Section 185: All about Loan to Directors

The Section 185 of the Companies Act, 2013 is among the most important section of the Act. The section deals with the provisions for advancing loan and providing guarantee and security to Director, any person in whom director of the company is interested and power of the company to grant loan to, or provide guarantee or security on behalf of, its Managing Director, Whole Time Director, or in its ordinary course of its business, or to its subsidiary companies.

Section is divided into four sub section; whereas sub section 1 put blanket restriction on providing loan to any directors or firm in which director or his relative is partner, sub section 2 specifies the restriction, however, allow such loan, guarantee or security subject to certain condition, sub-section 3 allows the granting of loan or providing such guarantee or security in certain cases and lastly sub section 4 provide about the penalty in case of contravention of the provisions of this section.

1. LOAN TO DIRECTOR

No company shall, directly or indirectly, advance any loan including any loan represented by a book debt to, or give any guarantee or provide any security in connection with any loan taken by. –

1. Any director of company, or of a company which is its holding company or any partner or relative of any such director.
2. Any firm in which any such director or relative is as partner.

Since the sub section start with “No company” hence section applicable to all type of company, so by implication it means no company whether Private, Public, Nidhi or Government can extend any loan to their directors etc. However, Ministry of Corporate affair vide their different notification has granted relief under this section subject to certain conditions.

EXEMPTIONS

In case of unlisted public company (so for listed public company no relief is available under this notification) which is licensed to operate by RBI OR SEBI OR IRDA from the International Financial Services Centre located in an approved multi services SEZ set-up under the SEZ Act.  

In case of Private Company which is licensed to operate by RBI or SEBI or IRDA from the International Financial Services Centre located in an approved multi service SEZ set-up under SEZ Act.

In case of Government Company, section 185 shall not apply, if Government Company obtains approval of the Ministry or Department of the Central Government/State Government which is administrative in charge of the company before making any loan or giving any guarantee or providing any security under the section.

In case of Private Company section 185 shall not be applicable subject to following conditions.

1. In whose share capital no other body corporate as invested any money;
2. If the borrowings of such a company form banks or financial institutions or any body corporate is less than twice of its paid-up share capital or fifty crore rupees, whichever is lower; and
3. Such a company has no default in repayment of such borrowings subsisting at the time of making transactions under this section.

All these conditions need to be fulfilled at the time of advancing of any loan or providing guarantee or security.

IMPORTANT WORDS AND PHRASES

We further we need to bring our focus to three crucial words i.e. “indirectly” and “Loan” and the phrase “Loan represented by book debt"

In order to understand these two terms we need to refer to decided case law “Dr, Fredie Ardeshir Mehta v. Union of India.

The word “indirectly” cannot be read as converting what is not a loan into loan. If we explicate it further we can understand that word “indirectly’ means providing loan through agencies or any other medium but does not include converting anything which does not qualify to be loan or loan represented by book debt or security or guarantee into loan, any loan represented by book debt or guarantee or security. 

The word “Loan” is defined by the honorable court in above case in following manner;

The loan is defined by the Oxford English Dictionary as ‘a thing lent; something the use of which is allowed for a time, on the understanding that it shall be returned or an equivalent given; esp., a sum of money lent on these conditions and usually with interest’. The essential requirement of a loan is the advance of money (or of some article) upon the understanding that it shall be returned, and it may or may not carry interest.

The phrase “any loan represented by book debt” is inserted in order to plug the loophole used in the case of “Dr, Fredie Ardeshir Mehta v. Union of India” where court took the view that book debt can’t be treated as loan and since the eelier Section 295 of Companies Act, 1956 does not explicitly include the phrase “any loan represented by book debt” hence any kind of credit facility extended by company to directors will not cover under the “Loan to director”.

2. LOAN GUARANTEE OR SECURITY TO THE PERSON IN WHOM DIRECTOR IS INTERESTED

Who is the “Person in whom Director is interested?”

As per the explanation provided by the section the “any person in whom director is interested” means-

1. Any private company of which any such director is director or member;
2. Any body corporate at a general meeting of which not less than 26% of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together; or
3. Any body corporate, the Board of directors, managing director or manager, whereof is accustomed to act in accordance with the directions or instruction of the Board, or of any director or directors, of the lending company

Company may advance any loan or loan represented by 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. Special resolution is passed in general meeting;

Provided that explanatory statement( as per section 102) to be attached with notice(section 101) to have complete detail of such transaction including purpose for which such amount is going to be utilized.

b. The loans are utilized by borrowing company for its principal business activity.

3. LOAN TO WHOLE TIME DIRECTOR AND MANAGING DIRECTOR, ETC.

Sub-section overrules the sub-section (1) and (2) and provides the conditions where company may advance loan or provide guarantee or security.

a. The giving of any loan( still providing security and guarantee is not allowed even under this section) to managing and whole time director-

1. As part of conditions of service extended by the company to all its employees; or
2. 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 loan or gives guarantees or securities for the due repayment of any loan and din respect of such loan an interest is changed at the rate not less than the rate of prevailing yield of one year, there years or ten years Government security closest to the tenor of the loan; or

c. 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.

It is to be noted that where holding company is allowed to advance loan and provide guarantee and security to wholly owned subsidiary company but in case of subsidiary company they can only provide guarantee and security.

It is further provided that loan made to wholly owned subsidiary company or subsidiary company must be utilized only for principal business activities.

4. PENAL PROVISIONS IN CASE OF CONTRAVENTION OF THE PROVISION OF THIS SECTION