Section 185 of Companies Act, 2013 has been notified along with total 98 Sections by the Ministry of Affairs on 12th day of September, 2013. Since that day, Sec 185 has been drawing a huge concern from the corporate sector because prima facie it emits a sense of challenging not only to loan but also guarantee and security within group companies.
In my following writ-up, try to make it Comprehensive.
In Bare Act language
Save as otherwise provided in this Act, no company shall, directly or indirectly,
advance any loan, including any loan represented by a book debt, to any of its directors or
to any other person in whom the director is interested or give any guarantee or provide any
security in connection with any loan taken by him or such other person:
Provided that nothing contained in this sub-section shall apply to—
(a) the giving of any loan to a managing or whole-time director—
(i) as a part of the conditions of service extended by the company to all its employees; or
(ii) pursuant to any scheme approved by the members by a special resolution; or
(b) a company which in the ordinary course of its business provides loans or gives guarantees or securities for the due repayment of any loan and in respect of such loans an interest is charged at a rate not less than the bank rate declared by the Reserve Bank of India.
The line save as otherwise provided in this Act is to be noticed. To elucidate, this would mean that if anywhere else, i.e if any other section of the Companies Act,2013 allows giving of loan to the person covered in this section 185,then it will be permitted.
Company means Sec 185 is applicable to both Public and Private Company. However
A Private Company which satisfies the following conditions w.e.f. 5th June 2015 would not invite restrictions contained in section 185: (a) In its capital no other body corporate has invested any money, i.e., its shareholder does not include any body corporate; (b) If the borrowings of the lending company from banks or financial institutions or anybody corporate is less than twice its paid up capital or Rs. 50 crores, whichever is lower; and (c) Such a company is not in default in repayment of such borrowings subsisting at the time of making transactions under this section.
Any Company which in the ordinary course of its business provides loans or gives guarantees or securities and the Company charges interest at a rate not less than the bank rate declared by RBI. Loan given by a holding Company to its Wholly Owned Subsidiary (not partly owned subsidiary),or guarantee given or security provided by holding company to its subsidiary (not wholly owned subsidiary) provided that the money is utilised by the subsidiary for its principle business activity.
The word directly is understandable for all. So our basic object is to understand indirectly which means (interpreted in the case of Dr. Fredie Ardeshir Mehta vs. Union of India (1991) 70 Comp Cas 210 (Bom.) lending Company is not eligible to give advance any loan, including any loan represented by a book debt to its director or to any other person in whom the director is interested through the agency of one or more intermediaries.
The term Loans is not defined anywhere in Companies Act, 2013. However in normal parlance any transaction in which money is given with the intention to be returned, with or without interest is loan. There is a difference between Loan, Advance and Deposit under Companies Act 2013. A deposit includes a loan, but every loan may not be a deposit. An advance may be deemed to be a deposit but it may not be a loan. We should understand the difference between Loan, Deposit and Advance for the purposes of Companies Act 2013 and related compliances.
The phrase loan includes any loan represented by a book debt
This clause appears to be very dangerous as any book debt in the books of the company, in the name of any Director or any other person in whom the Director is interested will be treated as a loan. Hence, a company can’t make “credit sales” or can’t accept any contract or provide any service on credit basis to any person as more elucidated in Section 185. (Existing loans already provided by the company as on 12th Sep 2013 are not affected by the above provisions .However the same shall be renewed and repaid on due date)
Better can be understand by Example-Suppose, a petrol bunk or gas company or ice cream company or Cig or PAN company sells to director even on market price and collect the money once a month for sales made on daily basis to the director, there will be outstanding in the books of the company on 29th or 30th day assuming the director is disciplined person who clears the debt on dotted date is also restricted.
Any of its directors means all directors except managing or whole time director subjected to fulfilment of the following conditions-
The giving of loan to a managing or whole time director as a part of the condition of service extended by the company to all its employees or in pursuant of the scheme approved by the member by passing special resolution.
To any other person in whom the director is interested means as per Bare Act
For the purposes of this section, the expression “to any other
person in whom director is interested” means—
(a) any director of the lending company, or of a company which is its holding company or any partner or relative of any such director;
(b) any firm in which any such director or relative is a partner;
(c) any private company of which any such director is a director or member;
(d) any body corporate at a general meeting of which not less than twenty five per cent. of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together; or
(e) 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.
(2) If any loan is advanced or a guarantee or security is given or provided in
contravention of the provisions of sub-section (1), the company shall be punishable with fine which shall not be less than five lakh rupees but which may extend to twenty-five lakh rupees, and the director or the other person to whom any loan is advanced or guarantee or security is given or provided in connection with any loan taken by him or the other person, shall be punishable with imprisonment which may extend to six months or with fine which shall not be less than five lakh rupees but which may extend to twenty-five lakh rupees, or with both.
The term Relative means relative as defined in Sec 2(77) of Companies Act, 2013. ‘relative’’, with reference to any person, means any one who is related to
(i) they are members of a Hindu Undivided Family;
(ii) they are husband and wife; or
(iii) one person is related to the other in such manner as may be prescribed;
As per definition of Sec 2 (46) holding company, in relation to one or more other companies, means a company of which such companies are subsidiary companies.
Firm means firm be registered under Indian partnership act, 1934 or may be a non registered one. It is also important to understand the word such. Such would mean in reference to the director of the lending company and/or in relation to the director of its holding company. Private Company means company as defined 2(68).
Body Corporate defined as under
(11) “body corporate” or “corporation” includes a company incorporated outside India, but does not include—
(i) a co-operative society registered under any law relating to co-operative societies; and
(ii) any other body corporate (not being a company as defined in this Act), which the Central Government may, by notification, specify in this behalf.
So we can say that loan given to the director of the co-operative society even if the such director is a director of lending company.
As per definition Sec 2 (27) control shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner.
Violation of Sec 185
For lending company- Shall be punishable with: Fine – not less than Rs. 5.00 lakhs and extending to Rs. 25.00 lakhs .
For Director or other person -Punishable with: Imprisonment – extending to 6 months Fine – not less than Rs. 5.00 lakhs and extending to Rs. 25.00 lakhs OR With both Under S. 295 of Act, 1956 Every person who was knowingly a part and person to whom loan is provided punishable with fine extending to Rs. 50,000 rupees or with simple imprisonment extending to 6 months
section 185 or section 186 is to be operative here but since, section 185 uses the word “Save as otherwise provided in this Act”, this section gets superior position to section 186 and thereby, section 186 gets inoperative in conditions where section 185 prevails.
As per Act, Any private company of which any such director is a director or member But relative is not mentioned so loan can be given to private company of which relative of director is a director.
Are deposits covered? The section does not make any separate distinction as such. Going by the case laws in this case, loans are different than deposits. Thus, deposits are not covered by the section.
Are advances covered? Advances are money advances against some due which is to be become due at a later period. It is a pre-payment against goods or services .So, advances are not covered.
Does the section also cover personal guarantees by directors? The section only covers guarantees extended by companies in relation to loans given by its director or related entities .Personal guarantees are thus not covered.
In case of holding-subsidiary relationship, can “accustomed to act” be assumed? No. This being not defined is purely circumstantial and onus is on the person alleging the same to prove If it can be proved that instructions were given consistently and the board of the subsidiary applied such instructions without analyzing the rationale, then ‘accustomed to act’ can be established.
If the director exercises more than 25% of total voting power in LLP and loan is extended to it, will S. 185 be applicable? Yes, by virtue of explanation (d) to S. 185(1). Since, the explanation envisages ‘body corporate’, company incorporated outside India will also be covered.
Learned members views are solicited.