Mr. Chintan Mehuriya & Ms. Jaya Sharma-Singhania

mr-chintan-mehuriya-mrs-jaya-sharma-singhania

INTRODUCTION:

The section 185 of Companies Act, 2013 was notified on 12 September, 2013 and was applicable from that day itself.  If there is any deviation from the conditions laid under this section then the Auditor is required to report the same in his Audit Report.  A non-qualified report would hold auditor in default.

The lending company and the receiver both would be liable for the penalty under the same section.

Now let us understand the basic of section 185 and 186.

Section 185:- This primarily deals with the subject of person to whom company cannot give loan.

Section 186:- This section enlists the exceptions and specifies the limits up to which a company can give loan.

The provisions of Section 185 of the Companies Act, 2013 which corresponds to Section 295 of the Companies Act, 1956 provides that:-

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Section 185(1) provides that save as otherwise provided in the Companies Act, 2013, no Company directly or indirectly shall:-

(a) Advance any loan; or

(b) Any loan represented by a book debt;   or

(c) Give any guarantee; or

(d) Provide any security in connection with any loan taken

 To any director of the company or such other person in whom the director is interested.

The Section 185(1) undoubtedly restrict giving of loan and other facilities to a Director of the company and further says “to any other person in whom the director is interested”. The Explanation to Section 185(1) further explain the meaning of expression “to any other person in whom director is interested” means: –

(a) Any director of the lending company, or

(b) Director of a company which is its holding company; or

(c) Any relative or partner of any such director; or

(d) Any firm in which any such director or his relative of such director is a partner; or

(e) Any private company of which any such director is a director or member;

(F) 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

(g) Anybody 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 if any director or directors, of the lending company.

SECTIONS & RULES INVOLVED:

Section 177 (4) (v) Every Audit Committee shall scrutiny of inter-corporate loans and investments.
Section 179(3) (e) The Board of Directors of a company shall exercise the power to invest the funds of the company by means of resolutions passed at meetings of the Board.
Section 185 Loan to any of its directors or to any other person in whom the director is interested
Section 186 Loan and Investment by Company
Rule 8 of the Companies (Meetings of Board and its Powers) Rules, 2014.
Rule 10 of the Companies (Meetings of Board and its Powers) Rules, 2014.
Rules 11, 12 and 13 of the Companies (Meetings of Board and its Powers) Rules, 2014

APPLICABILITY:

Earlier Section 185 was applicable to both public as well as private companies but after exemption notifications issued by Ministry of Corporate Affairs (MCA), dated 05.06.2015, Private Companies Sec-2(68), Government CompaniesSec-2(45) and Nidhi Companies Sec- 406(1) have been exempted from this section bringing it at par with the Section 295 of Companies Act, 1956 which exempted private companies.

Exemption to Private Companies:

Section 185 shall not apply to a private company-

a) in whose share capital no other body corporate has invested;

b) if the borrowings of such a company from banks or financial institutions or anybody corporate is less than twice of its paid up share capital or fifty crore rupees, whichever is lower; and

c) Such a company has no default in repayment of such borrowings subsisting at the time of making transactions under this section.

Exemption to Government Company:

Section 185 shall not apply to a Government company if such Company obtains approval of the Ministry or Department of the Central Government which is administratively in charge of the company, or, as the case may be, the State Government before making any loan or giving any guarantee or providing any security under the section.

Exemption to Nidhi Company:

Section 185 shall not apply to a Nidhi Company in which the loan is given to a director or his relative in their capacity as members and such transaction is disclosed in the annual accounts by a note.

What is the meaning of Direct or Indirect?

Now, we will have to understand the meaning of “direct or indirect” loan in the light of various judicial pronouncements.  The “indirect loans” will connote that the company shall not give loan through the mode of one or more intermediaries.  However, the word ‘indirectly’ cannot be read as converting what is not a loan into a loan.  Hence, the amount given must be strictly a loan and a debt, which is not in the nature of loan, cannot be said to be the case of an indirect loan.

WHAT IS MEANT BY “LOAN”:

In view of the importance and significance of this topic, it is absolutely necessary to understand the precise and concise meaning of word “loan” – in view of the serious implications in the event of violation of the provisions of the Act. The Section 2 of Companies Act, 2013, does not define “loan”. A loan is defined by the Oxford English Dictionary as ” a thing lent; something the use of which is allowed for a time, on the understanding that it shall be returned or an equivalent given, a sum of money lent on these conditions and usually with interest.”

