Loan to Director Under Section 185 and 186 of the Companies Act, 2013 By CS Annu Sharma


Dear Professionals,
 
This write up aims to bring a clear vision on the newly substituted provisions of Sec 185 and the practical issues prevailing thereon, substituted Section 185 deals with the restrictions on part of the Companies in advancing any loan or giving any guarantee or providing any security and to those whom a Company can provide such loan or guarantee or security subject to compliances under the Act. Also, the section provides relaxation for Individuals and Entities from the provisions of Sec. 185 subject to certain conditions and Punishment for those who contravene the same.
 
FACTS ABOUT SECTION 185 OF THE COMPANIES ACT, 2013
 
  • Section 185 brought to force from 12th September 2013 and Corresponds to Sec.295, 296 of the Companies Act, 1956.
  • There are no rules prescribed, at present, for Sec. 185 under the Companies Act, 2013.
  • Other sections of the Act relating to Sec. 185 are Sections 177, 179 and 186.
  • This section shall not apply to a Govt. Companies, Private Companies, and Nidhi Companies subject to conditions specified in MCA’s Exemption Notification dated 5th June 2015 and 13th June 2017.
  • 61 of the Companies (Amendment) Act, 2017 completely substituted the existing Sec. 185 with new provisions w.e.f 7th May 2018.MCA vide its notification dated 7th May 2018 notified the Sections 61 of the Companies (Amendment) Act, 2017, through which Section 185 has been amended and reproduced as follows:
 
1. LOAN TO DIRECTOR OR FIRM IN WHICH HE IS INTERESTED-ABSOLUTELY PROHIBITED
 
Pursuant to section 185(1), no company shall advance any loan to or give any guarantee or provide any security in connection with any loan taken by,—
 
  • Any director/its partner/its relative or director of its holding company
  • Any firm in which such director or director’s relative is a partner.
 
In general terms: Subsection 1 states that a Company (Private & Public whether small, OPC, Start-ups etc.) shall not directly or indirectly, advance any loan (including loan represented by a Book debt) OR give any guarantee OR provide any security in connection with any loan taken by:
 
a) Any director of the company; or
 
b) Any director of its holding company; or
 
c) Any partner of any such director; or
 
d) Relative of any such director;
 
e) Any firm in which any such director is a partner; or
 
f) Any firm in which the relative of any such director is a partner;
 
(Note: The Term “any such” would mean in reference to the director of the lending company and/ or in relation to the director of its holding company)
 
2. LOAN TO ANY PERSON IN WHOM ANY OF THE DIRECTORS OF THE COMPANY IS INTERESTED-ALLOWED
 
Pursuant to section 185(2), A company may advance any loan or give any guarantee or provide any security in connection with any loan taken by any person* in whom any of the directors of the company is interested, subject to the condition that—
 
(a) A Special Resolution required,
 
The explanatory statement attached to the notice for the relevant general meeting shall disclose the full particulars of the loans/guarantee/ security provided and the purpose for which the same is proposed to be utilized by the recipient and any other relevant fact; and
 
(b) The loans are utilized by the borrowing company for its principal business activities.
 
In general terms: Subsection 2 states that a Company can advance any loan (including Book debt) or give any guarantee or provide any security in connection with any loan taken by
 
(a) any private company of which any such director is a director or member;
 
(b) anybody corporate at a general meeting of which not less than 25% of the total voting power may be exercised or controlled by
 
  • any such director, or
  • by two or more such directors, together; or
 
(c) any body corporate, the Board of directors, managing director or manager, whereof is accustomed to act in accordance with the directions or instructions of the
 
  • Board; or of
  • any director or directors, of the lending company.
 
However, the above provisions are subject to the following conditions that:
 
a) A special resolution is passed by the Company in general meeting; and
 
b) The loans are utilized by the borrowing company for its principal business activities.
 
In a nutshell Subsection, 2 allows companies to provide loan/guarantee/security to other Companies/body corporate subject to conditions. This was earlier prohibited and now relaxed.
 
3. LOAN TO DIRECTOR OR ANY PERSON IN WHICH HE IS INTERESTED-SPECIAL CASES
 
Pursuant to section 185(3) and sub-section 1 & 2 not applicable,
 
  • the company can give the loan to its Managing Director/Whole-Time-Director as a part of the conditions of service extended by the company to all its employees or pursuant to any scheme approved by the members by a special resolution;
  • a company providing such loans/guarantee/security in the ordinary course of its business;
  • any loans/guarantee/security made by a holding company to its wholly owned subsidiary company and such loans/guarantee/security is utilized by the subsidiary company for its principal business activities. (also the special resolution is not required under section 186(3))
  • Any guarantee/ security made by a holding company in respect of the loan made by any bank or financial institution to its subsidiary company and are utilized by the subsidiary company for its principal business activities.
 
4. PENALTY FOR THE CONTRAVENTION OF WHOLE SECTION 185
 

Who will be liable for contravention

Fine/Imprisonment

 

For lending company

 

Minimum Fine: Rs. 5 lac

Maximum Fine: Rs. 25 lac

 

Every officer in default

Maximum imprisonment: 6 Months or

Minimum Fine: Rs. 5 Lac

Maximum Fine: Rs. 25 Lac

the director or the other person to whom any loans/guarantee/security made

 

 

Maximum imprisonment: 6 Months or Minimum Fine: Rs. 5 Lac

Maximum Fine: Rs. 25 Lac

With both

 
 
5. COMPLIANCE OF SECTION 186 IN RESPECT OF LOANS/GUARANTEE/SECURITY MADE BY COMPANY TO ANOTHER COMPANY
 
  • Pursuant to section 186(3), the Special resolution required if loans/guarantee/security made by company exceeding sixty percent. of its paid-up share capital, free reserves and securities premium account or one hundred percent. of its free reserves and securities premium account, whichever is more.
  • No loan/guarantee/security shall be given by the company unless the resolution passed at a board meeting unanimously and the prior approval of the PFI concerned where any term loan is subsisting, is obtained:
  • No loan shall be given under this section at a rate of interest lower than the prevailing yield of one year, three years, five years or ten years Government Security closest to the tenor of the loan.
  • No company which is in default in the repayment of any deposits accepted before or after the commencement of this Act or in payment of interest thereon shall make any loan/ guarantee/security till such default is subsisting.
  • Every company which has made any loan/guarantee/security shall keep a register in MBP-2.
 
CONCLUSION
 
When the section was originally introduced, there was the complete prohibition on loan to its directors and other entities and it was felt that the said changes were much required for better governance & transparency in the affairs of the Companies keeping in view the fiduciary character of the directors.

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