CS Divesh Goyal

 As per Section 185: No Company ( Private & Public)

  • Directly or Indirectrly
  • Advance any loan, including book debt,
  • to any of its directors or to any **other person in whom the director is interested 
  • Any guarantee or provide any security in connection with any loan taken by him or such other person

**TO ANY OTHER PERSON IN WHOM DIRECTOR INTERESTED MEAN :

  1. Any other director of the lending company, or of the holding company of the lending company
  2. Any partner or relative of such director
  3. Any private company of which director is a director or member
  4. Body Corporate in which 25% or more voting power rests with one or more directors
  5. Body Corporate whose Board accustomed to act on directions of BOD or Directors of lending company.

**But after publication of Exemption Notification on Private Limited Companies

(Dated 05.06.2015): (yet to be notified)

The above restriction will now no longer be applicable to the Private Companies which satisfies All The 3 Conditions mentioned below:

  1. In whose share capital no other body corporate has invested any money;
  2. If the borrowings of such a company from banks or financial institutions or any body corporate is less than [lower of (i) Two times of paid up share capital or (ii) Rs. 50 Crore]; and
  3. Such a company has no default in repaymnt of such borrowings subsisting at the time of making transactions under this section.

**But after Companies Amendment Act, 2015,

Provisions of Section 185 will not applicable on followings:

(a) Any loan made by a Holding Company to its Wholly own Subsidiary Company or any guarantee given or security provided by a Holding Company in respect of any loan made to its wholly own subsidiary Company,

(b) 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.

Provided that the loan made under clauses (c) and (d) are utilized by the subsidiary company for its principal business activity.

S. No. QUESTION & ANSWERS
A.        Can Loan given by Holding to Subsidiary?
  Assuming that directors of subsidiary co. (as well as “other persons in whom directors are interested”) do not hold any shares and are not director in holding co, Sec. 185 is not attracted.

MAY NOT COVERED IN

• Clause (c) (for Pvt Ltd co.,only if director is a director or member),

• Clause (d) (only if the director either by himself or two or more such directors hold 25% or more of total voting power in the borrowing company)

• Clause (e) (only if borrowing company /its Board/Directors are accustomed to act as per the Directors of the board/Directors of the lending company.)

KINDLY NOTE THAT TO ATTRACT SEC. 185,

·         Any interest of director (or other person) in his “personal capacity (not holding as nominee of company)” is relevant.

·         Interest of holding co. in subsidiary is not relevant.

B.        Can Loan given by Subsidiary to Holding?
  Assuming that directors of holding co. (as well as “other persons in whom directors are interested”) do not hold any shares and are not director in subsidiary co, Sec. 185 is not attracted.

MAY NOT COVERED IN

• Clause (c) (for Pvt Ltd co.,only if director is a director or member),

• Clause (d) (only if the director either by himself or two or more such directors hold 25% or more of total voting power in the borrowing company,

• Clause (e) (only if borrowing company /its Board/Directors are accustomed to act as per the Directors of the board/Directors of the lending company.

KINDLY NOTE THAT TO ATTRACT SEC. 185,

·         Any interest of director (or other person) in his “personal capacity (not holding as nominee of company)” is relevant.

·         Interest of holding co. in subsidiary is not relevant..

C.        Can Gurantee & Security provide by Holding Company to Subsidiary Company?
  Gurantee & Security can be provide by holding company in respect of Loan made by Bank And Financial Institution to Subsidiary Company.

Condition: Subsidiary use such loan for Principle Business Activity

D.       Non Applicability of Section 185 in case of Wholly Own Subsidiary Company.
  There is no restriction on giving Loan or Guarantees or Security by Holding Company to its Wholly Own Subsidiary (WOS) Company.
E.         Loan given in Ordinary Course of Business.
  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.

Here Ordinary Course of Business means: (Source: A Ramaiya page No. 3308)

i.            Something which is done as a matter of Corporate Historical practice is, as a matter of law, done “in the ordinary course of Business”.

ii.            Whether a transaction has taken place “in the ordinary course business” was a matter to be determined objectively by reference to business practices in the commercial world, the ordinary operational activities of business as a going concern, the past practices of a company and its dealing with creditors.

There is Two Test:

  1. If the company is engaged in lending activities regularity and
  2.  Lend not only to directors/directors’ entities but also to “arms’ length parties/unrelated parties

Hence, All NBFCs may not be engaged in lending activities in Ordinary Course.

