An India Private Limited Company (The Company) has advanced certain amounts to one of its subsidiary namely “S Private Limited”
The Company had planned to acquire 100% stake in the subsidiary vide Share purchase agreement from the shareholders of the subsidiary.
Pursuant to the above planned purchase of shares in the subsidiary, the Company had nominated its two directors as additional directors in the subsidiary which resulted in having common directors in both the companies.
The Company also had the responsibility of running the operations of the subsidiary and for this purpose it had appointed the employees in the Subsidiary for the same. Further, to run the subsidiary company, the Company also advanced certain amounts to the subsidiary for running the operations smoothly and shown as advance in the Balance Sheet of Subsidiary Company.
Later on, there were disputes amongst the then shareholders of the subsidiary and the Company on certain matters and the company could not complete the 100% stake in the subsidiary. Due to the disputes, the Company could not recover the amounts advanced earlier and also the investment in the subsidiary. Accordingly, various legal suits were filed in the court of law.
As the Company had hired employees for the subsidiary, the Company kept on paying the salary of the staff and showed the same as advances recoverable from the subsidiary company.
Finally, the Company and the then shareholders of the subsidiary has entered into a settlement agreement in the year 2015-16 and settled the entire claim of the Company via one time full and final settlement which included investment, loans and advances etc.
The Company wants to understand whether the above said advances given attracts the provisions of Section 185 and 186 of the Companies Act, 2013 or not.
Relevant provisions regarding providing of Loan to Directors, etc
Section 185(1) of the Companies Act, 2013 provides that 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:
Explanation.—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.
The company affianced to appoint two of its directors in the Subsidiary vide its Share Purchase, ergo both having common directors.
The pre requisite for the applicability of the provisions of Sub section 1 of Section 185 of the Companies Act, 2013 is whether the company has advanced loan to any of its directors or to any other person in whom the director is interested.
As per the terms and conditions stipulated in the covenant, the company had advanced certain amounts to the subsidiary for meeting the operational expenses. This amount of money cannot be construed to be loan to the directors of the company or any other person in whom the director is interested as the incumbents did not hold any prior interest at the time of advancing the loan, but were appointed only to fullfil the requirement of the Agreement as nominee of acquirer, thus is not repugnant to the above provisions.
Further in view of the serious implications in the event of violation of the provisions of section 185 it is absolutely necessary to understand the precise and concise meaning of word “loan” and “Advances”;
Loan has not been defined under Companies Act, 2013. Therefore we have to rely on the dictionary meaning of the term “Loan” and judicial clarification in this regard. As per dictionary meaning, loan is a sum of money or other valuables or consideration that an individual, group or other legal entity borrows from another individual, group or legal entity with the condition that it be returned or repaid at a later date with or without 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 Calcutta High Court in the case of Saradindu Sekhar Banerjee Vs. Lalit Mohan MANU/WB/0045/1941, AIR 1941 Cal. 538 Every loan is a debt but every debt is not a loan.
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.
The Hon’ble Privy Council in the case of Raja of Venkatagiri vs. Krishnayya Rao Bahadur MANU/PR/0017/1948 : AIR 1948 PC 150 at p. 155, has observed that ordinarily advance does not connote any idea of repayment is, hence loan is completely different from an advance as is understood in the common parlance in the sense of payment of money beforehand and which is likely to become due at some future time.
In the judgement passed by Madras High Court in K.M. Mohamad Abdul Kadir Rowther vs S. Muthiah Chettiar on 5 August, 1959, it was contended that, the advance were not to be considered as a loan, the amount was intended to be recovered, and that, therefore an obligation to repay the sum should be inferred; there being thus an obligation to repay a personal liability would subsist. The learned advocate for the appellant urged that the word ‘Advance’ itself would imply a loan. ‘Advance’ means literally a payment before hand; 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, this decision was based on London Financial Association v. Kelk L.R. (1884) 26 Ch. D. 107, where it was observed, that the words-‘advancing’ and ‘lending’ each have a different significance, the money might be ‘advanced’ without being ‘lent’.
