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Loans, Investment, Guarantee or Security by Company: FAQs based analysis of the Section 185 and Section 186 of Companies Act, 2013

The article explains the Section 185 and 186 of Companies Act, 2013 in the form of Q&A with practical approach.

“Section 185: “Loan to directors, etc.— (1) Save as otherwise provided in this Act, no company shall, directly or indirectly, advance any loan, including any loan represented by a book debt, to any of its directors or to any other person in whom the director is interested or give any guarantee or provide any security in connection with any loan taken by him or such other person:

Provided that nothing contained in this sub-section shall apply to—

(a) the giving of any loan to a managing 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) 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 bank rate declared by the Reserve Bank of India;

(c) (w.e.f. 29-05-2015) 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; 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:

Provided that the loans made under clauses (c) and (d) are utilised by the subsidiary company for its principal business activities.

Explanation.—For the purposes of this section, the expression ―to any other person in whom director is interested means—

(a) any director of the lending company, or of a company which is its holding company or any partner or relative of any such director;

(b) any firm in which any such director or relative is a partner;

(c) any private company of which any such director is a director or member;

(d) any body corporate at a general meeting of which not less than twenty-five per cent. of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together; or

(e) any body corporate, the Board of directors, managing director 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.

(2) If any loan is advanced or a guarantee or security is given or provided in contravention of the provisions of sub-section (1), the company shall be punishable with fine which shall not be less than five lakh rupees but which may extend to twenty-five lakh rupees, and 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 which shall not be less than five lakh rupees but which may extend to twenty-five lakh rupees, or with both.

Q&A:

1. Applicability of Section 185?

Section 185 is applicable to a public company as well as a private company. There is exemption to a Nidhi Company [Notification No. GSR465 (E), dated 05.06.2015] and Govt. Company [Notification No. GSR463 (E), dated 05.06.2015].

2. Exemption from Section 185 to a private company?

Notification No. GSR 464 (E), dated 05.06.2015, has specified that the Section 185 shall not apply to a private Company-

i. In whose share capital no other body corporate has invested any money;

ii. If the borrowings of such a company from banks or FI s or any body corporate is less than twice of its paid-up share capital or Rs. 50 crore, whichever is lower; and

iii. Such a company has no default in repayment of such borrowings subsisting at the time of making transactions under this section. 

3. A loan represented by Book Debt actually means?

Dictionary meaning: Any money that a company has not yet received from a person, who owe it money, as recorded in the company’s accounts.

Any credit sales or facility / service of the Company used and pay later, and that credit period is more than the usual credit period given to other customers and that credit extended period is in the nature of Loan.

It has been held that Flat sold to director, part amount in cash, balance amount in credit. Credit sale not to be treated as loan. Bombay HC held, that this will not attract provisions of Section 295 (Now section 185 of the Companies Act, 2013). Credit sales cannot be described as an indirect loan but, disclosure at and approval of Board meeting is necessary. [Fredie Ardeshir Mehta (Dr.) v Union of India (1989) 2 CLA244 (Bom): (1991) 70 Comp Cas 210(Bom): (1991) 1 CompLJ437(Bom)].

The debt can properly be called a book-debt, whether it is in fact entered in the books of the business or not. [Paul & Frank Ltd. v Discount Bank Overseas Ltd. (1967) 37 Comp Cas 76(Ch.D) : (1966) 2 All ER922: (1967)1CompLJ56].

Author view for Section 185: The book debt first must be qualified as LOAN, to be covered under this section. Merely credit sales or other receivable is not book debt for this section.

4. Indirect Loan means?

Loans given to the ultimate benefit of the Directors through one or more intermediaries. Any amount, which is not in the nature of loan cannot be said to be the indirect loan.

5. ABC Pvt. Ltd. give loans of Rs. 25 lakhs to Mr. X a renowned person in the same industry on 8th December 2022, subsequently on 11th December 2022 Mr. X become the Director of ABC Pvt. Ltd. whether violation of Section 185?

No, there is no violation of Section 185, the Section applicable at the time of granting loan and any change in circumstances thereafter will not make the section applicable. Any Loan/ guarantee given, or security provided was earlier exempted from the provision of the section 185, it will continue to be exempted. 

6. Imprest amount given to Directors is loan u/s 185?

Any advance or imprest given to Directors, employee (relative of directors) for expenses incurred on behalf of the Company, to the extend of unadjusted quite a long time, would be considered as loan for the purpose of section 185.

7. RE Pvt ltd having 2 shareholder and Directors Mr. M and Ms. D and AI Pvt. ltd where Mr. M and Ms. D are the only shareholder and Directors also. The Companies not having any loans from the banks. RE Pvt Ltd incurred Rs. 50 lakh for salary expenses of AI Pvt Ltd, which is not paid by AI Pvt Ltd for last 2 years, whether Section 185 attract?

