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What is a 'Related-Party Transaction'

A related-party transaction is a business deal or arrangement between two parties who are joined by a special relationship prior to the deal. For example, a business transaction between a major shareholder and the corporation, such as a contract for the shareholder's company to perform renovations to the corporation's offices, would be deemed a related-party transaction.

BREAKING DOWN 'Related-Party Transaction'

Related-party transactions are a common occurrence in the business marketplace. Companies often seek business deals with entities to which they are familiar with or have been referred to through past relationships. While these types of transactions are legal and ethical, the special relationship inherent between the involved parties creates potential conflicts of interest, which must be regulated because they can result in actions that benefit the people involved as opposed to the shareholders.

A number of regulatory procedures are in place to ensure that related-party transactions are conflict-free and do not negatively affect value for shareholders. American public companies are required to disclose all transactions with related parties such as executives, associates and their family members in their annual 10-K reports. As a result of this added reporting requirement, many companies have special policies and corporate compliance procedures in place to ensure that related-party transactions are appropriately documented and enacted.

Related Parties

Related parties and business services can take many different forms. Some of the most common types of related parties include business affiliates, shareholder groups, subsidiaries of the company and minority owned companies. Related party transactions can include sales, leases, service agreements and loan agreements.

The management of policies and procedures that track related-party transactions and business deals include a number of factors. These factors are regulated by the industry’s accounting and audit standards and in many cases these special transactions must be approved by management consensus or the company’s board of directors. Some specific standards and procedures set for related-party transactions include the monitoring of payment competitiveness, payment terms, monetary transactions and authorized expenses. Overall, all related-party transactions must be transparently reported in order to ensure that all actions are legal and ethical and do not harm shareholder value.

Examples

One example of fraudulent use of related-party transactions include the infamous Enron scandal. In this case, related-party transactions with "special-purpose entities" were used to help the company misreport its accounting numbers.

In large corporate situations, public companies are often minority or majority owned by other entities. These entities may have similar business interests due to business commonalities. In these cases related-party transactions may naturally occur such as vendor or supplier relationships for the mutual benefit of both companies.

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