Whether section 185 is talking about loan or advance or both?
Section 185(1) of the Companies Act, 2013 inter-alia provides that 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
Here words “advance any loan” are used, it is not used as “advance or loan/advance and loan”, and hence the word “advance any loan shall be read together and word advance is a verb and loan is a noun, accordingly “advance any loan” means to give any loan This section is not at all include the words ‘Advance’ as noun which means paying something in advance before it is actually due.
It is pertinent to refer to the case of Pennwalt India Ltd. v. RoC , wherein the Hon’ble High Court of Bombay has held that to ascertain whether a transaction is a loan or not, surrounding circumstances, relationship and character of the transaction and the manner in which parties treated the transactions will have to be considered. Hence, with reference to each transaction with Directors and other person in whom the Directors are interested; the nature of transactions has to be studied.
Purpose of Section 185:
It seems that legislature was intended to prohibit the flow of funds from the company to its directors or other persons in whom the Director is interested, more emphasis is likely to be laid on the fiduciary duty of the Directors and for such reason the loans, etc. to Directors and other specified person are prohibited. It simply means that a director shall not be enriched at the funds of the Company.
This provision is to curb the misuse of the powers by directors, whereby they do not use their fiduciary powers for self-benefit, and move the funds of the company away to their personal pocket directly or through any intermediaries.
Although the terms “loans and advances” are used together and in common parlance deemed to be synonyms of each other but in view of various judicial decision as illustrated above “Loan” and “Advance” both are two different words carrying independent meaning. In the given case the acquirer has given advances to its subsidiary company during the course of acquisition of 100% shares in accordance with Share Purchase for business purpose and to meet day to day running expenses and salary requirement of the employees appointed by the acquirer. It seems that neither it was intended by the acquirer to “advance any loan” nor has been reflected in the balance sheet of the target company the said amount as loan and we presume that the said amount has been shown as advance under sub head advance under the head “Loan and Advance”.
Whether there is any direct or indirect personal interest of Directors concerned?
There is no question of personal interest of directors where the Holding Company advance supports to its subsidiary company which was undergoing the course 100% acquisition. If it is not wrong to have subsidiaries, it cannot be said to be wrong to support subsidiaries. If the subsidiary does well, it augments the asset value of the holding company, therefore, the well-being of the subsidiaries is the well-being of the holding company. If the directors of the company are helping the subsidiaries, they are helping the business of the company, which is the very purpose for which they exist. Further in the given case the subsidiary company was under the process to become 100% subsidiary of the acquirer company in accordance with share purchase agreement and in pursuance of that the acquirer has already acquired 51% of shares of the target company as first trench acquisition and appointed two of its directors as its nominee directors in the subsidiary company as mandated in Share Holders Agreement and Share Purchase Agreement. Merely because of directorship in the subsidiary as the nominee of the holding company, such advance could not be treated as indirect loan to such Directors.
Meaning of Direct & Indirectly:
When section 185 is also talking about indirect loan, in the light of various judicial pronouncements illustrated above “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, which is not in the nature of loan, cannot be said to be the case of an indirect loan.
Section 186(vii)- Loan and Investment by Company provides that no loan shall be given under this section at a rate of interest lower than the prevailing yield of one year, three year, five year or ten year Government Security closest to the tenor of the loan.
An advance is not loan as discussed above hence there is no question of applicability of section 186(iii) Although the terms “loans and advances” are used together and in common parlance deemed to be synonyms of each other but as per various judicial decisions there is a clear line of demarcation between the two terms. Further nature and purpose of transaction of the current case do not resemble with that of loan.
Therefore in light of the above observations and examination of the provisions of the Companies Act, 2013 and the rules framed there under and various judicial decisions cited above, we are of the opinion that the company has not contravened any provisions of Section 185 or Section 186.
(Author: CS Ravi Bhushan Kumar is Partner with SR & Associates, Noida)