Confused Regarding Legal Position of Intercorporate Loans (In Respect of Sec 185 and 186 of Companies Act 2013 (As Amended)) – Read This!!

Inter-corporate loans and investments are important sources of funds for every company. The 2013 Act contains stringent provisions for providing loans to directors and companies in which directors are interested. Additionally, it provides guidance on loans, securities, and guarantees given to subsidiaries. Companies can also make investments in other entities as per Section 186 of the 2013 Act.

(A) Restriction on loans to directors by a company (Section 185 of the 2013 Act)

A company cannot advance any loan, including loan represented by a book debt, directly or indirectly to any of its directors. Such a restriction also extends to any guarantee given or security provided in connection with a loan. However, in certain situations, companies are allowed to advance loan or provide guarantee/security.

In other words, as per the amended provisions, such advancement of any loan or guarantee or security is partly prohibitive and partly restrictive. The section continues to prohibit the granting of loan/guarantee/security to some, while restricts the others in the following way:

(a) Prohibitive to:

– Directors of the company, or

– Directors of a company which is its holding co.; or

– Any partner of such director; or

– Relative of such director.

(b) Restrictive to:

– Any private co. of which any such director is a director or member;

– 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;

– Any body corporate, the BoD, MD or manager, whereof is accustomed to act in accordance with the directions or instructions of the BoD, or of any director or directors, of the lending company.

The amended provisions allow the companies to grant loans/guarantees/securities to entities in which directors are interested, in the above mentioned restrictive cases, subject to prior approval of the shareholders by a special resolution and on the condition that such loans are utilized by the borrower for its principal business activities.

Further, as per the provision of the amended law, the explanatory statement to the notice of the general meeting is required to disclose the full details of the loan/guarantee/security given.

Further, loans extended to persons, including subsidiaries, falling within the restrictive purview of Section 185 should be used by the subsidiary for its principal business activity only, and not for further investment or grant of loan.

(B) Special Exemption To Private Companies

The amended section 185 seeks to completely replace the existing provisions of section 185 of Companies Act, 2013. However, the exemption notification dated June 5, 2015, shall continue to hold good and the amended provisions of section 185 shall be not applicable to private companies subject to the conditions prescribed in the notification.

As per the notification, the provisions of Section 185 shall not apply to a private company –

  1. in whose share capital, no other body corporate has invested any money.
  2. Its borrowings from banks/financial institutions/ any body corporate is less than twice of its paid-up share capital or INR 50 crore, whichever is lower
  3. No default in repayment of such borrowings subsists at the time of making transactions under Section 185 of the 2013 Act.

(C) Other Exemptions from Section 185 shall stand unchanged (minor changes are in italics), which are as follows:

(a) Loans to Managing Director or Whole Time Director, subject to conditions

(i)   As a part of conditions of service or

(ii)  By passing a special resolution.

(b) Loan advanced in the ordinary course of the business and in respect of such loans an interest is charged at a rate not less than the rate of prevailing yield of one year, three years, five years or ten years Government security closest to the tenor of the loan.

{As per the Report of the Companies Law Committee 2016, the rate of interest for loans granted under section 185 was proposed to be aligned with section 186(7). Further, the report also suggested that it may not be appropriate to apply Indian interest rates benchmarks prescribed under section 186(7) to loans given by companies to foreign entities and the effective yield against the loan given, irrespective of whether the loan is given to a company incorporated outside India should not be less than the prescribed rate under section 186(7)}

(c) Loan made (or any guarantee or security) by holding company to its WHOLLY OWNED subsidiary.

(d)  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

(D) Extension of the penal provisions:

The amended section 185 has extended the penal provisions to an officer of the company, which has been defined in section 2 (59) to include any director, manager or key managerial personnel or any person in accordance with whose directions or instructions the Board of Directors or any one or more of the directors is or are accustomed to act. Therefore, the ambit of the penal provision has been widely extended.

(E) Let’s have a look on the provisions of sec-186 of the Companies Act – 2013

(I) Limits for Loan/Guarantee/Security/Investments (Sec-186(2)):-

According to the provisions of sec-186(2) of the Companies Act 2013, No company shall directly or indirectly,

(a) Give any loan to any person or any other body corporate;

(b) Give guarantee or provide any security to a person or other body corporate or

(c) Make any investment in the securities of any other body corporate, exceeding-

√ 60% of its Paid-up Share Capital + Free reserves + Securities Premium Account;

OR

√ 100% of its free reserves + Securities Premium Account;

Whichever is more? 

