The companies initially used to exercise a practice of borrowing funds and then passing them to the subsidiaries and other associate companies through inter-corporate loans.
Although, when it comes to compliance with the terms of the loan agreement, the holding Company can take a step back, which leaves the subsidiaries in the lurch. In order to stop the exploitation of the subsidiaries, Section 185 of the companies act 2013 was established.
What is Section 185?
The original Section 185 forbade the firms from making any loans or providing security or guarantees for loans taken by the Company’s directors or anybody else in whom the directors have an interest.
Only businesses or recipients who received such a loan, security, or guarantee were eligible for penalties if discovered in violation.
The Companies (Amendment) Act of 2017 made the following changes to Section 185:
- Only applies to Directors of the Company or its holding Company, any partner of such a Director, any partner of such a Director, or any firm in which such Director or relative is a partner.
- Allows the Company to lend money to anyone or any firm that any of the directors are interested in, as long as the following conditions are met: – The corporation must pass a special resolution at a general meeting (Approval of at least 75% of the members is required). – The borrowing corporation may only use loans for the purposes of its main business operations.
- An officer in default of the Company is also subject to the penalty measures outlined in Section 185(4) of the Act – in addition to the Company (which is inclusive of any Director, Manager or KMP, or any individual in accordance with whose directions BODs are accustomed to act.)
Loan To Directors
Section 185(1) of the Act states that a company cannot –
- Advance loan directly or indirectly,
- Advance loan which includes a loan represented by a book debt,
- Give guarantee or provide security with connection to any loan taken
by a director, director of its holding company, partner or relative of any director, or any firm in which a director is a relative or a partner.
Thus, this Section prohibits granting loans to the directors or relatives or partners of the directors of the company.
Loan To Any Interested Person Of A Director
A company may advance loans including any loan represented by a book debt or give guarantee or provide security in connection with any loan taken to any person in whom any of the directors of the company is interested. Section 185(2) allows a company to give loans to any person/entity in whom any of the directors are interested in 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-
- The company must pass a special resolution in general meeting.
- The borrowing company must utilise the loan granted for its principal business activities.
- The explanatory statement to the notice of the general meeting in which such a resolution for granting the loan is passed should disclose:
- full particulars of the loans or guarantee given or security provided and
- purpose for which the loan or guarantee or security is proposed to be utilised by the person receiving the loan.
The Act provides the list of the persons who are considered as persons in whom any of the directors of the company is interested. The company can advance the loans or give the guarantee, or security only to these persons. They are-
- Any private company of which any director of the lending company is a director or member.
- Any body corporate at whose general meeting not less than 25% of the total voting power may be exercised or controlled by any director of the lending company, or by two or more such directors together.
- Any body corporate, managing director, the board of directors, or manager, which is accustomed to act in accordance with the directions or instructions of the board, or of any director or directors, of the lending company.
Exemptions to the Loans that are given to the Directors
For the Loans Given to Managing Directors or Time Directors | The loans to MD or WTD may only be provided if the following requirements are met: Where it is a requirement of the Company’s Policy of Service that loans be provided to all employees; In accordance with any plan that is properly approved by the members by way of a Special Resolution. |
The Loans that are Given by Banks and Financial Institutions | The following conditions must be met in order for a loan to be granted: The holding Company must offer security or a guarantee in connection with any loan issued to the subsidiary firm by a bank or other financial institution. The loan must be used for the primary business purpose of the subsidiary. |
The Loans Given to Subsidiary Companies | When a holding company gives a totally owned subsidiary company a loan, guarantee, or security, and that subsidiary uses it exclusively for commercial purposes. |
Loan to Directors by Private Company | Loans may be provided to businesses in the regular course of business if the interest rate on such loans is not less than the rate imposed at the time by the RBI. |
Penalty
Section 185(4) of the Act lays down penalty if the provisions mentioned above relating to providing loans are contravened. If the company advances loan in contravention to Section 185, the company shall be punishable with fine which shall not be less than Rs.5 lakh but which may extend to Rs.25 lakh.
The director or any other person related to the director, to whom any loan is advanced or guarantee or security is given shall be liable to be punished with imprisonment which may extend to six months or with fine which shall not be less than Rs.5 lakh but which may extend to Rs.25 lakh or with both.
FAQs
What is Section 185 of the Companies Act, 2013?
Section 185 of the Companies Act, 2013, governs the provision of loans, guarantees, or securities by a company to its directors or to any other person in whom the director is interested. It is designed to prevent any undue advantage or conflicts of interest arising from such loans or guarantees.
Can a company give loans to its directors under Section 185?
Under Section 185, a company is generally prohibited from giving loans, providing guarantees, or offering securities to its directors or any other person in whom the director is interested, except in certain specified circumstances.