K.        Conditions for give loan in Ordinary Course of Business.
  1.      The Lending Company has in the past provided loans/guarantees/securities to such entities as a matter of routine. The frequency of such transactions and a certain amount of continuity is imperative as ‘business’ itself implies carrying on a particular trade or vocation as a ‘continuous’ activity by application of labour, skill and money to earn the income. Also, important is that such transactions have been appropriately disclosed in the financial statements of the Lending Company for the past years.  The disclosure of such transactions in the financial statement indicate that such activities were being carried on normally in the usual course of business, specifically inclusion of the amounts involved as ‘business income’ gives further credence to the fact.

2.      The memorandum of association of the Lending Company allows for such transactions i.e. the providing of loans/guarantees/security to other entities should be part of at least the incidental or ancillary objects of the memorandum of association. The Courts have not been uniform in their ruling with respect to the significance of the objects clause of the memorandum of association in making this assessment. The Courts also differ on whether an activity is in ‘ordinary course’ only if part of the main objects is or whether an activity ancillary to the main objects may also be considered so.

·         The Lending Company has passed a board resolution, specifically, categorizing the transaction as being in ‘ordinary course of businesses. Also, the board should have examined the transaction from the perspective of Section 185 and should have resolved to undertake the same. The consent of all the directors present at the meeting should have been obtained in accordance with Section 186 (5) of the Act. Whether a transaction is in the ‘ordinary course of businesses is a question of fact and a board resolution is important in making this assessment.

F.         What is the planning for sec 185?
1) Convert  both Lender co & receiver co to LLP or

2) Convert other co (to whom loan is given) to public Ltd to enjoy 25% limit or 3) Rearrange shareholding pattern & directorship pattern:

a) Appoint new directors in lender Co, who personally neither hold any share in

Other company nor are directors in other co. If their relatives holds shares or

are directors than there is no problem or

b) One can gift  shares to other relative to rearrange shareholding pattern

G.       How to rearrange shareholding & Directorship pattern as referred in Q-F above?
  Suppose A,B,C,D are 4 members in a family. They have 2 Cos: A Pvt Ltd & C Pvt Ltd.

i) We can appoint A& B as directors of A Pvt Ltd. & gift all shares in name of C & D in A Pvt Ltd to A & B.

ii) We can appoint C& D as directors of C Pvt Ltd  & gift all shares in name of A & B in C Pvt Ltd to C & D.

H.       Is Loan given before 12th Sep, 2013 affected by sec 185?
Existing loan/guarantee/security provided before 12th Sep, 2013 is not affected by above provisions. However, it should not be renewed & should be repaid on due date.
I. Possible Situations for Giving Loan, Guarantee and Security?
  Ø  Giving Loan in 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.

Ø  Change Composition of Board of Borrowing Company: In such a manner that the Director of lending Company are neither the Director nor the shareholder in the Borrowing Company.

Ø  Making Borrowing Company as WOS of Lendig Company.

Ø  Converting Group partnership firms and Private Limited Companies into LLP.

Ø  Converting group private limited company into public limited company and restructuring the Board in such a manner that the voting power of common directors kept below 25% in such Public Limited Company.

K. Punishment for violation of Section 185.
  According to sub-section 2 of Section 185 of the Act, if any loan is advanced or a guarantee or security is given or provided in contravention of the provisions of sub-section (1):

(a) The Company shall be punishable with fine which shall not be less than 5 lakh rupees but which may extend to 25 lakh rupees, and

(b) 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 the other person, shall be punishable with 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.

L.         “to other persons in whom directors are interested”
i. Individual

ii.

a. Director of lending company ;

[ABC Limited has given the loan to A, Director of ABC Limited]

b. Director of a company which is its holding company ;

[PQR Limited is holding company of ABC Ltd, ABC Ltd has given the loan to P, director of PQR Limited]

c. Any partner of any such director ;

[ABC Limited has given the loan to D, Partner in AD Partnership Firm in which A and D are partner and A is also director of ABC Limited]

d. Relative of any such director ;

[ABC Limited has given the loan to E, Relative of Directors of ABC Limited]

iii. Firm

a. In which any such director is a partner;[ABC Limited has given the loan to AD Partnership Firm in which A and D are partners and A is also director of ABC Limited]

b. in which any relative of such director is a partner[ABC Limited has given the loan to DE Partnership Firm in which E and D are partners and E is Relative of director of ABC Limited]

iii. Private Limited Company :

a. of which such director is a director

[ABC Limited has given the loan to XYZ Limited in which A is director of ABC Limited and XYZ Limited i.e. common director]

b. of which such director is a member;

[ABC Limited has given the loan to XYZ Limited, where A is member of XYZ Limited and is also director of ABC Limited]

M.      Definition of “body corporate’’
Body corporate means as defined u/s 2(11) of the act. It is inclusive definition. Section 2(11) of the companies act 2013 defines ’body corporate’ or “corporation” includes a company incorporated outside India, but does not include-

i. a co-operative registered under any law relating to co-operative societies: and

ii. any other body corporate (not being company as defined in this act), which the central government may, by notification, specify in this behalf:

The term “body corporate “is wider than the expression  “company “and is used in several section of  the act to denote not only a company incorporated in India but also a foreign company .it includes a corporation formed under any special law of Indian or a foreign country ,except as expressly excluded by the definition. It includes all public financial institutions mentioned in section 4A of the act as well as  nationalized banks incorporated under section 3(4) of the banking companies (acquisition and transfer of undertaking) Act.1970.  However, it excludes a body corporate, which is not a company under the act and which is specified by the central government in the notification in official gazette.

