Section 185 of companies outline the company law requirements concerning direct or indirect borrowing or company directors’ advances. Loans or advances include loans represented by the book debt or those to which the director is or may offer any assurances in connection with or assurance of any loan taken by him or that other person. Loans shall include any loans or advances. The provisions of Article 185 of the Act on Companies of 2013 clarify also the filing condition for loan or advance to directors and the penalty of the violation.

Introducing of Section 185 of the Companies

The original Section 185 of the Companies Act of 2013 (the “Amendment Act”) concerning Loan to Directors and so forth has fully replaced the new provisions (see e. g. 7 May 2018), by the Company Act of 2017 (“Amendment Act”).

Section 185 replacing this section discusses the limits on companies’ advance or guarantee or guarantee of any loan and on those who are permitted to offer such loans or guarantees or securities subject to compliance under the Act. Furthermore, this section provides relief for individuals and entities under certain circumstances from the provisions of Sec. 185 and punishment for persons who contravene it.

The goal of this article is to provide a clear view of the newly replaced provisions of Section 185 and the practical questions that prevail thereon.

What is a loan for directors?

Loans to directors may be granted subject to certain conditions. Under section 185 of the Companies Act, 2013, the Company may not provide loans directly or indirectly, including any loans represented by credit cards.

  • To any of its directors
  • To any other person the Director is interested in, or
  • Provide any security in respect of loans taken by the Director or any such person

For purposes of Section 185 of the Companies Act, 2013, the expression “any other person to whom a director of interest” means :

  • Any Company whose relative is a Partner
  • Any Company whose relative is a director
  • Any Corporate Body where it holds or controls 25% or more of the voting power
  • Any Corporate Body headed by a Director / Manager / Board of Directors acts as directed.

Section 185 of the Companies Act, 2013, read with Act 10 of the Companies Act (Board Meeting and its Powers), 2014 provides that a Company may not guarantee or lend to directors or any other person related to a Company Director. The rules and the above provisions make it clear that the Director must not be involved in any activity that benefits him or her personally.

Loan to Any Interested Person Of A Director

A business can advance loans, including any loan represented by a book debt, or provide a guarantee or protection for any loan taken to a person in whom any of the corporate administrators are involved. Section 185(2) allows a corporation to offer loans to any person/entity in whom any of the administrators have an interest the subject to certain conditions.

The conditions which are to be fulfilled for advancing loans or providing guarantee or security to the person in whom the director is interested is that a special resolution generally meeting is to be passed which the borrowing company utilizes the loans granted for its principal business activities. The explanatory statement to the notice of the overall meeting during which such a resolution for granting the loan is passed should disclose the complete particulars of the loans or guarantee given or security provided and therefore the purpose that the loan or guarantee or security is proposed to be utilized by the person receiving the loan.

The Act provides the list of the persons who are considered as persons in whom any of the administrators of the corporate is interested. the corporate can advance the loans or give the guarantee, or security only to those persons. They are-

  • Any Private Limited Company of which any director of the lending company may be a director or member.
  • Anybody is corporate at whose general meeting not but twenty-five percent of the entire voting power could also be exercised or controlled by any director of the lending company, or by two or more such directors together.
  • Any body corporate, director, the board of directors, or manager, which is familiar with act following the directions or instructions of the board, or of any director or directors, of the lending company.

Loan to subsidiary by company

In the Companies (Amendment) Act, 2015, the exemption is given to the company that provides a loan, guarantee, or securities to the wholly-owned subsidiary. The subsidiary uses the loans which are given for its principal commercial activity.

Loan by Companies in Ordinary Business

In the ordinary course of business, a Company provides loans, guarantees, or provide security as long as the speed of interest is charged at a rate not but rate prevailing declared by the Federal Reserve Bank of India (RBI).

Loan by Bank and Financial Institutions to a subsidiary

The Companies (Amendment) Act, 2017, the exemption is given to the company which provides security and guarantee in respect of a loan made by any bank or financial organization to its subsidiary. The subsidiary should use the Loans which are given for its principle commercial activity.

Loan by Private Companies

The Companies (Amendment) Act, 2017, a personal Company can provide for a Loan including a Loan represented by book debts, or give a guarantee or security in connection to the loan taken by a person in whom the Director of the Company is interested. The loan is often given only a special resolution is passed within the general meeting. The statement of the resolution should disclose:

  1. All the particulars of the loan given
  2. The purpose that the recipient proposes the loan, guarantee, or security.
  3. The loans are utilized by the borrowing company for the principal commercial activity of its Company.

The requirement of Filling: 

Upon the adoption of the Special Resolution by the representatives of the Board, the Company shall, within 30 days of the adoption of the Special Resolution, file form MGT-14 with the same ROC concerned. 

