Related parties: Overview, definition, and example
What are related parties?
Related parties are individuals or entities that have a close relationship with a business, typically through ownership, control, or significant influence. These parties may include family members, subsidiaries, affiliates, or entities that share common ownership. The relationship between related parties can impact business transactions, as these parties may have interests that conflict with those of the company or its shareholders.
For example, if a company’s CEO owns a substantial portion of a supplier company, that supplier would be considered a related party to the business.
Why are related parties important?
Related parties are important because transactions between them may not be conducted on an arm’s length basis, meaning they could be influenced by personal relationships rather than purely business considerations. This can raise concerns about fairness, transparency, and potential conflicts of interest. For businesses, identifying related party transactions is critical for ensuring compliance with accounting standards and legal requirements.
In many cases, businesses are required to disclose related party transactions to shareholders or regulatory bodies to ensure transparency and avoid potential issues with corporate governance.
Understanding related parties through an example
Imagine a family-owned business, XYZ Corp., where the owner’s brother runs a construction company. If XYZ Corp. contracts the construction company to perform work, that would be a related party transaction because of the family relationship. These types of transactions need to be carefully evaluated to ensure they are fair and meet the same standards as transactions with non-related parties.
In another example, a large corporation, ABC Inc., has a subsidiary, DEF Ltd., which is also controlled by the same parent company. Any transactions between ABC Inc. and DEF Ltd. would be considered related party transactions and need to be disclosed for financial reporting purposes.
An example of a related parties clause
Here’s how a clause like this might appear in a contract:
“The Parties agree to disclose any related party transactions that may occur during the term of this Agreement, including those between the Parties and their affiliates, subsidiaries, or family members, in accordance with applicable laws and accounting standards.”
Conclusion
Related parties are individuals or entities with a close relationship to a business, which can influence the nature of business transactions. Identifying related party transactions is crucial for ensuring transparency and fairness in business dealings. For businesses, properly disclosing and managing related party transactions helps maintain good corporate governance and comply with legal and regulatory requirements.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.