Introduction
Through the Companies (Amendment) Act, 2017 (“Amendment Act”), the
existing Section 185 of the Companies Act, 2013 (‘the Act’), which deals with
Loan to directors, etc has been completely substituted with the new provisions
w.e.f 7th May,2018.
The substituted Section 185 deals with the restrictions on part of the
Companies in advancing any loan or giving any guarantee or providing any
security and to those whom a Company can provide such loan or guarantee or
security subject to compliances under the Act. Also, section provides relaxation
for Individuals and Entities from the provisions of Sec. 185 subject to certain
conditions and Punishment for those who contravene the same.
This article aims to bring a clear vison on the newly substituted
provisions of Sec 185 and the practical issues prevailing thereon.
Rationale Behind Substitution of Section 185
Sec. 185 was completely
substituted with the new section through the Amendment Act, 2017. The Amendment
Act was based on suggestions of the Companies Law Committee, constituted by the
Ministry of Corporate Affairs (MCA), in its report dated 1st February
2016, with the aim to strengthen corporate governance and ease doing business in the
country. Recommendations for amendment along with the reasons were clearly
reported in the report.
The Extract of the
committee’s report w.r.t Sec. 185 is reproduced below for reference:
“Loans to Directors, etc.
12.14
The Committee acknowledged that there are difficulties being faced in genuine
transactions due to the complete embargo on providing loans to subsidiaries
with common directors, but at the same time there is no doubt that the route
has been misused in the past for siphoning of funds by controlling
shareholders. The Committee noted that
limited relaxation has already been provided to private companies not having
other body corporates invested in them and therefore any further relaxation
should be subject to greater safeguards. The Committee, therefore, recommended,
that it may be considered to allow companies to advance a loan to any other
person in whom director is interested subject to prior approval of the company
by a special resolution. Further, loans extended to persons, including
subsidiaries, falling within the restrictive purview of Section 185 should be
used by the subsidiary for its principal business activity only, and not for
further investment or grant of loan.
12.15
The Committee also felt that there was no rationale as to why the interest rate
prescribed in the proviso (b) to Section 185(1) should not be aligned with the
rate prescribed under Section 186(7). Thus,
it recommended that this be aligned, keeping in mind further changes suggested
to the provision, in the succeeding paragraphs dealing with other issues in
Section 186.”
Facts about Section 185 of the Act
a) Sec. 185 brought to force from 12th September, 2013 and Corresponds
to Sec.295, 296 of the Companies Act, 1956.
b) There are no rules prescribed, at present, for Sec. 185
under the Companies Act, 2013.
c) Other sections of the Act relating to Sec. 185 are Sections
177, 179 and 186.
d) This section shall not apply to a Govt. Companies,
Private Companies and Nidhi Companies subject to conditions specified in MCA’s Exemption
Notification dated 5th June, 2015 and 13th June 2017.
e) Sec. 61 of the Companies (Amendment) Act,
2017 completely substituted the existing Sec. 185 with new provisions w.e.f 7th May,2018.
Provisions of Substituted Section 185
(After the Amendment Act, 2017)
Subsection 1 states that a Company (Private & Public whether small,
OPC, Start-ups etc.) shall not directly or indirectly, advance any
loan (including loan represented by a Book debt) OR give any
guarantee OR provide any security in connection with any loan take by:
a)
Any director of the company; or
b)
Any director of its holding company; or
c)
Any partner of any such director; or
d)
Relative of any such director;
e)
Any firm in which any such director is a
partner; or
f)
Any firm in which the relative of any such
director is a partner;
(Note: The Term “any Such” would mean in reference to the director of
the lending company and/ or in relation to the director of its holding company)
This subsection strictly prohibits providing Loan or Guarantee or Security
to the aforesaid Individuals and firms.
Subsection 2 states that a Company can advance any loan (including Book
debt) or give any guarantee or provide any security in connection with any loan
taken by
(a)
any private company of which any such
director is a director or member;
(b) any body corporate at
a general meeting of which not less than 25% of the total voting power may
be exercised or controlled by
a. any such director, or
b. by two or more such
directors, together; or
(c) 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
a. Board; or of
b. any director or
directors, of the lending company.
However, the above provisions are subject to following conditions that:
a)
A special
resolution is passed by the Company in general meeting; and
b)
The
loans are utilised by the borrowing company for its principal business
activities.
Subsection 2 allows companies to provide loan/guarantee/security
to other Companies / body corporates subject to conditions. This was earlier
prohibited and now relaxed.
As per Subsection 3, the following entities and individuals are exempted
from complying with subsection 1 & 2 as explained above, subject to certain
conditions:
a) 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 way of special resolution;
b) Company which in the
ordinary course of its business provides loans or gives guarantees or
securities for the due repayment of any loan e.g Banking Companies and Loan NBFCs. (In respect of such loans an
interest shall be charged at a rate not 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) 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; (in case of WOS complete relaxation from Sec.