Cases in which the Organization does not need a Special Resolution, even though the above limitations are exceeded: 

  • Managing Director or Whole Time Director’s loan: 
  • Under the Employee Stock Option Plan, as a condition for the services provided by the company to all its employees.
  • The ordinary course of business of the Lending Company is the lending or provision of loans and the rate of interest paid should be greater than the Government Security’s prevailing yield closest to the loan duration.
  • The loan or guarantee was given to its wholly-owned subsidiary. 
  • The guarantee is given to its subsidiary business about the loan obtained from any bank/financial institution.

Important Changes made under Section 185 by the Amendment Act

  •  In order to avoid confusion as to whether the provisions of section 186, which begins with “without prejudice to the other provisions” can exclude section 185, the new section omits the words “save as otherwise provided in the Act.”
  •  This new section allows companies to issue loans, guarantees, and securities to organizations in which directors are involved, subject, in some situations, to the prior approval of the shareholders by special resolution and on condition that such loans are used by the borrower for the principal business of the company.
  •  The interest rate set out in clause (b) of Section 185(3) is consistent with the rate set out in Section 186(7) of the Act. It was “interest at a rate not less than the bank rate declared by the Reserve Bank of India” prior to the amendment.
  •  The extent of the penalties has been broadened and, as a result, the duties of each company’s ‘officer’ (as specified in Section 2(59) of the Act) have been increased to ensure that all loans, protection, and guarantees compliance with the provisions of the Act in which the company’s defaulting officer is liable for penal acts and may also be liable for criminal liability. The special offense of contravention in loan use has also been added to the list of offenses under this clause.

Exemptions

Section 185(3) of the Act provides exceptions to the restrictions on the corporate to grant loans. the corporate can advance loans or provides a guarantee, or security to-

  • The manager or full-time director of the terms of service extended by the company to all or any of its employees as a neighborhood or under any scheme authorized by a special resolution by the representatives of the company.
  • A company that gives loans or gives guarantees or securities for the due repayment of any loan within the ordinary course of its business. The interest in respect of such loans advanced is charged at a rate not but the speed of the prevailing yield of 1 year, three years, five years, or ten years agency security closest to the tenor of the loan.
  • Any loan is given by a company to its wholly-owned subsidiary or any guarantee given or security provided by a company in respect of any loan made to its wholly-owned subsidiary. The subsidiary must utilize such loans provided for its principal business activities.
  • Any guarantee is given or security provided by a company in respect of a loan made by any bank or financial organization to its subsidiary. The subsidiary must utilize such loans provided for its principal business activities.

Penalty

Section 185(4) of the Act lays down a penalty if the provisions mentioned above concerning providing loans are contravened. If the corporate advances loan in contravention to Section 185, the corporate shall be punishable with a fine which shall not be but five lakh rupees but which can reach twenty-five lakh rupees. Every officer of the corporate who is in default shall be susceptible to be punished with imprisonment for a term which can reach six months or with a fine which shall not be but five lakh rupees but which can reach twenty-five lakh rupees.

The director or the other person associated with the director, to whom any loan is advanced or guarantee or security is given shall be susceptible to be punished with imprisonment which can reach six months or with a fine which shall not be but five lakh rupees but which can reach twenty-five lakh rupees or with both.

Checklist

The points to be recognized under Section 185 of the Act while encouraging loans or giving guarantee or security with link to any loan are-

  • A company cannot advance loans to directors, their relatives, or partners, nor any guarantee or security with connection to any loan are often provided to them.
  • A company cannot advance loans to a firm during which a director may be a relative or partner nor can provide any guarantee or security with connection to any loan to them.
  • Loans are often advanced, and any guarantee or security with connection to any loan is often given to the person in whom the director of the corporate is interested after passing a resolution within the general meeting and if the loan amount is utilized by the borrowing company for its principal business activities.
  • Only the persons and entities mentioned in Section 185(2) are considered as persons in whom the director of the corporate is interested. Thus, the corporate must check if the persons to whom they need to grant a loan comes under the list of persons mentioned during this section as persons in whom the director is interested.
  • The company can grant a loan or provide a guarantee or security with connection to any loan to the managing, or whole-time director when the corporate satisfies the condition mentioned in Section 185(3) of the Act.
  • The company which provides loans or gives guarantees or securities for the due repayment of any loan in its ordinary course of business can grant a loan.
  • The company can grant a loan to its subsidiary if the corporate satisfies the condition mentioned in Section 185(3) of the Act.

Conclusion

The implementation of Section 185 gives rise to a total ban on the granting of loans to directors and other individuals and organizations affiliated with directors. Later on, it was considered that improvements in the Section for greater accountability and governance of the Company’s affairs should be made. The adjustments were made to keep an eye on the Directors of the Company’s fiduciary character. The section was updated to provide ease of doing business. Section 185 of the Companies Act, 2013, now permits the company and its officers to loan directors with sufficient protections and additional liability.

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