Section 185(1) of Companies Act 2013 primarily deals with the subject; Person to whom Company cannot give loan/ guarantee/ security. It basically covers individuals and firms:
It states that, A Company shall not, directly or indirectly, advance any loan (including book debt) or give any guarantee or provide any security in connection with any loan taken by to the below mentioned individuals and firms –
a. Any Director of the Company or
b. Any Relative of such Director or
c. Any Partner of such Director or
d. Any Director of its Holding Company or
e. Any Relative of the Director of its Holding Company or
f. Any Partner of the Director of its Holding Company or
g. Any Firm in which any of the above mentioned Director is a Partner or
h. Any Firm in which Relative of the above mentioned Director is a Partner
Following points to be kept in mind while complying with this Section:
1. Prohibition under this sub- section is only of Individuals and Firms.
2. This section is applicable on all companies (both Private Company as well as Public Company including One Person Company).
3. This section only covers loan, guarantee and security. It does not cover investment.
Section 185(2) deals with the provisions relating to advancement of Loan/ Guarantee/ Security in connection with any loan taken:
It states that a Company can advance any loan (including book debt) or give any guarantee or provide any security in connection with any loan taken to the following persons subject to the conditions:
a. any private company in which the director of the lending Company is a director or member
b. any body corporate at a general meeting of which at least 25% of the total voting power may be exercised or controlled by any director, or by two or more such directors of the lending Company, together; or
c. 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.
1. Pass Special Resolution in General Meeting; and
(the explanatory statement to the notice for the relevant general meeting shall disclose the full particulars of the loans/ guarantee given or security provided and the purpose for which the loan or guarantee or security is proposed to be utilized by the recipient of the loan or guarantee or security and any other relevant fact)
2. Loan must be utilized by the borrowing Company for its Principal business activities.
Following Points to be Kept in Mind while Complying this Section:
1. If borrower is Private Limited Company having common directors/ members then by using this sub section loan can be given.
2. If the borrower is Body Corporate includes LLPs, therefore as per, point (ii) of any person L/G/S can be given to LLP also. [Condition 25% or more voting power vested with one or more director of lender Company together].
Section 185(3) deals with the provision relating to exemption from complying of sub- section 1 and 2 of Section 185:
A Company can give any loan/ guarantee/ security to the following:
1. as a part of condition of their service; or
2. pursuant to any scheme approved by passing Special Resolution
Condition: 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.
Condition: Loan must be utilized by the wholly owned subsidiary company for its principal business activities.
Condition: Loan must be utilized by the subsidiary Company for its principal business activities.
Thus, as per Sec 185 (3), above mentioned individuals and entities are not required to comply with sub-section 1 and 2 of Section 185, if they are fulfilling the conditions mentioned for them.
Section 185(4) talks about the punishment and penal provisions for the contravention of any of the provisions of the Section 185:
***** Private Company fulfilling all 3 conditions mentioned in Exemption Notification dated: 05th June, 2015.
1. In whose share capital no other body corporate has invested any money;
2. If the borrowings of such a company from banks and financial institutions or any other body corporate is less than twice of its paid up share capital or fifty crore rupees, whichever is lower; and
Such a company has no default in repayment of such borrowings subsisting at the time of making transactions under this section.
INTENTION behind Provisions of Section 185 of Companies Act, 2013:
The intent of the rigidity of Section 185 of the 2013 Act was to ensure that directors do not surpass their fiduciary duty towards the company for personal benefit.
Section 185 of the 2013 Act, being a restrictive section, had a significant impact on structured lending transactions which were backed by credit support, collateral or guarantee from a parent company or a group company. The provisions of this section created major hurdles for market players for fund raising, intra-group credit support and collateral and in order to address these issues and promote flexible business opportunities, the entire section had been substituted under the 2017 Act.
Therefore, with the amendments introduced by the 2017 Act, the intention of the legislature is clear, that where the shareholders of the company, being the ultimate owners, themselves approve the utilization of the funds of the company, the law need not create a bar on the same.
Thus, the provision under the Section 185 of the 2013 Act, has been amended to remove the prohibition to an extent by providing for a way out in the form of a shareholders’ resolution for granting of loans/guarantees/securities to entities in which directors are interested or for group companies under common control.
While the amended sub-section (2) is an enabling provision for companies to undertake financial exposures towards any ‘person’ in whom its director is interested, the working of condition (b) under sub-section (2) of Section 185, to which this right is subject to, appears to apply specifically to a borrower which is a ‘company’ and not any other entity or person that may be a borrower.
The resulting construct of the amended section begs a question as to the exact legislative intent behind the condition (b) being applicable to a borrower which is a company or any other entity or person.
Under the amended provisions, the ambit of the penalties has been largely widened and as a result, the obligations of every ‘officer’ of a company has been increased to ensure that all loans, securities and guarantees are in compliance with the provisions of the Companies Act 2013.
Note: Section 185 and Section 186 of the Companies Act, 2013 should be read with together in order to comply the law in a true and fair manner.