If economic activity and growth are analogous to a wheel, then provisions of section 185 and 188 of the Companies Act, 2013 are surely analogous to disc brakes!!!
Efficiency of production requires efficient choice and free movement of resources. Ideally, economic models assume complete mobility of resources and perfect competition throughout the world, both of which are far away from real world scenario. The new law has been framed with all the good intentions. But if the mechanism is not efficient, right things can have wrong consequences.
Resources include tangible, intangible, moveable, immovable and monetary resources. While section 188 takes care of the tangible, intangible, moveable and immovable resource movement, section 185 and 186 takes care of the monetary counterpart.
Section 188 has been a regulatory scare crow since its inception. The coverage of section 188 extends to sale, purchase and supply of goods and materials, property of any kind, lease transactions, services, appointment of agents, underwriting contracts and appointment to office or place of profit.
The coverage of section 185 extends to loans, guarantees and securities. It restricts loans, guarantees and securities to a director(s) as well as entities falling within certain radius of the director(s) like directors of lending company, holding company, relative or partner of director of such lending or holding company, any firm where the director or his relative is partner, any private company where such director is a director or member, body corporate where such director singly or jointly with other director(s) hold 25% or more voting power or the Board of which is accustomed to act in accordance with the Director or the lending company.
While section 185 is a restrictive section, section 186 is an enabling section. Companies can lend, provide guarantee or security subject to the limits of and in compliance with section 186. Section 185 has a choking effect on the movement of intra-group funds. The exemption notification allows conditional exemption to private companies on the basis of share capital having no corporate investment, borrowing being less than lower of Rs. 50 Cr. or twice the paid up capital and clean repayment record. However, three simultaneous conditions render the exemption look good on paper only.
The exemptions granted to private companies by MCA Notification dated June 5, 2015 takes contacts of private companies with its holding, associate, subsidiary and with fellow subsidiaries out of the purview of section 188. Additionally, the said exemption permits participation of interested directors in Board proceedings subject to disclosure of their interest. Further, related parties can vote in general meetings too!
Third proviso to Section 188(1) states that the sub-section shall not apply to transactions which are in the ordinary course of business as well as on arm’s length basis. While ordinary course of business may be interpreted to mean transactions that the company undertakes on regular and frequent basis, what is to be considered “arm’s length” has been left untouched which creates confusion and apprehensions of future trouble.
Consider the case of two defence manufacturers jointly acquiring a steel plant for captive consumption. If steel was to be bought from the market the input cost would be much higher for both. Now every time there is transfer of steel from the steel unit to the defence production unit, elaborate RPT rituals need to be undertaken. The only way out would be to get a wholly owned subsidiary which is permitted but may not be economically feasible or efficient.
There was a stark similarity between Indian politics and RPT provisions: Majority of minority. A significant change has come as the amendment to section 188 replacing “special resolution” by “ordinary resolution”.