♦ Purpose of the provisions of Section 185: 

To address the difficulties being faced in genuine transactions due to the complete embargo on providing loans to subsidiaries with common directors, the companies are permitted to give loans to entities in which directors are interested after passing special resolution and adhering to disclosure requirements. This would give big relief to the companies.

Granting of loan, guarantee or security is nicely categorized as prohibited, conditional and exempted.

The prohibition is proposed to be made applicable for assistance to director or his partner or relative or a firm in which such director or relative is a partner or to holding company of the company.

The conditional assistance is possible to any person in whom the director is interested (other than prohibited categories). Company has to pass a special resolution & explanatory statement to the notice should disclose all the facts & particulars.

If the borrower is a Company then loan should be utilized for its principal business activity.

The exempted categories are loan to MD/ WTD as a part of service condition or scheme and loans by companies in their ordinary course of business by charging interest as per tenure and loan, guarantee or security by holding company to its WOS and guarantee or security by holding company to its subsidiary company with a condition to use it for its principal activity.

In the list of offenses under this section specific offence of contravention in utilization of loan is proposed to be added.

  • Loans: Loans is not defined anywhere in the Act. However in normal parlance, loan means lending of money with absolute promise to repay.
  • Advance: Advance is not defined under the Act, in normal parlance, advances is adjusted against supply of goods and services.
  • Indirect Loan: Indirect Loan is not defined in section 185 or elsewhere in the Act. Indirect loan is interpreted in case of Dr. Fredie Ardeshir Mehta v. Union of India [1991] (Bombay) to mean a loan to a director through the agency of one or more intermediaries.

√ For example: If company A borrows from company B and lends the same to company C and loan from B to C is covered by section 185 of the Act. In this case, section 185 of the Act shall also be applicable in case of lending from company A to C because it would be construed as an indirect loan from company B to C.

Section – 2(77): “relative”, with reference to any person, means any one who is related to another, if:

(i) they are members of a Hindu Undivided Family;

(ii) they are husband and wife; or

(iii) one person is related to the other in such manner as may be prescribed;

List of Relatives in Terms of Clause (77) of section 2:

A person shall be deemed to be the relative of another, if he or she is related to another in the following manner, namely:

(1) Father: Provided that the term “Father” includes step-father.

(2) Mother: Provided that the term “Mother” includes the step-mother.

(3) Son: Provided that the term “Son” includes the step-son.

(4) Son’s wife.

(5) Daughter.

(6) Daughter’s husband.

(7) Brother: Provided that the term “Brother” includes the step-brother;

(8) Sister: Provided that the term “Sister” includes the step-sister.

Section – 2(59): “officer” includes any director, manager or key managerial personnel or any person in accordance with whose directions or instructions the Board of Directors or any one or more of the directors is or are accustomed to act;

Section – 2(60): “officer who is in default”, for the purpose of any provision in this Act which enacts that an officer of the company who is in default shall be liable to any penalty or punishment by way of imprisonment, fine or otherwise, means any of the following officers of a company, namely:

(i) whole-time director;

(ii) key managerial personnel;

(iii) where there is no key managerial personnel, such director or directors as specified by the Board in this behalf and who has or have given his or their consent in writing to the Board to such specification, or all the directors, if no director is so specified;

(iv) any person who, under the immediate authority of the Board or any key managerial personnel, is charged with any responsibility including maintenance, filing or distribution of accounts or records, authorises, actively participates in, knowingly permits, or knowingly fails to take active steps to prevent, any default;

(v) any person in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act, other than a person who gives advice to the Board in a professional capacity;

(vi) every director, in respect of a contravention of any of the provisions of this Act, who is aware of such contravention by virtue of the receipt by him of any proceedings of the Board or participation in such proceedings without objecting to the same, or where such contravention had taken place with his consent or connivance;

(vii) in respect of the issue or transfer of any shares of a company, the share transfer agents, registrars and merchant bankers to the issue or transfer;

Section – 185:

Sec – 185(1): No company shall, directly or indirectly,

  • advance any loan, including any loan represented by a book debt(say: credit sales, short term advances) to, or
  • give any guarantee or
  • provide any security in connection with any loan

taken by:

(a)

  • any director of company, or
  • of a company which is its holding company or
  • any partner or relative of any such director; or

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

Sec – 185(2): A company may

  • 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 any person in whom any of the director of the company is interested, subject to the condition that:

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

  • Provided that the explanatory statement shall disclose the full particulars in the notice:
  • loans given, or
  • guarantee given or
  • security provided and
  • purpose – proposed to be utilised by the recipient and
  • any other relevant fact;

and

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

> Expression “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, 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.

Sec – 185(3): Exceptions to Section – 185:

(a) Loans to the managing or whole-time director:

(i)  as a part of the conditions of service extended to all its employees; or

(ii) pursuant to any scheme approved by the members by a special resolution; or

(b) Loan to companies 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

(c) Loans to wholly owned subsidiary company:

  • any loan made or
  • any guarantee given or
  • security provided in respect of any loan made

by a holding company to its wholly owned subsidiary company; or

  • Loans to subsidiary company:
  • any guarantee given or
  • security provided in respect of loan made by any bank or financial institution

by a holding company 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.

 Sec – 185(4): Penalty provisions for the contravention of this section:

(i) For company:

  • Fine – Minimum Rs. 5 lakhs and Maximum Rs. 25 lakhs;

(ii) For every officer who is in default:

  • Imprisonment – Maximum 6 months, or
  • Fine – Minimum Rs. 5 lakhs and Maximum Rs. 25 lakhs; and

(iii) For 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 – Maximum 6 months, or
  • Fine – Minimum Rs. 5 lakhs and Maximum Rs. 25 lakhs, or
  • with both.

♦ Filing Requirement:

  • The Company shall file Form MGT-14 within 30 days of passing of Special Resolution** to intimate the concerned ROC.

** (Approval of minimum 75% consent of members of the lending company is required)

♦ Example 1: A company purchased a motor vehicle in the name of a director of the company. It is also the co-borrower of the loan taken for the said purpose. Does this transaction fall under the ambit of the provisions of section 77 of the Companies Act, 2013?

What difference would it make if the loan was taken only in the name of the director but the payment was made by the company?

Answer:

As the company is the co-borrower of the loan and it is making a charge on the vehicle, thus, section 77 of the Companies Act, 2013 shall apply on the company and it is required to file Form CHG-1 for the registration of the charge. Further, as the vehicle is registered in the name of director only, it will amount to an indirect loan to the director and provisions of the Act relating to grant of loans to directors shall apply.

In the case where the loan is taken by the director and the vehicle purchased on such loan is not in the name of the company but the company is still providing payment to settle the loan against vehicle on behalf of the director, it will also be considered as loan to the director to the extent of payments made by the company and section 185 and section 188 of the Companies Act, 2013 will apply.

Disclaimer: The entire content of this document have been prepared on the basis of relevant provisions and as per the information existing at the time of the preparation. Although care has been taken to ensure the accuracy, completeness and reliability of the information provided, Author assumes no responsibility thereof. The user of the information agrees that the information is not a professional advice and is subject to change without notice. In no event, we shall be liable for any direct, indirect, special or incidental damage resulting from, arising out of or in connection with the use of information.

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