  • The Hon’ble Supreme Court in the case of Shree Ram Mills Ltd Vs. Commissioner of Excess Profit Tax, MANU/SC/0054/1954 = AIR 1953 SC 485 has defined the word “Loan” in the following words:-

At bottom this is a question of fact. Of course, money so, left could, by a proper agreement between the parties, be converted into a loan, but in the absence of an agreement mere inaction on the part of the managing agents cannot convert the money due to them, and not withdrawn, into a loan. A loan imports a positive act of lending coupled with an acceptance by the other side of the money as a loan.

The relationship of borrower and lender cannot ordinarily come about by mere inaction. The clause in the Articles of Agreement quoted above was relied on for the purpose of showing that there was such an agreement in the case. We are unable to construe the provisions in that way. They merely give the managing agents a right to receive their commission at a certain time. If the money is not paid in time it lies with the assesse as a debt due to the agents

  • The Calcutta High Court in the case of Saradindu Sekhar Banerjee Vs. Lalit Mohan MANU/WB/0045/1941 = AIR 1941 Cal. 538

It is contended on behalf of the appellant that the appellant is entitled to the benefit of the Bengal Money-lenders Act, 1940. That Act deals with money-lending and money-lenders. Leaving the purchase money unpaid is leaving a debt unpaid. Every loan is a debt but every debt is not a loan. The purchase money due to the plaintiff is a debt due to the plaintiff but is not a loan or a transaction which is in substance a loan.

  • The Division Bench of Allahabad High Court in the case of M/s Laxmi & Co. Vs. Commissioner Of Income Tax MANU/UP/0063/1960=AIR 1960 ALL. 278

The actual nature of the transaction was the supply of goods on credit to the assessee by Messrs J. K. Kothi and thereupon the assessee accepted the liability to pay the price of those goods to Messrs J. K. Kothi in future together with interest on that amount of price. Such a transaction could not be a transaction of loan and no question of borrowing of money arose.

WHAT IS THE MEANING OF WORD “ADVANCE”?

The Hon’ble Madras High Court in the case of KM. Mohammed Abdul Kadir Rowther vs. S. Muthia Chettiar MANU/TN/0424/1959 that advance means literally a payment beforehand.  In certain cases, it may be a loan but it cannot be said that a sum paid by way of advance is necessarily a loan.

EXEMPTED LOAN:

The following types of loans are exempt and shall fall outside the purview of Section 185 of the Act. The proviso to Section 185(1) provides that nothing contained in this sub-section shall apply to

(a) the giving of any loan to a managing or whole-time director

(b) as a part of the conditions of service extended by the Company to all its employees; Loan could be any of the following nature:-

a) Housing Loan

b) Soft Furnishing loan

c) Education loan

d) Religious, Social, Traditional & Customary ceremonies and functions.

e) Vehicle loan

f) hard furnishing loan

g) Marriage loan

h) Loan against Foreign Visits

If the proposed loan is not covered as a part of conditions of services,  the company may, by passing a board resolution, amend the service conditions and uniformally and provide for giving of loan to all employees subject such approval either by Board or its Committee thereof;

Pursuant to any scheme approved by the members by a Special Resolution; or under this head, if the proposed loan is not covered as a part of conditions of service, then the company may formulate “Scheme” to cover giving loan under any of the above “Head” but, of course, such Scheme must be approved by way of Special Resolution.

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.  A question arises as to what is the meaning of the word “in the ordinary course of its business” in relation to loan

Exemptions to the holding company for its wholly owned subsidiary company –

Clause (c) provides that;

(a) Any loan made; or

(b) Any guarantee given; or

(c) Any security provided;

By a holding company in respect of any loan made to its wholly owned subsidiary company is exempted from the requirements under Section 185 of the Companies Act, 2013 provided, however, such loans are utilized by the subsidiary company for its principle business activities.

Exemptions to the holding company for its subsidiary company:-

Clause (d) provides that;

(a) Any guarantee given; or

(b) Security provided;

By a holding company in respect of loan made by any bank or financial institution to its subsidiary company is exempted from the requirements under Section 185 provided, however, such loans are utilized by the subsidiary company for its principle business activities.

In other words, the subsidiary company, in turn, cannot give loan (out of the above loan) but can use the loan for its main or predominant or principal business activities.  However, any company, side by side, can have more than one principal business activities – in other words multi- disciplinary or multi-product or multi-purpose company.   In my view, the law nowhere says that there can be only one principal business activity.

Rule 10 of the Companies (Meetings of Board and its Powers) Rules, 2014 also provided the exemptions in relation to transactions by the holding company with its subsidiary company, but the same is OMITTED as per Notification dated December 14, 2015.

The Ministry has received a number of references seeking clarification on the applicability of provisions of section 186 of the Companies Act, 2013 relating to grant of loans and advances by Companies to their employees. The issue has been examined and it is hereby clarified that loans and/or advances made by the companies to their employees, other than the managing or whole time directors (which is governed by section 185) are not governed by the requirements of Section 186 of the Companies Act, 2013. This clarification will, however, be applicable if such loans/advances are in accordance with the conditions of service and the remuneration policy.