185).
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. (Unlike class ‘C’
(i.e WOS) only Guarantee & Securities provided for loan made by any bank
or financial institution are allowed for subsidiary company).
Provided that the
loans made under clauses (c) and (d) are utilized by the subsidiary company for
its principal business activities.
(In order to ensure that the companies do not take advantage of the
relief, the provision ensure that there is no siphoning of funds received by
the companies, as the amount received under this section should be utilised by
the borrower for its principal business activities and not for further
investment or grant of loan.)
(Even though ‘principal business activity’ has
not been defined under the Act, generally the activities provided in the main
objects of the MOA will qualify as the principal business activity of that
company)
Subsection
4 talks about the punishment, where any loan advanced or a guarantee
or security given or provided or utilized in contravention of the provisions of
this section.
In case of
|
Punishment
|
Remarks
|
Lending Company
|
Punishable with fine which shall not be less than Rs.
5 lakh but which may extend to Rs. 25 lakh
|
Only Fine
|
Officer in default
|
Punishable with imprisonment for a term which may
extend to 6 months or with fine which shall not be less than Rs.
5 lakh but which may extend to Rs. 25 lakh.
|
Fine or imprisonment
|
Recipient Director/ Entity
|
Punishable with imprisonment which may extend to 6
months or with fine which shall not be less than Rs. 5 lakh but which
may extend to Rs. 25 lakh, or with both.
|
Fine or imprisonment or both
|
Under this subsection, specific offence of contravention
in utilization of loan and punishment for officers in default is introduced vide
the Amendment Act.
In
Simple words,
Summary of Section 185 after the Amendment Act
 |
| Summary of Provisions of Sec. 185 |
Substantial Changes made under Section 185 by the Amendment Act
Ø New section omitted
the words “save as otherwise provided in the Act” to avoid confusion as
to whether the provisions of section 186, which starts with “without prejudice
to the other provisions”, can exclude section 185.
Ø By this new
section, Companies are allowed to grant loans, guarantees and security to
entities in which directors are interested, in certain cases, subject
to prior approval of the shareholders by a special resolution and on the
condition that such loans are used by the borrower for its principal business
activities.
Ø Interest rate
prescribed in the proviso (b) to Section 185(3) is aligned with the
rate prescribed under Section 186(7) of the Act. Prior to amendment it was “interest
at a rate not less than the bank rate declared by the Reserve Bank of India”.
Ø The ambit
of the penalties has been widened and as a result, the obligations of
every “officer” of a company (as defined in Section 2(59) of the Act) have been
increased to ensure that all loans, security and guarantees are in compliance
with the provisions of the Act failing which officer of the company who is in
default shall be liable for penal actions and may also attract criminal
liability. Also, in the list of offenses under this section, specific offence
of contravention in utilization of loan has been added.
Exemptions from
Section 185
Other
Provisions of the Companies Act relating to Sec. 185
While providing the Loan
or Investment or Security and guarantee, in addition to Sec. 185, the Company shall
also comply with the following provisions of the Act:
Section 177 (4) (v): Every Audit
Committee shall scrutiny of inter-corporate loans and investments.
Section
179(3) (e): The Board of Directors of a company shall exercise the power to
invest the funds of the company by means of resolutions passed at meetings of
the Board.
Section
180(1)(d): To remit, or give time for the repayment of, any debt due from a
director.
Section
186: Loan and Investment by Company.
Practical Problems / Case Laws for better understanding
Problem: Abc
Ltd is a Computer manufacturing company. One of the Directors Mr. A is setting
up an Office for which he will also need to buy Computers. Mr. A asks the
Company to give him 20 Computers for a long credit period. Whether is there any
restriction on this transaction?
Solution: As per Sec. 185 (1) providing loan either directly or indirectly, including
any loan represented by a book debt to any director of company, is
prohibited. Hence, this transaction is prohibited and violation of Sec.
185.
Further, in the case of “Pennwalt India Ltd. v. RoC”,
wherein the Hon’ble High Court of Bombay has held that to ascertain whether a
transaction is a loan or not, surrounding circumstances, relationship and
character of the transaction and the manner in which parties treated the
transactions will have to be considered. Therefore, with reference to
each transaction with Directors and other person in whom the Directors are
interested, the nature of transactions has to be studied, in case they relates to
book debts.
Question:
Whether a company can lend through intermediary to the persons who are
otherwise related with the lending company?
Answer: Under subsection 1 of Sec. 185 a company shall not advance any loan either
directly or indirectly. Further, in the case of Dr.
Fredie Ardeshir Mehta V. Union of India [1991] 70 Comp. Cas. 210 (Bom.), the
term Indirect used in the Section 295 of CA, 1956 (now Sec.185 of CA, 2013) is
interpreted as “When Section 295 refers to indirect loan to director, what it
means is that the company shall not give a loan to a director through the
agency of one or more intermediaries.” The word “indirectly” used in Sec. 295
cannot be read as converting what is not a loan into a loan. Therefore,
the company shall not lend through intermediary to the persons who are
otherwise related with the lending company.