No, Section 185 is not attracted, in view of Notification No. GSR 464 (E), dated 05.06.2015.

8. Whether the offence committed under the section 185 is compoundable?

Yes, Where the offence u/s 295 of CA-1956 (Corresponding to section185) has been committed but there is no wilful default and no malafide intention petitioner is entitled for compounding of offence. [KPR Agrochemicals Ltd. 2016 (135) CLA 226 NCLT.] 

9. Any disclosure requirement under Schedule III of Companies Act, 2013

Yes, Loans and advances due by directors or other officers of the company or any of them either severally or jointly with any other persons or amounts due by firms or private companies respectively in which any director is partner of a director, or a member should be stated separately.    

10. Whether MGT-14 is required to file with ROC?

Yes, for any scheme of loan approved by special resolution in General meeting, form MGT-14 is required to file with ROC.  

“186. Loan and investment by company.— (1) Without prejudice to the provisions contained in this Act, a company shall unless otherwise prescribed, make investment through not more than two layers of investment companies:

Provided that the provisions of this sub-section shall not affect,—

(i) a company from acquiring any other company incorporated in a country outside India if such other company has investment subsidiaries beyond two layers as per the laws of such country;

(ii) a subsidiary company from having any investment subsidiary for the purposes of meeting the requirements under any law or under any rule or regulation framed under any law for the time being in force.

(2) No company shall directly or indirectly —

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

(b) give any guarantee or provide security in connection with a loan to any other body corporate or person; and

(c) acquire by way of subscription, purchase or otherwise, the securities of any other body corporate, exceeding sixty per cent. of its paid-up share capital, free reserves and securities premium account or one hundred per cent. of its free reserves and securities premium account, whichever is more.

(3) Where the giving of any loan or guarantee or providing any security or the acquisition under sub-section (2) exceeds the limits specified in that sub-section, prior approval by means of a special resolution passed at a general meeting shall be necessary.

(4) The company shall disclose to the members in the financial statement the full particulars of the loans given, investment made 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.

(5) No investment shall be made or loan or guarantee or security given by the company unless the resolution sanctioning it is passed at a meeting of the Board with the consent of all the directors present at the meeting and the prior approval of the public financial institution concerned where any term loan is subsisting, is obtained:

Provided that prior approval of a public financial institution shall not be required where the aggregate of the loans and investments so far made, the amount for which guarantee or security so far provided to or in all other bodies corporate, along with the investments, loans, guarantee or security proposed to be made or given does not exceed the limit as specified in sub-section (2), and there is no default in repayment of loan instalments or payment of interest thereon as per the terms and conditions of such loan to the public financial institution.

(6) No company, which is registered under section 12 of the Securities and Exchange Board of India Act, 1992 (15 of 1992) and covered under such class or classes of companies as may be prescribed, shall take inter-corporate loan or deposits exceeding the prescribed limit and such company shall furnish in its financial statement the details of the loan or deposits.

(7) No loan shall be given under this section at a rate of interest lower than the prevailing yield of one year, three year, five year or ten year Government Security closest to the tenor of the loan.

(8) No company which is in default in the repayment of any deposits accepted before or after the commencement of this Act or in payment of interest thereon, shall give any loan or give any guarantee or provide any security or make an acquisition till such default is subsisting.

(9) Every company giving loan or giving a guarantee or providing security or making an acquisition under this section shall keep a register which shall contain such particulars and shall be maintained in such manner as may be prescribed.

(10) The register referred to in sub-section (9) shall be kept at the registered office of the company and —

(a) shall be open to inspection at such office; and

(b) extracts may be taken therefrom by any member, and copies thereof may be furnished to any member of the company on payment of such fees as may be prescribed.

(11) Nothing contained in this section, except sub-section (1), shall apply—

(a) to a loan made, guarantee given or security provided by a banking company or an insurance company or a housing finance company in the ordinary course of its business or a company engaged in the business of financing of companies or of providing infrastructural facilities;

(b) to any acquisition—

(i) made by a non-banking financial company registered under Chapter IIIB of the Reserve Bank of India Act, 1934 (2 of 1934) and whose principal business is acquisition of securities:

Provided that exemption to non-banking financial company shall be in respect of its investment and lending activities;

(ii) made by a company whose principal business is the acquisition of securities;

(iii) of shares allotted in pursuance of clause (a) of sub-section (1) of section 62.

(12) The Central Government may make rules for the purposes of this section.

