Interpretation of Loan to Directors (sec 185)- An analysis

Section 185 (1) reads as under –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 director is interested or give any guarantee or provide any security in connection with any loan taken by him or such other person”- This section correspond to section 295 (loan to directors) and section 296 (Application of section 295 to book debts in certain cases) of the erstwhile act i.e 1956 Act.

The provisions of section 185 prohibits from granting any loans, giving of guarantees or providing any security for loans advanced to its directors or any other person in whom the director is interested, except in cases where specific exemptions are stipulated in the section.

Interpretation of the word “ Save as otherwise”-In legal context, Save means except but other than to preserve something from harm, injury, loss, etc. This phrase seeks to keep applicability of any other provision on the same subject unaffected.

The provisions of this section is always under debate and it should be taken note of that it widens to private companies as well irrespective of the erstwhile corresponding section of the 1956 Act which clustered around only public companies.

With the usage of the words “Save as otherwise provided in this Act” doubts are raised as to whether a loan to a director and other person in whom a director is interested may also be made after complying with the provisions of section 186 of the Act, which has been notified with effect from 01/04/2014. It is pertinent to mention here that section 186 of the Companies Act, 2013 corresponds to section 372A of the Companies Act, 1956 and provides for provisions relating to loans and investments made by a company. This section specifically provided exemption to private companies.

Now to get an analysis of it if the usage of the words “save as otherwise provided under this Act”, whether the intent of law is such that coming into force of Section 186 of the Act, loans to director and other person in whom the director is interested may also be made after complying with the provisions of section 186, we need to refer the Rule of harmonious Construction or understanding the intent of legislation- The rule of harmonious construction is the thumb rule to interpretation of any statute. An interpretation which makes the enactment a consistent whole, should be the aim of the courts and a construction which avoids inconsistency or repugnancy between the various sections or parts of the statute should be adopted.

Hence when we apply the Rule of Harmonious Construction to the situation wherein section 185 and section 186 of the Companies Act,2013 exist, if upon exercise of provisions specified under section 186, section 185 is rendered inoperative, then both the sections should be read independently so as to give effect to section 185.

Exemptions as provided in section 185:

First proviso to section 185 provides certain exemptions from the operation of section 185 to certain transactions. These are as follows:

(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

Thus, the company can give loan or advance to its managing director which is in accordance with the terms and conditions of service framed by the company for all its employees and not exclusively for managing or whole time director leaving out all other employees of the company

Secondly, a loan or advance can also be granted to the managing or whole time director pursuant to any scheme approved by the members by a special resolution. Such schemes may include housing loan scheme, education loan scheme, ESOP etc.

(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 loans an interest is charged at a rate not less than the bank rate declared by the Reserve Bank of India.

The Law has also granted exemption to companies which in the ordinary course of its business provides loan or gives guarantee or securities for due repayment of loan with specified interest rate.

It seems that, in order to be within the ordinary course of business, a transaction must adhere to the practices and customs that are considered normal for an industry. It would not be unusual for businesses in the same industry to engage in transactions similar to a transaction under examination. Determining whether something is within the ordinary course of business or not can involve evaluating similar types of businesses and industries to see if they outline any practices for a given profession or industry. Hence, it may be argued that the exemption provisions cannot be construed to cover only Banking Companies or NBFCs in its purview.

Besides above, Rule 10 of the Companies (Meeting of The Board and its powers) Rules, 2014 also exempts loans/advances/guarantee/security made by holding company to its subsidiaries. This Rule exempts following transactions from the requirements of Section 185 of Act-

1. Transactions amongst holding and wholly owned subsidiary company with regard to

a. Any loan made by a holding company to its wholly owned subsidiary company or

b. Any guarantee given or security provided by a holding company in respect of any loan made to its wholly owned subsidiary company, and

2. Transactions amongst holding and subsidiary Company with regard to-

a. Any guarantee given or security provided by a holding company in respect of loan made by any bank or financial institution to its subsidiary Company,

Wherein such loans are utilized by the subsidiary Company (including wholly owned subsidiary) for its principal business activities.

The Ministry of Corporate Affairs vide circular no. 03/2014 dated 14 february,2014 clarified that any guarantee given or security provided by a holding company in respect of loans made by a bank or financial institution to its subsidiary company, exemption as provided in clause (d) of sub-section (8) of section 372A of the Companies Act, 1956 shall be applicable till section 186 of the Companies Act, 2013 is notified. This Clarification was, however, applicable for cases where loans so obtained were exclusively utilized by the subsidiary for its principle business activities.

Fortunately, the new notified rules have now exempted such transactions between the holding company and its subsidiary from the requirements of section 185. The eventual purpose of section 185 is to put additional restrictions on loan to directors only and not on giving of Corporate Guarantee by the holding company to its subsidiary company.

Restricted parties under Section 185:

The section 185 not only restricts loan/advances/guarantee to directors but also covers “to any other person in whom director is interested”- Accordingly for the purposes of this section, the expression “to any other person in whom the 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 such director,

Relative, with reference to a director included any of the following persons [Section 2(77)] of the Act read with list of relatives provided in Rule 4 of the Companies (Specification of definition details) Rules, 2014

i. Members of Hindu Undivided Family

ii. Spouse

iii. Father (including step father)

iv. Mother (including step mother)

v. Son (including step son)

vi. Son’s wife

vii. Daughter

viii. Daughter’s husband

ix. Brother (including step brother)

x. Sister (including step sister)

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 25% of the total voting power may be exercised or controlled by any such director, or by two or more such directors together,or

The term ‘Control’ is defined in section 2(27) of the Act which 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 if any

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.

It appears that all wholly owned subsidiaries would be covered within the purview of this provision for identifying whether or not subsidiaries ( not wholly owned subsidiaries). Some analysis would be required especially for listed subsidiary which have Independent Directors on its Board. Fact here remains that there being no specific yardstick or parameter to address or analyze such issue,this criteria has added much subjectivity to the provision and thus leaving scope for different interpretations. However, the rules have specifically exempted the transactions from the purview of section 185.

Punishment for violation:

Contravention of the provisions of sub section (1) of section 185 leads to:-

a. Fine of Rs 5 lakhs extendable upto 25 lakhs to the company

b. Imprisonment which may extend to 6 months or with fine which shall not be less than 5 lakh rupees but which may extend to 25 lakh rupees or with both to 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 other person

Disclaimer: This is only a knowledge sharing initiative and author does not intend to solicit any business or profession. I assume no responsibility for the consequences of use of such information. In no event shall i be liable for any direct, indirect, special or incidental damage resulting from arising out of or in connection with the use of the information. it is not a professional advice so please do consult your professional adviser for your queries

Disclaimer: This is only a knowledge sharing initiative and author does not intend to solicit any business or profession. I assume no responsibility for the consequences of use of such information.

About the author: Miss Suman Gupta is a Company secretary from Guwahati region of India. She is into whole time employment in a company with a post qualification experience of three plus years. She can be reached out at guptacssuman@gmail.com. Any suggestions or queries can be mailed.