Understanding of Amended Legal Position of Intercorporate Loans as per section 185 and Section 186 of companies act, 2013 in a simple language.
If you have started reading this article then you already know that section 185 and 186 deals with loan to director and inter-corporate loans and investment, but before explaining the changes in these section in detail, let me tell that why do we need this section, because to become a professional, it is not only to know the provision but also necessary to have the knowledge regarding the reason for such provision. So, let’s begin.
Every company needs the funds to carry out its operating activities and for this, they can use their own capital or take loans from other entities or banks. Although, there is one more important source of fund used by the company, is Inter-corporate loans and investments. However it is seen in many instances that the company took the loan for their operating use but it further gives a loan to director or its relative without any interest and they use it for their own personal purpose and when company becomes unable to repay the loan amount to banks, it becomes the bankrupt and the ultimate loss have to be bear by the innocent shareholders.
Hence, the Companies Act, 2013 has provided us the specific provisions for providing loans to directors and companies in which directors are interested. Also, it gives guidance on loans, securities, and guarantees given to subsidiary companies. Companies can also make investments in other entities up to specific limits as prescribed in Section 186 of the 2013 Act.
Section 185: Restriction on loans to the directors of a company
Recently there is a major amendment made in section 185 of the companies act. Almost the whole section has been changed. So, if you have already known the old provision of this section, then it would not be difficult for you to understand this section.
As per section 185 of companies act,
- A company cannot give any loan,
- Including loan represented by a book debt,
- Directly or indirectly to any of its directors
- Or the person related to such director
- Such restriction has also extended to any guarantee given or security provided in connection with a loan.
However, in certain situations, companies are allowed to give a loan or provide guarantee/security.
In other words, as per the amended provisions, there are certain situations in which the advancement of loan or guarantee or security is partly prohibitive and partly restrictive.
In this section, you can easily relate that there is a prohibition on loan to the director but what if the director has taken the loan in the name of its relative. Lawmaker already knows this fact and due to this, they have also inserted one more line with directors I,e, “person related to the directors” and explained the person covered in this insertion.
The person who covered under “person related to the director” are:
- Directors of the company, or
- Directors of a holding company.; or
- Any partner of such director or Relative of such director;
- Any private company of which any such director is a director or member;
- Any body corporate at a general meeting of which at least 25% of the total voting power is being exercised or controlled by any such director, or by two or more such directors, together;
- Any body corporate, Managing Director, the board of directors, or manager, whereof is accustomed to act as per the directions or instructions of the board of directors, or of any director or directors, of the lending company.
Till now, we have discussed the provision which contains the prohibitions on the director and person related to such director for taking the loan or guarantee or security of a company. Now we will understand the exception to this provision.
As per the amended provisions of section 185, companies are allowed to grant loans/guarantees/securities to other entities in which directors are interested,
However, it can be possible only with the prior approval of the shareholders by a special resolution and with the condition that such loans would have to be utilized by the borrower for its principal business activities, not for further investment or grant of loan.
Also, in the provision of the amended law, full details of the loan/guarantee/security are required in the explanatory statement to the notice of the general meeting.
The exemption is given To the Private Companies
As we already discussed above that the amended section 185 seeks has completely changed the existing provisions of section 185 of Companies Act, 2013. Although there’s an exemption notification dated June 5, 2015, came which shall continue to apply in the amended provisions of section 185 which contains that the said section shall be not applicable to private companies subject to the conditions as mentioned in the notification.
As per the notification, the provisions of Section 185 shall not apply to those private company –
- In whose share capital, no other body corporate has made an investment in such a company.
- The amount of borrowings from banks/financial institutions/ any body corporate is less than 2 times of its paid-up share capital of INR 50 crore, whichever is lower
- The company should not be made any default in repayment of such borrowings subsists at the time of making transactions under Section 185 of the 2013 Act.
Other Exemptions given in Section 185 shall which shall remain unchanged
(a) Company can give the Loans to Managing Director or Whole Time Director, only subject to the conditions which are
(i) As a part of conditions of service or
(ii) Bypassing a special resolution.
(b) Loan given in the ordinary course of the business and the rate of interest charged shall not be less than the rate of prevailing yield of 1 year, 3 years, 5 years or 10 years Government security closest to the tenor of the loan.
(c) Loan or any guarantee or security provided by holding company to its WHOLLY OWNED subsidiary.
(d) Any guarantee is given or security provided by a holding company to a bank or financial institution which gives the loan to its subsidiary company. It is to be noted that, here, it is not necessary that the subsidiary company should be a wholly-owned subsidiary.
Penalty for Non-Compliance of provisions:
The amended section 185 has also levied the penalty provisions to an officer of the company, as defined in section 2 (59) which include any director, manager or key managerial personnel or any person in whose directions or instructions the Board of Directors or any one or more of the directors is or are accustomed to act. Hence, the ambit of the Penalty provision has been widely extended.
Now we will look at the provisions of sec-186 of the Companies Act – 2013
Limits for Loan/Guarantee/Security/Investments (Sec-186(2)):-
As per the provisions of the subsection of 2 of Section 186 of the Companies Act, 2013, Company shall not directly or indirectly
- Give any loan to any person or any body corporate,
- Give any guarantee or provide security to any other body corporate or person and
- Acquisition of the securities by way of subscription, purchase or otherwise of any body corporate exceeding
60% of paid-up capital (+) free reserves (+) securities premium account
100% of its free reserves (+) securities premium account,
Whichever is more
In the amendment, it has excluded the employees of the company from the term ‘person’ to whom a company cannot directly or indirectly give loans exceeding the prescribed threshold. The same has also been clarified by the Ministry vide it’s General Circular  dated 10th March 2015. However, the said Circular specified the 2 conditions for such exclusion which are:
The loan is given should be as per the terms of service policy of the company along with
The same should be provided as per the terms of remuneration policy of the company – these conditions are no more applicable, as the provision directly excludes employees from the term ‘person’
Non-applicability of provisions of section 186 in which no change has been made in companies act:
Section 186(11): Non-Applicability of Section
Now we will discuss those companies on which this section shall not be applicable:
- banking company, or
- an insurance company, or
- a housing finance company engaged in its ordinary course of the business, or
- a company established with the object of providing financing industrial enterprises, or
- infrastructure company;
which has made any investment in – (a) made by an investment company, (b) made in the shares allotted in pursuance of clause (a) of subsection (1) of section 62 of the Act or in shares allotted in pursuance of rights issues made by a body corporate;
Made, in respect of investment or lending activities, by a non-banking financial company whose principal business is the acquisition of securities and registered under Chapter III B of the Reserve Bank of India Act, 1934.