The Shocking Revelation of Section 185 Of The Companies Act, 2013

Through the Companies (Amendment) Act, 2017 the existing Section 185 of the Companies Act 2013, the old Section 295 of the Companies Act, 1956, Section 86 D of the Indian Companies Act, 1913 and Section190 of the English Companies Act, 1948 which provides for loans to directors have been replaced.

The substituted Section 185 deals with the restrictions on the part of the Companies in advancing any type of loan or providing any security or giving any guarantee and to those whom a Company can provide such loan or security or guarantee subject to compliances under the Companies Act. Also, the section provides relaxation for Individuals and Entities subject to certain conditions. It also provides a penalty for its contravention.

This article aims to bring a clear vision of the newly substituted provisions of Section 185 and the practical issues prevailing thereon.

Read Also: Contents of Articles of Association

What is the term ‘Loan’?

The term ‘Loan’ is not defined anywhere in the Companies Act, 2013. A loan as defined by the Oxford English Dictionary is ” a thing lent; something the use of which is allowed for a time, on the understanding that it shall be returned or an equivalent given, a sum of money lent on these conditions and usually with interest.

The rationale behind the substitution of Section 185

Section 185 was substituted with the new provision through the Amendment Act, 2017. The Amendment Act was based on the suggestions of the Companies Law Committee, which was 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 the amendment along with the reasons, were clearly reported.

Provisions as per the Companies Amendment Act, 2017

Section 185 of the Amendment Act is divided into four parts:

S. 185 (1) states that a Company whether it is Private or Public shall not directly or indirectly, advance any loan which includes loan represented by a Book debt or provide any security or give any guarantee in connection with any loan taken by:

Any director of its holding company; or

Any director of the company; or

Any partner of any such director; or

Any relative of any such director;

Any firm in which any such director is a partner; or

Any firm in which the relative of any such director is a partner.

Here, it is pertinent to note that the term “any Such”  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 Security or Guarantee to the aforesaid Individuals and firms.

S.185 (2) talks about a situation in which a Company can advance any loan which will include Book debt or provide any security or give any guarantee in connection with any loan taken by:

any private company of which any such director is a director or member;

any body corporate at a general meeting of which not less than 25% of the total voting power may be exercised or controlled by

any such director, or

by two or more such directors, together; or

anybody corporate, the Board of directors, managing director or manager, whereof is accustomed to act in accordance with the directions or instructions of the

Board; or

any director or directors, of the lending company.

However, the above provisions are subject to certain conditions, which are:

Special resolution- passed by the Company in general meeting; and

Loans- utilized by the borrowing company for its principal business activities.

Subsection 2 earlier prohibited companies to provide loan/ security/ guarantee to other Companies/body corporates, but now it is relaxed, subject to certain conditions.

As per Section 185 (3), the following entities and individuals are exempted from complying with subsection 1 & 2 again, which are subject to certain conditions:

giving of any loan to a managing or whole-time director –

as a part of the conditions of service extended by the company to all its employees; or

pursuant to any scheme approved by way of a special resolution;

A company which in the ordinary course of its business provides loans or securities or gives guarantees for the due repayment of any loan.

E.g. Banking Companies and Loan NBFCs.

In respect of such loans, 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;

any loan made by a holding company to its wholly-owned subsidiary company or security or any guarantee given provided by a holding company in respect of any loan made to its wholly-owned subsidiary company, in case of WOS there is complete relaxation from S. 185:

any security provided or guarantee given by a holding company in respect of a loan made by any bank or financial institution to its subsidiary company. Unlike class ‘C’ which includes WOS only securities and guarantee provided for a loan made by any bank or financial institution are allowed for a 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 or the body corporates 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 utilized by the borrower for its principal business activities and not for further investment or grant of loan.

‘Principal business activity’ has not been defined under the Act, but it generally includes all those activities which are provided as the main objects of the MOA.

Section185 (4) is a penalty provision. It states that where any loan advanced or a guarantee or security given or provided or utilized in contravention of this provision.

Lending Company: In the case of the lending company, any contravention is punishable with fine which shall not be less than Rs. 5 lakh but which may extend to Rs. 25 lakh.

Officer in default: In case of Officer in default, any contravention is 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.

Recipient Director/ Entity: In case of Recipient Director/ Entity any contravention is 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.

Conclusion

The amended Section 185 of the Companies Act is somewhat a middle way between section 185 of the 2013 Act and section 295 of the earlier 1956 Act. The amendment mandates a final approval from the shareholders and also makes it compulsory to disclose all the related documents to them, before sanctioning the loan. The amendment is beneficial to the private sector as it is less restrictive than the previous norms. The current section 185 is legislated
according to the guidelines of the Companies Law Committee and is in accordance with the rules of ease of doing business in India.