Section 185 of Companies Act, 2013 - Loan to Directors

Section 185 & its reference with Section 186 of Companies Act, 2013

Section 185 of the Companies Act, 2013 which has been notified on 12th September 2013 corresponds to section 295 of the Companies Act, 1956 which deals in loan to directors. This section is more restrictive than that of old Companies Act, 1956.

Section 185 prohibits any company from giving loans, guarantees and securities in favor of its directors or to any other person in whom the director is interested in.

Bare – Act:

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 twenty five per cent 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:

a) This section applies to both private and public companies,

b) No company can directly or “indirectly” advance loan to its “directors” or to “other persons in whom directors are interested”

Indirect lending means that the company does not give a loan to director through the agency of one or more intermediaries. But, this word of ‘indirect’ cannot be read by converting what is not a loan into a loan as was discussed in Dr Fredie Ardeshir Mehta Vs Union of India (1991) 70 Comp Cas 210,

c) Definition of loan is not mentioned in the companies act. Therefore in layman language, it can be said that all transactions where sum of money is given to a person to be returned with or without interest can be termed as loan,

d) But advance is not covered in the definition of loan as it is a kind of prepayment. For eg, if the company gives advance to a person against purchase of materials, this will not be treated as loan,

e) Share Application money received is also not covered in the definition of Loans,

f) Company cannot give any guarantee or provide any security in connection with any loan taken by him or such other person,

Now, this is restrict a very common situation of holding company that used to give guarantee of its subsidiary company, so that the later could avail bank funding and loans (if holding company and subsidiary company have common directors),

But, it is to be taken into consideration that here guarantee or security is covered but not letter of comfort. The basic difference between guarantee and letter of comfort is that in case of guarantee, guarantor undertakes the liability of principal debtor, whereas in letter of comfort, guarantor does not undertake any liability of principal debtor but instead introduces him to the third party.

g) Also, company cannot give loan which is represented under the head ‘book debts’ to directors or persons in whom directors are interested, i.e. if a company advances a loan/ sum of money to directors and shows the same under the head of ‘book debts’, i.e. director is debtor from whom company has to receive money is also prohibited.

It is to be noted that Section 296 of Companies Act, 1956 considered a book debt as loan for the purpose of Section 295. Time for repayment & other terms & conditions should be considered to consider any debt as a loan.

h) Loan given before 12.08.2013 is not covered under this section as the act says "no company shall 'advance' any loan or 'give' any guarantee or 'provide' any security…….” which is in future tense and therefore the section applies prospectively. But, the same loan should not be renewed or altered.

i) Company shall maintain a register in Form MBP 2 and enter therein separately, the particulars of loans and guarantees given, securities provided and acquisitions made as aforesaid in chronological order in respect of each such transaction within seven days of making such loan or giving guarantee or providing security or making acquisition. The entries in register is to be signed and authenticated by the company secretary employed in the company or by any other person authorised by the Board for the purpose.

j) Penalty:

i. Lender Company – Fine Rs. 5 lakhs to Rs. 25 lakhs &

ii. Receiver: Director or other person to whom any loan is advanced or guarantee or security is given -Imprisonment upto 6 months or fine Rs. 5 lakhs to Rs. 25 Lakhs, or both.

i.e. both receiver and lending company is covered here.

Now lets us discuss the term, “to any other person in whom director is interested”

a) INDIVIDUAL: Director of  lending co., or holding co. or any partner or relative of any  “such director”; 

b) FIRM: in which any such director or relative is a partner;

c) Private Limited Company: of which  such director is a director or member;

(it is to be seen that in case of companies, relative of director is not covered),

d) BODY CORPORATE at a general meeting of which at least 25 % of  voting power may be exercised  or “controlled” by such director, or by two or more such directors, together;
(it is to be seen that in case of companies, relative of director is not covered),

Meaning of word “control”: "Control" has been defined u/s 2(g) of Companies Act, 2013 as to include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholding or management rights or shareholders agreements or voting agreements or in any other manner.

e) BODY CORPORATE Board, Managing Director or manager, whereof is accustomed to act in accordance with the directions or instructions of Board, or of any director or directors, of  lending company.

Exceptions to section 185:

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. 

Ordinary Course means that its usual business is to lend & accept loans & deposits from people. It has 2 tests:

i.  If the company is engaged in lending activities  regularity &

ii. Lend  not only to directors/directors’ entities but also to “arms’ length parties/unrelated parties”. Arms length means to give loan to reasonable parties or at reasonable interest rate at which two or more rational people will give their consent.

It is to be noted here that a company is said to be engaged in ordinary course of lending even if its 10% networth has been advanced as loan or even  10% revenue comes from lending activities and principal business of lending when  its 50% networth has been advanced as loan or its more than 50% revenue comes from lending activities. Section 185 exempts even those company who are engaged in ordinary course of action.

Section 186:

186(2) No company shall directly or indirectly —

a) give any loan to any person or other body corporate;

b) give any guarantee or provide security in connection with a loan to any other body corporate or person; and

c) acquire by way of subscription, purchase or otherwise, the securities of any other body corporate, exceeding sixty per cent. of its paid-up share capital, free reserves and securities premium account or one hundred per cent. of its free reserves and securities premium account, whichever is more.

Now, to see that whether section 185 renders section 186 inoperative or allows loans to directors and to persons in whom directors are interested, following points is to be considered:

i. Section 185 uses the word, “Save as otherwise provided in this Act”,

ii. Rule of Harmonious Construction is to be used, i.e. law should be interpreted in the manner taking into consideration all other relevant provisions. Relevant provisions cannot be read in isolation. Therefore, section 185 or section 186 is to be operative here but since, section 185 uses the word “Save as otherwise provided in this Act”, this section gets superior position to section 186 and thereby, section 186 gets inoperative in conditions where section 185 prevails.

Planning:

If one company has to advance loan to other company:

i.  If that company is a Private Company: then if there are common directors or director of lending company is member of receiving company, just gift the shares to some one else and resign from the post of directorship (if held),

ii. If that company is a Public Company and directors are holding less than 25% of total voting powers: Section 185 is exempt, and

iii. If that company is a Public Company and directors are holding equal to or more than 25% of total voting powers, then liquidate those powers.

iv. Holding company can give loan/guarantee to subsidy company by removing common directors and gift their shares to some one else.

Author:

Sagar Gupta

Email: info@onlinelawsolutions.com

Website: www.onlinelawsolutions.com