Loans to Director under Section 185

Since the enactment of the Companies Act 2013, Section 185 of Companies Act, 2013 was seen as unacceptable by companies across India because it was not in consonance with company laws in other countries where such transactions are either permitted or restricted but not prohibited. The other reason for resistance is that majority of Indian businesses are promoter driven and they are barred to access funds of their own business.

Earlier, public companies were permitted to grant loans, guarantees and securities subject to Central Government approval and private companies were exempted under Section 295 of the erstwhile Companies Act, 1956.

Section 185 of the Companies Act, 2013 imposed blanket ban on loans to directors, their relatives and partners. The main intention of the Section 185 is to ensure that directors who hold a fiduciary position with respect to shareholders do not misappropriate the funds of the company for their own benefits.

Why Companies opposed the Section 185 of Companies Act, 2013?

The argument of promoters is that where the shareholders being the ultimate owners themselves approve the utilization of the funds of the company in the specified manner, the law should not create a bar or restrictions on the same.

Why Companies debarred?

In India, majority of companies are enjoying credit facilities from banks and financial institutions. Thus, they are using public money in an indirect way. So, it’s very much important to check and balance the acts of promoters that they don’t misappropriate the funds of the shareholders and banks for their own benefits.

JOURNEY OF RELIEF SINCE ENACTMENT OF COMPANIES ACT, 2013

A diverse section of stakeholders including professionals opposed the Section 185 since its enactment and notification and various representations have been made to Government for some relaxation at least to the Private Companies.

A journey of relief started with the exemption notification dated 5th June, 2015 exempting Private Companies from Section 185 and thereafter Companies (Amendment) Act, 2017 which allowed to give loans, guarantee and securities to other Companies and Body Corporates after passing Special Resolution.

Exemption from Section 185 to Private Companies vide Notification dated 5th June, 2015

Private Companies were facing problems due to stringent provisions of Section 185 while carrying out operations. So, Government exempted private companies from entire Section 185 to ease the compliance requirement vide notification dated 5th June, 2015, subject to following 3 conditions:

1. There should be no investment in the concerned company from any other body corporate;
2. The company should not have any borrowings from banks, financial institutions and other body corporate equal to or more than twice its paid up share capital, OR Rs. 50 crores, whichever is lower; and
3. There should be no subsisting default at the time of making such transaction, and that the company should have the capability to pay off the loan.

Hence, any Private Company fulfilling above conditions are completely out of purview of Section 185. However, before granting any loan to Directors or any other person in whom directors are interested, Company has to pass Board Resolution as per Section 186 and the said loan must be within the limit specified in Section 186 of the Companies Act, 2013.

Companies (Amendment) Act, 2017.

Government substituted entire Section 185 by way of Companies (Amendment) Act, 2017 to promote ease of doing business. The original Section 185 specified more exhaustive list to which Companies can’t give loans, guarantee and securities. Thus, at par with the global company laws, the provision has been amended to remove the prohibition to an extent and provides for the passing of shareholders’ resolution for granting of loans, guarantees, and securities to entities in which directors are interested.

For better understanding of the section, I classified 3 categories i.e Prohibited, Restricted and Unrestricted for giving loans, guarantees and securities.

1) PROHIBITED

All the Companies (Except Private Companies which fulfill the criteria of exemption notification dated 5th June, 2015) are prohibited to give loans, guarantees and securities to the following persons and firm:

1. Any Director of a Company
2. Any Relative of a Directors
3. Any Partner of a Directors
4. Any Directors of a Holding Company
5. Any firm in which any such director or relative of a Director is a Partner

2) RESTRICTED

Companies can give loans, guarantee or securities to the following entities after passing Special Resolution at a duly convened general meeting:

1. Any private company of which any such director is a director or member;
2. Any body corporate in which more than 25% of the total voting power exercised or
   controlled by any such director, or by two or more such directors, together;
3. 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.

Earlier, Companies were prohibited to give loans, guarantee or securities to above mentioned entities but after enactment of Companies (Amendment) Act, 2017, Companies may grant loans, guarantees and securities to above entities, subject to approval of the shareholders by passing a special resolution and on the condition that such loans are utilized by the borrower for its principal business activities.

It is noted that the loan, guarantee and security provided under this section must be within the limit of Section 186 of the Companies Act, 2013.

3) UNRESTRICTED OR EXEMPTED

The Provisions of Section 185 doesn’t apply to the following transactions:

1. Any loan given to a M.D or W.T.D as a part of the conditions of service extended by the
   company to all its employees; OR pursuant to any scheme approved by the members by a Special Resolution;
2. 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 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; or
3. Any Loan/Guarantee or Security made by a holding company to its wholly owned subsidiary Company.

PENAL PROVISIONS

If any loan is advanced or a guarantee or security is given or provided or utilized in contravention of the provisions of this section,—

1. The company shall be punishable with fine between Rs. 5,00,000/- to Rs. 25,00,000/-
2. Every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to six months or with fine between Rs. 5,00,000/- to Rs. 25,00,000/- and
3. 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 six months or with fine between Rs. 5,00,000/- to Rs. 25,00,000/- or with both.

Companies (Amendment) Act, 2017 seeks to make section 185 less stringent in nature, by proposing that certain transactions be completely prohibited, while others be subject to a special resolution. Another check and balance mechanism in which the section provides that full disclosures relating to the amount of loan, purposes of the loan, and other relevant details must be placed before the shareholders for their informed consent. Thus, the Amendment Act of 2017 is partly prohibitive and partly restrictive by nature. It strikes balance between both section 295 of the erstwhile 1956 Act and section 185 of the 2013 Act.