(13) If a company contravenes the provisions of this section, the company shall be punishable with fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees and every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to two years and with fine which shall not be less than twenty-five thousand rupees but which may extend to one lakh rupees.

Explanation.—For the purposes of this section,—

(a) the expression ―investment company‖ means a company whose principal business is the acquisition of shares, debentures or other securities;

(b) the expression ―infrastructure facilities‖ means the facilities specified in Schedule VI.”

Q&A:

1. Applicability of Section 186?

Section 186 is applicable to a public company as well as a private company. There is exemption to Govt. Company w.e.f. 13.06.2017. 

2. What is included in free reserves?

Reserves as per latest audited balance sheet available free for distribution as dividend, Security premium. 

3. What is not included in free reserves?

Share application money, revaluation reserve, Capital redemption reserve, statutory reserve, etc.    

4. What is included in Securities?

Includes bonds, debentures, equity share, preference shares, warrants, script, other marketable securities, derivatives, right and interest in securities, instruments convertible into shares, Mutual funds issued by body corporate.

5. What is not included in Securities?

Mutual funds issued by TRUST, properties, fixed assets. 

6. An Artificial intelligence (AI) based company create network and technology based eco system for providing services, whether it covered under infrastructure facilities?

Yes, as Schedule VI, under clause 9 (b) ‘technology related infrastructure’ covered technology based eco system. 

7. Whether Employee of the Company covered u/s 186?

No, The Explanation to section 185 (1) w. e. f. 7-5-2018, provides that the word “person” does not include any individual who is in the employment of the company. 

8. What is the power of the Board for section 186?

The BOD of a company can approves only up to 60% of the paid-up capital and free reserves or 100% of the free reserves of the company, whichever is more. The said limit applies either to loans, investments or guarantee/security individually or to all the above transactions put together. 

9. Can a blanket permission be given by the shareholders?

No Blanket permission will be given by the shareholders [Circular No. 8/99, 4-6-1999]

A blanket permission of the shareholders empowering the Board to make loans or investments or to give guarantee or security up to a certain aggregate limit will not be adequate compliance with the provisions issued by the MCA, stating, inter-alia, that en-block approval should be avoided (except in the case of guarantee where the resolution can indicate an amount on annual basis). A resolution passed at a GM in terms of section 186 (3) may specify the total amount up to which the BOD is authorised to give guarantee. 

10. Can an interest free loan be given within limit of section 186?

No loan shall be given under this section at a rate of interest lower than the prevailing yield of 1 year, 3-year, 5 year or 10 year Govt. Security closest to the tenor of the loan.

The MCA by General Circular No. 6/2015, dated 9th April, 2015 has clarified that in cases where the effective yield (effective rate of return) on tax free bonds is greater than the prevailing yield of 1/3/5/10, Govt. Security closest to the tenor of the loan, there is no violation of 186(7). 

11. What is the format of register u/s 186?

Form MBP-2 

12. What is IFSC company means and applicability of section 186

International Financial Services Centre (IFSC). An IFSC caters to customers outside the jurisdiction of the domestic economy. Such centers deal with flows of finance, financial products and services across borders.

Exemptions to the IFSC Company [Notification No. GSR8(E) & 9(E), dated 04.01.2017] Section 186 (3) shall not apply to Specified IFSC Public & Private Company, if a company passes a resolution either at meeting of the BOD or by circulation.

Some Pointers:

1. Rationale behind these sections is to prevent siphoning off funds, misuse of funds, to prevent from personal gains to directors.

2. Disclosure as per Schedule III for Section 185 and disclosure under section 186(4) is mandatory under financial statements.

3. Secretarial compliances such as MGT-14, MBP-2, provision of SS-1 and SS-2 to be strictly followed to avoid any penalty.

4. Loans, guarantee, advances, security, Investment will be examined case to case basis for compliance of sections.

5. Compliance of Section 185 and 186 have interlinking with disclosure under AS-18 or Ind AS-24 “Related Party Disclosure”, transfer pricing u/s 92 of Income Tax Act, 1961 and GST provisions.

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Author Bio

Naveen, about 37 years, is a Chartered Accountant, Company Secretary and GST certified from VG Learning – with more than 14 years of experience in Assurance, Taxation, Strategy Consultancy, advisory, Process Transformation, Secretarial compliances, setting-up of Operations, Stakeholders’ Relatio View Full Profile

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One Comment

  1. Venugopal Dasari says:

    clarification please:
    If a company gives corporate guarantee to another company for the loans taken from Bank and its securities were given to bank by mortgage against Sec 185, will the mortgage become invalid abinitio and keep the bank exposure as clean, ofcourse subject to the penalties to be imposed on both the companies as per sec 185(4).

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