Loan to Directors, etc.

Section 185 of Companies Act, 2013, explains the provisions related to loans or advances to directors or any security provided in connection with any loan taken by him or his relative either directly or indirectly by the company and also the punishment for contravention of the provisions of this section. The main intention behind this section in Companies Act is to ensure that directors who are having a fiduciary position in the Company with respect to shareholders cannot utilize the funds of the Company for their own benefits. However, it is also known that the Shareholders are the ultimate owner of the Company so they have full right to approve the utilization of the funds of the Company in a specified manner in the interest of the Company. Let’s discuss the provisions:

Section 185 (1) says that:

No Company shall directly or indirectly:
  • advance any loan including any loan represented by a book debt, or
  • give any guarantee, or
  • provide any security in connection with any loan taken by:
A B
any director of the company; or Any firm in which any such director is a partner; or
any director of Holding company; or
any partner of any such director; or Any firm in which any relative of such director is a partner.
any relative of any such director; or

Section 2(77) “relative”, with reference to any person, means anyone who is related to another, if—
Members of a HUF

Husband and wife

Father including step father

Mother including step mother

Son including step Son

Son’s wife

Daughter

Daughter Husbands

Brother includes step  Brother

Sister includes step sister

Q- Is it strictly prohibited to advance loans/ guarantee/ security?

Section 185(2) says that:

A company may:
  • advance any loan including any loan represented by a book debt to, or
  • give any guarantee, or
  • provide any security in connection with any loan taken by any person in whom any of the director of the company is interested:

⇓⇓⇓

“any person in whom any of the director of the company is interested” means—
(a) any private company of which any such director is a director or member;
(b) 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
(c) any body corporate, the Board of directors, MD 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.

Q-What is the conditions that to provide a loan to the above three categories person in whom any of the directors of the company is interested??

Condition to follow:

(a) A special resolution is passed by the company in general meeting:

  • The explanatory statement to the notice for the relevant general meeting shall disclose the full particulars of the loans given, or guarantee given or security provided and
  • The purpose for which the loan or guarantee or security is proposed to be utilised by the recipient of the loan or guarantee or security and any other relevant fact; 

(b) The loans are utilised by the borrowing company for its principal business activities.

Section 185(3): Exceptions to Sections 185(1) and 185(2):

It means said provisions shall not apply in case of following situations:

(a) If the giving of any loan to a MD  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; or
(b) If a company 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 such loans an interest is charged at a rate not less than the rate of prevailing yield of 1 year, 3 years, 5 years or 10 years Government security closest to the tenor of the loan; or
(c) any loan made by a holding company to its wholly-owned subsidiary company or any guarantee given or security provided by a holding company in respect of any loan made to its wholly-owned subsidiary company and it is used for principal business activities by the subsidiary company ; or
(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 and it is used for principal business activities by subsidiary company:

Section 185(4): Punishment for Contravention under Section 185:

(i) The Company
  •  Fine: Minimum Rs. 5 Lakhs rupees
  • Fine: Maximum Rs. 25 Lakhs rupees
(ii) Every officer in default
  • Imprisonment: upto 6 months
  • Fine: Minimum Rs. 5 Lakhs rupees
  • Fine: Maximum Rs. 25 Lakhs rupees
(iii) The director or the other person to whom any loan/ guarantee/ security is given or provided.
  • Imprisonment: upto 6 months
  • Fine: Minimum Rs. 5 Lakhs rupees
  • Fine: Maximum Rs. 25 Lakhs rupees or
  •  with Both

EXEMPTIONS TO THE PRIVATE COMPANY

Section 185 of Companies Act 2013 not applicable on the private Company as per exemption notification (notification no. G.S.R 583(E)) dated 5th June 2015: If fulfill following Conditions:
a) In whose share capital no other body corporate has invested any money.
b) If the borrowings of such a company from Banks or financial institutions or anybody corporate is less than twice its paid-up capital or Rs. 50 crores; whichever is lower.
c)  Such Company has no default in repayment of such borrowings subsisting at the time of making transactions.

EXEMPTIONS TO THE GOVERNMENT COMPANY

Section 185 shall not apply to the Government Company if it takes prior approval of concern ministry or department as per Notification No. G.S.R. 463 (E) dated 05th June, 2015.

EXEMPTIONS TO THE NIDHI COMPANY

Section 185 shall not apply to a Nidhi Company as per Notification No. G.S.R. 465(E) dated 05th June, 2015.

Conclusion:

We can determine that the loans, Guarantee and security to the directors and their relatives either directly or indirectly by the company are strictly prohibited under section 185 of the Companies Act, 2013. But there are some exceptions where the shareholders who are ultimate owners of the Company can approve the utilization of the funds of the Company in a specified manner in the interest of the Company and also there are some exemptions to private companies in view to ease of doing business.

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Disclaimer: The contents of this article are for information purposes only and does not constitute an advice or a legal opinion and are personal views of the author. It is based upon relevant law and/or facts available at that point of time and prepared with due accuracy & reliability. Readers are requested to check and refer relevant provisions of statute, latest judicial pronouncements, circulars, clarifications etc before acting on the basis of the above write up.  The possibility of other views on the subject matter cannot be ruled out. By the use of the said information, you agree that Author / TaxGuru is not responsible or liable in any manner for the authenticity, accuracy, completeness, errors or any kind of omissions in this piece of information for any action taken thereof. This is not any kind of advertisement or solicitation of work by a professional.

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Location: DELHI, New Delhi, IN
Member Since: 27 Jun 2020 | Total Posts: 3
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