(3) threshold. Anything new goes on the agenda before it is signed. A company that does this for two years will hand over the register on the first day of diligence, and the list in the opening paragraph will never be written.

Nothing here is legal or tax advice; confirm the current rule with a chartered accountant or lawyer before acting.