Summary: Section 186(2) of the Companies Act, 2013 regulates a company’s power to grant loans, make investments, provide guarantees, and create securities by prescribing monetary limits beyond which shareholder approval through a Special Resolution is required. The provision applies to loans, guarantees or securities given in connection with a loan, and acquisitions of securities, subject to specified thresholds. A key distinction exists between financial guarantees and performance guarantees. A financial guarantee secures repayment of a loan or credit facility and is therefore covered by Section 186(2). In contrast, a performance guarantee secures contractual or operational obligations, such as project completion or supply commitments, and has no connection with a loan. MCA General Circular No. 04/2015 clarifies that performance guarantees issued in the ordinary course of business are outside the scope of Section 186(2) and are excluded from the prescribed limits. However, instruments that are substantively financial guarantees, despite their description, must be evaluated under Section 186.
Section 186 of the Companies Act, 2013
Loans, Investments, Guarantees & Securities
Performance Guarantee vs. Financial Guarantee — Applicability & Limits
Page Contents
1. Overview
Section 186 of the Companies Act, 2013 governs and regulates loans, investments, guarantees, and securities provided by a company. The provision is intended to ensure prudent deployment of corporate funds and to safeguard the interests of shareholders and creditors by placing quantitative ceilings on a company’s exposure to related financial transactions.
Sub-section (2) of Section 186 is the operative restriction. It prohibits a company
— directly or indirectly
— from undertaking certain transactions beyond prescribed thresholds without prior approval by a Special Resolution of shareholders.
2. Scope of Section 186(2)
Section 186(2) restricts a company from the following transactions, individually or in aggregate, beyond the prescribed limits:
1. Giving any loan to any person or other body corporate;
2. Giving any guarantee or providing any security in connection with a loan to any other body corporate or person; and
3. Acquiring securities of any other body corporate.
The prescribed limits are the higher of:
– 60% of paid-up share capital + free reserves + securities premium account; or
– 100% of free reserves + securities premium account.
| Statutory Language — Key Phrase
The guarantee restriction under Section 186(2)(b) is explicitly qualified: it applies to guarantees given “in connection with a loan.” This express linkage to a loan transaction is the cornerstone of the distinction between financial and performance guarantees. |
3. The Critical Distinction: Performance vs. Financial Guarantee
Financial Guarantee
A financial guarantee is issued in connection with a loan or credit facility. The guarantor undertakes to repay the lender if the principal borrower defaults on repayment. Such a guarantee is squarely covered by Section 186(2)(b) and (c) of the Act, as the statute explicitly refers to guarantees given “in connection with a loan.”
Performance Guarantee
A performance guarantee is issued to secure the contractual or operational obligations of a party — for instance, timely completion of a project, supply of goods as per specification, or adherence to agreed service levels. Crucially, a performance guarantee has no connection whatsoever with a loan. It does not secure any borrowed money; it secures performance.
Because the condition precedent under Section 186(2) — viz., a nexus “in connection with a loan” — is absent in a performance guarantee, the provision is not attracted.
4. MCA General Circular No. 04/2015 dated 10.03.2015
The Ministry of Corporate Affairs (MCA) issued General Circular No. 04/2015 dated 10 March 2015, which has become the key regulatory clarification on this subject. The Circular addressed transitional issues concerning Section 186 and, in doing so, confirmed the settled interpretive position:
| MCA Circular No. 04/2015 — Clarification
The MCA clarified that the word “loan” in Section 186 does not apply to guarantees given in the ordinary course of business which are performance guarantees in nature, since these do not involve any loan element. Performance guarantees given in the ordinary course of business are thus excluded from the computation of limits under Section 186(2). |
This clarification is authoritative and widely relied upon by practitioners, company secretaries, and legal counsel. It conclusively establishes that performance guarantees fall outside the ambit of Section 186(2) and need not be counted towards the applicable limits.
5. The Settled Legal Position
The following represents the consistent and widely accepted interpretive position:
- Performance guarantees are NOT covered under Section 186(2) and therefore do not count towards the prescribed limits.
- This exclusion follows from the express statutory language of Section 186, which restricts guarantees given “in connection with a loan” — an element entirely absent in a performance guarantee.
- The position is confirmed and reinforced by MCA General Circular No. 04/2015 dated 10 March 2015.
- The exclusion applies to guarantees given in the ordinary course of business that are genuinely performance-based in nature.
6. Practical Considerations & Caveats
Substance Over Form
The exclusion applies only to pure performance guarantees. If an instrument described as a performance guarantee is, in substance, structured to secure repayment of money — i.e., it carries a financial or loan character dressed up as a performance obligation — it would not qualify for the exclusion. Such instruments must be assessed within Section 186 limits. Classification is a fact-specific exercise.
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Author – CS Divesh Goyal, GOYAL DIVESH & ASSOCIATES Company Secretary in Practice from Delhi and can be contacted at csdiveshgoyal@gmail.com).
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