N.       Is receiving of Share Application and Advance covered u/s 185?
Here is no contravention of sec 185 if share application money/advance for property/goods/services is given to specified person u/s 185. However, private placement provisions have to be complied, if share application money is given on or after 1st April, 2014.
O.       Can company give loan to member of Company?
The Company can give the loan to member of the company subject to not relative of director of the company.
P.         Offence done under Section 185 is compoundable or not?
The offence committed under this section is compoundable in accordance with the provisions of section 441 of the Act.

 IMPORTANT NOTE:

Given of loan in the ordinary course of business.

Any loan advanced or guarantee/security provided by a company, which in its ordinary course of business provides loans or gives guarantees or securities for repayment of any loan, provided that such loans shall not be provided at an interest rate less than the bank rate declared by the Reserve Bank of India. No loan may be given by the Lending Company at an interest rate lower than the prevailing yield of one year, three year, five year or ten year government security closest to the tenor of the loan. The phrase ‘ordinary course of business’ has also not been defined under the Act. This is because there can be no universal meaning ascribed to it. What is ordinary for one entity or one type of business or one sector or even one region may not be so for another.

However, based on judicial precedents and keeping in view the intent and purpose of the provision, a transaction can be said to be in ‘ordinary course of business’, if:

1. The Lending Company has in the past provided loans/guarantees/securities to such entities as a matter of routine. The frequency of such transactions and a certain amount of continuity is imperative as ‘business’ itself implies carrying on a particular trade or vocation as a ‘continuous’ activity by application of labour, skill and money to earn the income.Also, important is that such transactions have been appropriately disclosed in the financial statements of the Lending Company for the past years.

The disclosure of such transactions in the financial statement indicate that such activities were being carried on normally in the usual course of business, specifically inclusion of the amounts involved as ‘business income’ gives further credence to the fact.

2. The memorandum of association of the Lending Company allows for such transactions i.e. the providing of loans/guarantees/security to other entities should be part of at least the incidental or ancillary objects of the memorandum of association.The Courts have not been uniform in their ruling with respect to the significance of the objects clause of the memorandum of association in making this assessment. The Courts also differ on whether an activity is in ‘ordinary course’ only if is part of the main objects or whether an activity ancillary to the main objects may also be considered so

  • The Lending Company has passed a board resolution, specifically, categorizing the transaction as being in ‘ordinary course of businesses. Also, the board should have examined the transaction from the perspective of Section 185 and should have resolved to undertake the same. The consent of all the directors present at the meeting should have been obtained in accordance with Section 186 (5) of the Act.Whether a transaction is in the ‘ordinary course of business’ is a question of fact and a board resolution is important in making this assessment

3. The loan documents/security documents executed for the purpose of the loan/security/guarantee provided by the Lending Company should contain a clause stating that the transaction contemplated therein is in ‘ordinary course of business’.

4. The transaction should be conducted at arms’ length basis and appropriate disclosures should be made with respect to the interest of any management of the Lending Company in the entity receiving the loan, guarantee or security.Ultimately the aim of Section 185 is to prohibit related party transactions where the Lending Company provides undue advantage or gain to any other entity related to the management of the Lending Company and to avoid conflict of interest scenarios for directors of such Lending Company.

5. The Lending Company (not if it is a banking company or an insurance company or a housing finance company providing the loan/security/guarantee in ordinary course of business or company engaged in business of financing of companies or of providing infrastructural facilities should have complied/should comply with the following conditions under Section 186 of the Act:

(Author – CS Divesh Goyal, ACS is a Company Secretary in Practice from Delhi and can be contacted at csdiveshgoyal@gmail.com)

Read Other Articles Written by CS Divesh Goyal

(Republished with amendments)

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2 responses to “Loan to Director – Section 185”

  1. Swamy mohan says:

    will a membership of Director’s HUF in a pvt co. be considered as director’s membership for Sec 185

  2. Aarti Chatakchand Pandey says:

    if a company have common director than do section 185 attract

  3. lekha says:

    Whether a body corporate include a society registered under an act of state government

  4. ketan says:

    Excellant article on sec.185

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