Section 185

PENALTY FOR CONTRAVENTION:

The Section 185(2) provides that if any loan is advanced or a guarantee or security is given or provided in contravention of the provisions of section 185(1), the company shall be punishable with fine which shall not be less than Rs. 5 lakhs but which may extend to Rs. 25 lakhs, 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 6 months or with fine which shall not be less than Rs. 5 lakhs but which may extend to Rs. 25 lakh, or with both.

Under the new dispensation of Section 185, the provisions have been more rigorous.  The Ministry has also taken a supporting step by giving exemptions to Government Companies, Nidhi Companies and Private Companies complying with certain conditions. It would be useful for the trade and industry as private companies are more or less in the nature of family company.

TO ELABORATE THIS WITH AN EXAMPLE:

Say a Company manufactures Computer. One of the Directors of the Company is setting up an Office for which he will also need to buy Computer. The director in the erstwhile situation (when section 185 was not applicable) could have taken a loan from the Company for buying the same. But in the present situation, since he is not able to take that loan, he asks the Company to give him 20 Computers for a long credit period. If the credit period extended by the Company is as per the normal period and in the normal terms and conditions, as extended to its other buyers, then there is no problem but as soon as it is biased and tilted to give undue benefit to the director and/or other person in whom the director is interested, then such transaction will be considered to be loan.

QUICK SNAPSHOT OF THE SECTION 185:

Applicability All Companies subject to exemptions available to government, private and nidhi companies vide notification  dated 5  June 2015
Key points for granting loan to directors 1. Company cannot give loan to director or any other person in which director is interested.

2. Transactions permissible u/s  185:-

  • Loan to MD/ WTD, as part of conditions of service extended by the company to all its employees, or pursuant to any scheme approved by the members by a special resolution.
  • Loan given by the company in the ordinary course of its business of providing loans or guarantees at a rate of interest not less than the RBI bank rate.
  • Any loan made by a holding company to its wholly owned subsidiaries.
  • Any guarantee given or security provided by a holding company to its subsidiaries.
  • Any loan made or guarantee given or security provided by a private company to a director or to any entity or the person in which the director is interested if such private company meets the following exemption vide notification no. G.S.R. 434(E) dated 5th June 2015 i.e. a private company:-
    • in whose  share capital  no other body  corporate has invested any money;
    • if the borrowings of such a company from banks or financial  institutions or any body corporate is less than twice its paid up share capital or fifty crore rupees, whichever is lower; and
    • Such a company has no default in repayment of such borrowings subsisting at the time of making transactions under this section.
Applicable register Register of Loan, Guarantee, security and acquisition made by the company in MBP-2 for given to MD/WTD.
Penalty u/s 185 (2) Company: Fine of Rs. 5 Lakh to Rs. 25 Lakh

Director or the other person to whom any loan is advanced or guarantee or security is given or provided in connection with any loan tken by him or the other person: Imprisonment up to 6 months or with fine of Rs. 5 Lakh up to Rs. 25 Lakh, or with both.

CONCLUSION:

It may be appreciated that restrictions apply only at the time of entering into the transaction. For example, if a person is only an employee of the company and later on, he becomes a director of the said company, Section 185, would not be attracted as he does not fall within list of those persons with whom contract is restricted.

BIBLIOGRAPHY:

www.mca.gov.in

www.indiafiling.com

www.thecompaniesact2013.in

www.icsi.edu

CONTRIBUTED BY:

Ms. Jaya Sharma-Singhania

Mr. Chintan Mehuriya

(M/s. Jaya Sharma & Associates, Practicing Company Secretary, Mumbai)

Disclaimer

The entire contents of this article have been prepared on the basis of relevant provisions and as per the information existing at the time of the preparation. Although care has been taken to ensure the accuracy, completeness and reliability of the information provided, I assume no responsibility therefore. Users of this information are expected to refer to the relevant existing provisions of applicable Laws. The user of the information agrees that the information is not a professional advice and is subject to change without notice. We assume no responsibility for the consequences of use of such information. IN NO EVENT SHALL WE SHALL BE LIABLE FOR ANY DIRECT, INDIRECT, SPECIAL OR INCIDENTAL DAMAGE RESULTING FROM, ARISING OUT OF OR IN CONNECTION WITH THE USE OF THE INFORMATION. This is only a knowledge sharing initiative and author do not intend to solicit any business or profession.

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One Comment

  1. Veena says:

    Hello. Companies Rules 2014 omitted rule 10. Does that mean a holding company is prohibited from making loans/gurantees & securities to its wholly owned subsidiary also?

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