G S Rao

Introduction: Inter corporate loans and investments play a vital role in the growth of Industries since they result in flow of funds to group companies or other companies in need of funds. In the Companies Act, 1956 Section 372-A deals with inter corporate loans and investments. In 1998 to give free hand to industries drastic changes were made by merging section 370 and 372 into a new Section 372-A enabling more flexibility and dispensing with approval of central Government. The Companies Act, 2013(CA2013 or new Act) incorporated Section 186 which deals with loans and investments and corresponds with Section 372-A of the Companies Act, 1956(CA1956 or Old Act). The focus of the article is to compare Section 186 of CA 2013 with Section 372-A of CA1956.

Section 372-A

Section 372-A is one of the most important sections which is be used by every company in the ordinary course of its business. Every company has to plan to deploy its surplus funds in a productive manner and within the legal frame work of Section 372-A. Since Section 186 of CA 2013 has not been notified, Section 372-A applies to Public Limited companies. Let us see the permissions/restrictions imposed by this section.

  1. Applicability: This section is applicable only to public Ltd companies and not to private Ltd companies.
  1. Transactions: Section 372-A is applicable to following type of transactions

–       loans given to another body corporate( Loans include ICDs  and debentures)

–       Guarantees given by the company as a back up for any loan given by any other person to any other body corporate.

–       Investment in shares of another body corporate by way of subscription or by purchase of shares.

  1. Approvals: Unanimous consent of all directors present at the meeting of Board is required for passing a resolution for approving inter corporate loans or investments. Resolution must specify the limits.
  1. Limits: Board of directors can exercise their power for making inter corporate loans or investments up to 60% of paid up capital and free reserves of the company or 100% its free reserves which ever is higher. {Free reserves means for this section, reserves free for distribution as dividends and share premium but excluding shares application money}.  Prior approvals of financial institutions (if any loans are subsisting) if there is default in repayments of interest/installments as per terms. For granting loans or making investments or giving guarantees exceeding the limits permissible for Board, approval of shareholders by a special resolution has to be obtained.
  1. Guarantees in emergency: In case of urgency, guarantees exceeding the limits can be given subject to the condition that such urgent approval is justified and approval of shareholders has to be obtained within 12 months from the date of board meeting or on the date of next AGM held after board meeting which ever is earlier. This relaxation is only to facilitate business transactions in the interests of the company.
  1. Other restrictions:

–       Loans shall not be made at a rate below the prevailing bank lending rate

–       If any default u/s 58-A is committed, Company is prohibited from giving making ICDs and investments/guarantees.

  1. Register of inter corporate loans/investments: A register must be maintained showing the details of ICDs and investments made during the year such name of the body corporate, date and amount of loan/investment/guarantee, purpose, entries have to be made within 7dyas of  making investment or  giving of loan or guarantee
  1. Exemptions: The restrictions of 372-A are not applicable to loans, investments etc  made by

–       A Banking company, insurance or housing financing company, in the ordinary course of their business;

–       Company established with the object of financing industrial enterprises or of providing infrastructural facilities.

–       Company whose principal business is the acquisition of shares, stock, debentures or other securities.

–       Private company unless it is a subsidiary of public Ltd company

–       Investments in wholly owned Subsidiary, Loans made/ guarantees given by a holding company to its wholly owned subsidiary co

–       Investment made in rights shares allotted in pursuance of section 81(1)

Provisions of Section 186:

This section corresponds to section 372-A of Old Act. Having seen the requirements of Section 372-A, let us now analyse Section 186. This section has not been brought into force and as such Section 372-A is to be followed by the companies till this section is notified for compliance.