The amended provision clearly excludes employees of the company from the term ‘person’ to whom a company cannot directly or indirectly give loans exceeding the prescribed threshold. The same was clarified by the Ministry vide it’s General Circular [3] dated 10th March 2015. However, the said Circular provided two conditions for such exclusion i.e. the loan being given should be in terms of service policy of the company along with the same being in terms of remuneration policy of the company – these conditions are no more applicable, as the provision directly excludes employees from the term ‘person’

(II) A Company can give loan, guarantee or provide any security or make any investment beyond the limits specified u/s 186(2), subject to prior approval of members by a special resolution passed in a general meeting.

{As per the amended provisions the shareholders’ approval will not be required where a loan or guarantee is given or where a security has been provided by a company to its: wholly owned subsidiary company or a joint venture company, or acquisition is made by a holding company, by way of subscription, purchase or otherwise of, the securities of its wholly-owned subsidiary company. The exemption will increase the investing power of the company.}

(III) Rate of Interest (Sec-186(7)):-

No loan shall be given at a rate of interest lower than the prevailing yield of one year, three years, five years or ten years Government Security closest to the tenor of the loan. In other words, Interest-free loans to any person or body corporate will be a contravention of the provisions of section 186 of the Companies Act 2013. 

(IV) No Loan by Defaulter Company (Sec-186(8)):-

A company, who has committed any default in repayment of any deposits accepted before or after the commencement of this Act or in payment of interest thereon, shall not give any loan or give any guarantee or provide any security or make investments till such default is subsisting.

(V) Register of Loan (Sec- 186(9) & (10)):-

According to the provisions of sec – 186(9) of the Companies Act 2013, shall keep and maintain a register, in Form MBP 2, which shall contain particulars of loan or guarantee is given or security provided or investment made, (either manually or in electronic form) shall be authenticated by the company secretary of the company or by any other person authorized by the Board for the purpose, at registered office of the company.

(VI) Transactions exempt from the requirements of Section 186 under the Companies (Amendment) Act, 2017

The provisions of Section 186 of the 2013 Act (except restriction on layers of investment companies) do not apply to the following situations:

  1. Loan/guarantee/security/investment made by a banking company or an insurance company or a housing finance company in the ordinary course of its business or by a company established with the object of and engaged in the business of financing of industrial enterprises or of providing infrastructural facilities
  2. Any investment made:

i. By an investment company

ii. In shares allotted in pursuance of Section 62(1)(a) or in shares allotted in pursuance of rights issues made by a body corporate

iii. In respect of investment or lending activities, by a NBFC registered under Chapter III-B of the RBI Act, 1934 and whose principal business is an acquisition of securities.

(F) Requirements prescribed under the Listing Regulations

Listing Regulations do not contain specific provisions on inter-corporate loans/investments or loans to directors. However, they prescribe the following requirements in relation to loans and investments by companies:

  • Review of loans by the audit committee (Part C of Schedule II): The role of the audit committee, inter alia, includes scrutiny of inter-corporate loans and investments.
  • Information to be placed before BoD (Part A of Schedule II): Minimum information required to be placed before the BoD of a listed entity would, inter alia, include the sale of investments by the entity.
  • Disclosure in the annual report (Schedule V): Annual report of every debt and equity listed entity (except listed banks) would, inter alia, disclose the following with respect to amounts at the year-end and the maximum amount of loans/advances/investments outstanding during the year:

– In the case of holding entity: Loans and advances in the nature of loans to subsidiaries/associates and firms/companies in which directors are interested in name and amount.

Additional disclosure of investments by the loanee in the shares of parent entity and subsidiary, when the entity has made a loan or advance in the nature of the loan.

– In the case of the subsidiary: Same disclosures as applicable to the parent entity in the accounts of a subsidiary entity.

(G) Other Points to Remember

  1. The exemption of the non-applicability of the provision of section 186 (except the provision relating to restriction on layers of subsidiaries) has been extended to a rights issue made by a body corporate especially to include foreign companies.
  2.  In the case of Government Company – Section 186 shall not apply to:-

(a) a Government company engaged in defense production;

(b) a Government company, other than a listed company, in case 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 or making any investment under the section.  – Notification dated 5th June 2015.

  1. In the case of Section 8 Company– In Sub-section (7) of Section 186, the following shall be inserted namely: – Notification Dated 13th June 2017.

Provided that nothing contained in this sub-section shall apply to a company in which twenty-six percent. Or more of the paid-up share capital is held by the Central Government or one or more State Governments or both, in respect of loans provided by such company for funding Industrial Research and Development projects in furtherance objects as stated in its memorandum of association.”

Note: The write up has been prepared for educational purposes, to give clarity regarding the effective changes being made in the above provisions relating to Inter-corporate loans and advances.

For any valuable comments and feedback, kindly write to us at camridulgupta0709@gmail.com.

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