Question:
Is the section applicable to a letter of comfort (LoC) given by the company?
Answer: No, Guarantee has been covered, however, LoC is not
covered by sec 185. In case of Guarantee,
guarantor undertakes the liability of principal debtor, whereas In case of
letter of Comfort, intention is to give introduction of debtor, without
undertaking the liability of principal debtor. The word guarantee is
defined in the Contracts Act to imply the “undertaking of the liability of a principal
debtor by the guarantor”. However, in case of letter of comfort, the commitment
of comforting party is merely to the extent of introducing the principal debtor,
but there may be a moral obligation, but there is no contractual obligation of
the comforting party, and hence, there is no guarantee. Therefore, LoC is not
covered under the Sec. 185.
Problem:
Abc Ltd provided corporate guarantee to Xyz Pvt Ltd ( Mr. A, shareholder of Abc
Ltd is also a director in Xyz Pvt Ltd) on 01.07.2018. Later on in the view of
conditional exemption u.s 185(2), the Abc Ltd obtained approval of shareholders
for the said corporate guarantee on 20.07.2018. Whether this transaction is
violative of Sec. 185? Whether Prior Approval of shareholders are required for
loans to certain entities under Sec. 185 (2)?
Solution: As per the substituted Section 185, Company may provide loan/guarantee
to any person in which director is interested u/s185(2), subject to the condition
that A special resolution is passed. This condition has to be prior
approval, because only after meeting with this condition, company is allowed to
give loan/guarantee to any person as specified under Section 185(2). Hence,
this transaction is violative of Sec. 185 and prior approval of members is
mandatory.
Problem:
ABC Ltd grants loan to its director Mr. A for Construction of flat / house
pursuant to a Loan Scheme approved by the shareholders by way of Special
Resolution. Whether the same violates Sec. 185? Also, whether the director is
criminally liable?
Solution:
Yes, as per Sec. 185 (3), giving of any loan to a managing or whole-time director
alone is exempted from the provisions of Sec. 185 subject to the
condition that it was provided pursuant to scheme approved by the members by a
special resolution. Hence, providing loan to Mr. A who is not WTD or MD is
violation of Sec. 185 and the director is criminally liable.
Problem:
Abc Ltd, Lender Company and also Subsidiary of Xyz Pvt Ltd. Abc Ltd wants to give
Loan/Guarantee/ Security to Holding Company. Whether the same is possible in the
following scenario i) Where Directors of Abc Ltd are also shareholders of Xyz Pvt
Ltd. ii) If the holding Company is Public Limited.
Solution: (i) Where Directors of Lender Company are Directors or shareholder of
Holding Company, it will fall under u/s 185(2). Therefore, Subsidiary can give loan to
holding Company by complying with conditions of subsection 2 of Sec.185
i.e prior approval of the shareholders by a special resolution and such loans
are used by the borrower for its principal business activities.
(ii) If the Holding Company is Public Limited Company, Lender
(Subsidiary) can give loan to such holding Company and such transaction will not
fall u/s 185.
Problem: ABC
Pvt Ltd and XYZ Pvt Ltd does not have any common director. In ABC Private
Limited, Mr. R is a Director and in XYZ Private Limited, the wife of Mr. R is a
Director. In this scenario whether the provisions of Sec. 185 will attract?
Solution: In such a situation, the loan can be given by ABC Pvt Ltd to XYZ Pvt
Ltd. The condition mentioned u.s 185(2) is common directorship i.e “private
company of which any such director is a director or member”. It clearly
excludes the relative of director and hence the provisions of Sec. 185 will not attract.
Conclusion
When the section was originally introduced, there were complete
prohibition on loan to its directors and other entities and it was felt that
the said changes were much required for better governance & transparency in
the affairs of the Companies keeping in view the fiduciary character of the
directors.
However, the section was quite harsh when it came to implementation, even
the deserving and genuine cases were debarred from raising Loans from the
Companies. Considering the same and for ease of doing business in India, the relief
has been given to certain entities vide the substituted provisions, while at
the same time providing adequate safeguards and additional responsibility on
the part of company and its officers.
DISCLAIMER: The information
given in this document has been made on the basis of the provisions stated in
the Companies (Amendment) Act, 2017 and Companies Act, 2013. It is based on the
analysis and interpretation of applicable laws as on date. The information in
this document is for general informational purposes only and is not a legal
advice or a legal opinion. You should seek the advice of legal counsel of your
choice before acting upon any of the information in this document. Under no
circumstances whatsoever, we are not responsible for any loss, claim,
liability, damage(s) resulting from the use, omission or inability to use the
information provided in the document.