Significant changes:

  1. Restriction on layers: Firstly this section prohibits investment through more than 2 layers of investment companies. However this restriction is not applicable for investment in company incorporated out side India which has investment subsidiaries beyond two layers as per laws of that country. What is the meaning of layer? Let us find out the reason for this stipulation. If a holding company wants to invest funds, then it can invest directly in another two subsidiaries of it which are investment companies. This restriction is obviously for preventing siphoning of funds through subsidiaries which are investment companies. This could also be for easy tracking of funds and bring out transparency. Whether this restriction applies only for direct investment? Can the investment company create layers? There is some ambiguity and clarifications are expected from MCA in this regard for clear understanding and to avoid violation of the section.{Section 186(1)}
  2. Limits: The same limits as in Section 372-A have been retained for exercising power by the board of directors and prior approval of shareholders is mandatory for any limits beyond 60% of paid up capital + free reserves+ securities premium account  or 100% of free reserve. However this limit not only covers the transactions with bodies corporate but also transactions with any person. This is a significant change. {Section 186(2) and (3)}
  3. Disclosure: This is a new requirement. Section 186(4) stipulates that a disclosure has to be made in the financial statement about the full particulars of loans given, investments made or guarantees or security given and the purpose for which the recipient is going to utilise the loans/guarantees/security. This disclosure ensures good governance and transparency. This change is welcome.
  4. Approvals: There is no change in the manner of seeking approvals for granting of loans or investments. Like in 372-A, unanimous consent of Board of directors for limits up to 60% is required. Prior approval of institutions is required only, if loans are subsisting and default is made in payment of either interest or installments as per terms of loan. Prior approval of shareholders is to be obtained in case company wants to sanction loans/guarantees/investments exceeding the limits fixed for sanction by board of directors. {section 186(5) and 186(3) }
  5. Restriction on companies registered with SEBI:  This is also a new requirement to protect the shareholders interest. The central government may notify such class of companies which will be prohibited from taking inter corporate loans or deposits exceeding the prescribed limit and shall make a disclosure  of loans or deposits taken in its financial statement.{Section 186(6)}
  6. Rate of Interest: There is change in this provision also. The rate of interest on loans given can not be less than the prevailing yield rate on 1 year,3 year, 5 year or 10 year government securities closest to the tenor of the loan.{section 186(7)}
  7. Penalty: The fine for violation of Section 186 has been increased. Fine levied can be  any sum  between Rs.25,000 to 5.00 lakhs on defaulting company  and  every defaulting  officer  can be punished with imprisonment for a term  up to 2 years besides the  fine ranging from Rs.25,000 to 1.00  lakh.
  8. With drawl of exemption: This section is applicable to both private and public Ltd while section 372-A is applicable only to public Ltd companies. Similarly loans given/ Investments made by a holding company in its wholly owned subsidiary also comes under the purview of Section 186 while it is specifically exempted by Section 372-A of CA1956.

Other requirements/restrictions such as maintaining a register of inter corporate deposits/ loans/ guarantees and keeping it open for inspection by any member, exemptions(excepting layers) as mentioned in section   372- A above remain the same.

Clarifications of MCA: On 14th February 2014 MCA issued a clarification vide its General Circular No 03/2014 as section 185 (as this section was notified on 13.09.2013 and comes into force) prohibits giving of guarantees or any security by a holding company for any loans availed by  its subsidiary except in the ordinary course of its business. This circular had clarified that exemption provided by Section 372A is applicable for such transactions. This clarification is surprising. Even without clarification section 372-A is applicable as section 186 has not been notified yet. This clarification however does not resolve the restriction imposed by section 185(Loans to directors) on guarantees to be given by holding company for loan availed by its subsidiary which is an unintended drafting error. Similarly in November, 2013 Circular no.18 of 2013 was issued which clarifies that Section 372-A remains in force till section 186 is notified.

Conclusion: There is always an apprehension that the flexibility given by Section 372-A or Section 186 for loans or investments can be misused to siphon of funds. The law makers must have obviously kept in mind some fraud cases wherein inter corporate investments and loans are used as a tool for siphoning of funds to group companies or director related firms or companies. This apprehension may be the reason for bringing in restriction on layers of investment. Let us hope that other sections in the new act too act as checks and balances for preventing misuse of position of directors

G S Rao, Consultant

Source: Companies Act, 2013, Companies Act,1956, Circulars issued by MCA

Tags: The Companies Act, 2013, Loans and investments, inter corporate loans and investment

Author- G S Rao, Deputy General Manager (Legal) OCL India Limited, Email –   gsrao@ocl.in

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  1. ca s s agarwal says:

    can u please update the above article in the light of recent notification as well as other amendment after 22nd march 2014

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