Analysis of Sec 185 of the companies act 2013: Every banker should know

Giving a corporate guarantee to banks/lenders by a company, other than the borrower, that the loan will be paid back, is a usual practice in the normal course of trade and commerce across the world. By and large, a larger company (often a known flagship or holding or parent company or another related company) will provide corporate guarantee to banks/lenders on behalf of a smaller or its subsidiary company that may not be well-known or have developed a relationship with the banks/ lenders. Corporate Guarantee is a written declaration or guarantee of payment made by a known flagship, or holding or parent company, on behalf of its other business entity who would be normally smaller or a subsidiary company. This guarantee to banks is provided in consideration of bankers/vendors providing credit to a business on whose behalf the guarantee is made. A corporate guarantee is a guarantee in which a flagship or holding or parent company agrees to be held responsible for completing the duties and obligations of a smaller/ subsidiary company/debtor to banks/lenders, in the event that the smaller/subsidiary company/ debtor fails to fulfill the terms of the debtor-lender contract. Section 185 of the Companies Act, 2013 which was notified on 12th September, 2013, has replaced the old Section 295 of the Companies Act, 1956 which provides loans to the directors. This Section 185 now applies to all companies including private companies too. While under the old provisions of Section 295 of the Companies Act, 1956, private companies had been exempted. So now, both public and private companies cannot give any loans to directors or to persons in whom the director is interested. Since Section 185 of the new Companies Act, 2013 became effective in September 2013, there is all-round confusion in the banking sector whether a bank on sanction of certain credit facilities to any company can stipulate and corporate guarantee. Can the banks take corporate guarantee of holding private limited companies while sanctioning certain credit facilities to subsidiaries of any company, in view of the Section 185 of the new Companies Act, 2013? Detailed analysis of Sections 185 and 186 of the new Companies Act, 2013 and Section 372A of the Companies Act, 1956 gives us the following inputs:

Section 185: Loan to Directors, etc. (The above section is notified and operative with effect from 12th September, 2013.)

(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.

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 25%. 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.

Analysis: In accordance with the Section 185 which is notified and operative with effect from 12th September, 2013, no company, whether public or private, can give any loan or provide any security or guarantee in connection with a loan to a director or any other person in whom he is interested. As per the intent of the legislation, there is a restriction for loans to directors, etc., and to any other person in whom the director is interested, which was earlier permitted under Section 295 of the Companies Act, 1956. But in this connection, if there are no common directors in the Board of the Directors of the companies giving corporate guarantee to bank on behalf of its subsidiary company wherein no directors or directors exercise or control of voting power in excess of 25% in the other company, the said corporate guarantees can be provided to any bank. No legislation or statutory enactment can put speed breakers or bottlenecks for the growth of trade and commerce. Because when corporate guarantees are provided to a bank, the bank lends monies in the economic system of the country and that money, is normally used, in the ordinary course of business for productive purposes in the overall growth the economy of the country. The ultimate purpose of Section 185 of the new Companies Act, 2013 is to put additional restrictions on loan to directors only and not on giving of corporate guarantee by the holding company to its subsidiary company if the Boards of Directors are not common.

NOW LET US UNDERSTAND THE SECTION WITH THE HELP OF PRACTICAL EXAMPLES

EXAMPLE 1

Company A has two Directors Mr. X and Mr. Y. Both holds 50% share each of Company.

Company A wish to give loan to following and have asked for your views on same.

A) Loan to Director X.
B) Loan to a relative of Director Y.
C) Director of company D which is the holding company of A.
D) A partner of Director of Holding Company.
E) A partner of Director of company A.
F) To a firm in which Mr. X is a partner.
G) To a firm in which relative of Mr. Y is a Partner.

SOLUTION 1

EXAMPLE 2   (PRIVATE LTD CO WITH COMMON DIRECTOR)

A and B are Husband and wife. D is their Son.

Company B wish to avail loan from Company A, Whether Possible?  

SOLUTION 2

Company A cannot give loan to company B as it would be in contravention of Section 185 and would attract penalty.

Planning

1) Mr B should resign from the post of Director of Company A and gift his shares to Mr A (gift of shares is tax free). They shall appoint another Director in the company.

As B resigns and transfer the shares then the provisions of section 185 wont apply and company A would be able give loan to company B. OR

2) Converting Company A into a LLP. OR

3) Converting Company B into a Public Limited Company and Mr B reducing his shareholding in Company B to less than 25%.

EXAMPLE 3   (Private Ltd Co To Public Ltd Co)

Company B wish to avail loan from Company A, Whether Possible?

SOLUTION 3

No it is not possible to advance loan to company B as Director A, B and C collectively are holding 25% of shares of Company B. And hence get covered under the clause 4 of interested party to Director.

PLANNING

1) Either Mr A or Mr B or Mr C should resign from the post of Director of Company A. This would bring down the holding of shares to less than 25% and will enable the borrowing between two Companies. OR

2) Converting Company A into a LLP. OR

3) Either Mr A or Mr B Or Mr C should give up atleast 1% of their share held in Company B to bring down the holding under 25%.

FAQ:

AMOUNT ALREADY EXISTING ON 12Th SEPTEMBER 2013

Q. In Case any amount is outstanding on 12th September as a loan to Director or anyone in whom Director is interested.

A. The loan can still continue to appear in the books of accounts of Company; however it can’t be renewed and is to be repaid on the end of the term. If it’s a loan repayable on demand then still it is suggested to make a formal agreement with tenure specified in it.

Q. Company A holds more than 5 % share of company B and have common Director. Company B has availed a loan from bank and because company A holds more than 5% of share of company B it has to be give corporate guarantee for company B to bank.

A. These types of cases are common between related private limited companies. Banks usually takes corporate Guarantee of the companies. In such a case again company cannot renew the Guarantee given to Bank.

However, the CC limits of a company are renewed each year and new Sanction ticket is issued. In such a case corporate Guarantee also gets renewed. It is advised to corporate to approach bank and get the clause of Corporate Guarantee removed. 

Note: Sec 186 of the Companies Act 2013 is to be read with sec 185, however length of article does not permit me to include here analysis of Sec 186, next article would be on Sec 186.

Sumat Singhal,
Company Secretary
PNB Investment Services Ltd, Delhi
(B.Com, CAIIB, DTIRM, ACA, ACS, CWA(F)

January 2016
Sources; Various Reading