Understanding Section 185 of Companies Act, 2013

Understanding Section 185

Section 185 of the Companies Act, 2013 is the replacement section of 295 of the Companies Act, 1956. Upon a perfunctory glance at the section, the key points of departure from the old act is wiping out of Central Government’s Approval and applicability of the said section to public as well as private Companies.

The Section initiates with the words “Save as otherwise provided” it must be pointed out that no other section supersedes this section.

Section 185 of the Companies Act, 2013 can be termed game of Loans, wherein the Companies cannot advance loan to its directors or to any other person in whom director is interested. However, exemption has been provided to:-

(a).  the Company can grant loans to MD or WTD, where the Company extends as a part of service to all of its employees or pursuant to any scheme approved by all the members by Special Resolution.  

(b). the Companies which in ordinary course of business provides loan or guarantees.

It may be noted that nowhere in the act, lack of clarifications and precedents of the term “Ordinary Course of business” leaves a great room for subjectivity. However, one may argue that objects provided in main object clause of Memorandum of Association would be adequate for it to meet the criteria of ordinary course of business. On the Contrary, if the same business is not being undertaken regularly would be debatable for being considered in ordinary course of business of the Company.

In the Following cases the director shall be assumed to be interested and thus loans cannot be provided: - (i.e. explanation of the term “any other person whom director is interested”)

Situation 1

Mr. A is a director in Company M/s. XYZ Pvt. Ltd. and also a partner in M/s. ABC & Associates then loan cannot be to M/S. ABC & Associates as it shall be construed as Loan to Mr. A, director of M/s. XYZ Pvt. Ltd. and loan to director is strictly prohibited under section 185.

Solution / Planning / Legal opinion:

a. Either Mr. A should resign from directorship.  OR

b. Either Mr. A should resign from partnership firm. OR

c. Convert Co. to LLP.

Situation 2

Mr. A is director in M/s. DEF Pvt. Ltd. & also in M/s. GHI Pvt. Ltd. then either of the Companies cannot give loan to other parties. However, it’s worthy to note that even if Mr. A is a member of first / second mentioned company alongwith director in second / first mentioned company then too loan cannot be provided.

Solution / Planning / Legal opinion:

a. Mr. A should resign from directorships of either Company.

b. Convert either of the Company to LLP.

c. Mr. A should gift his shares held in either of Companies to another person as gift of shares is tax free.

Situation 3

Mr. A & Mr. B are the directors of M/s. JKLMNO Ltd. & and exercise 15% and 10 % of total voting power at general meeting of M/s. PQRS Ltd. then loan cannot be advanced to M/s. PORS Ltd.

Solution / Planning / Legal opinion:

a. Mr. A or Mr. B should resign from directorship. OR

b. Convert the Company to LLP. OR

c. Mr. A or Mr. B should bring down atleast 1% of their shareholding.

Situation 4

If the Board of directors of borrowing Company are accustomed to act in accordance with directions of Board of directors / director of lending Company then loan cannot be given.

Yet another challenging term is “accustomed to act” which adds to qualms to this section. Due to lack of Indian judicial precedents, lending the meaning from UK jurisprudence would be appropriate to large extent; wherein it was held that a person shall not be a shadow director where the person has acted only once instead there should be “proof of pattern of conduct” thus the question of determining accustomed to act is fact based and subject to litigations too.

It must be noted that in case of existing loans to directors; the Companies may opt the saving clause which provides that any exemption taken under 1956 would remain valid. But it shall here be noted that any renewal shall attract the provisions of this section.

However, one may interpret the term “accustomed to act” in following manner:-

Illustration 1

Company ABC Ltd.

In the above case; all the directors of Borrowing Company, are accustomed to act in accordance with Directions of Lending Company, so provisions of sec. 185 are attracted and thus loan, guarantee or security cannot be provided.

Illustration 2

In this case; Mr. A can be considered accustomed to act reason being Mr. A is MD in M/s. XYZ Ltd. and director in M/s. DCE Ltd. and thus will attract provisions of section 185 of the Act and thus loan cannot be given.

Illustration 3

In this case; Mr. A is WTD in M/s. XYZ Ltd. and director in M/s. DCE Ltd. and thus will not attract provisions of section 185 of the Act and thus loan can be given because the section specifically specifies for Managing Director and Board of the directors. And in this case none of these conditions are satisfied, thus loan can be given.  

The author of the above is Mr. Sumit Talreja, he can be contacted at: 08819016904.  For any Suggestions, Comments & Queries you may contact the Author at talreja.sumit27@gmail.Com