Understanding Loans to Directors as per Companies Act, 2013

In the corporate world, the Companies Act, 2013 (hereinafter referred to as “Act”), plays a crucial role in regulating and governing the functioning of companies in India. One of the critical aspects addressed by this legislation is the provision of loans to directors. The Act has established stringent guidelines and regulations to ensure transparency, accountability, and fairness in dealings between a company and its directors. This article delves into the provisions and implications of Loans to Directors as per Companies Act, 2013.

However, before we move on to discuss about Loans to Directors as per Companies Act, 2013, let us first understand about the position of Director in a Company.

Director of the Company as per Companies Act, 2013

The appointment of Director takes place by a company’s board of directors, according the Companies Act, 2013. The board of directors is tasked with making strategic choices to ensure the company’s development and success as well as general management and administration of the business. Directors have a fiduciary duty to act in the company’s and its stakeholders’ best interests.

A Director is defined by the Act as “any person occupying the position of a director, by whatever name called.” Therefore, whoever fulfils the duties of a director is legally regarded as a director, regardless of the title given to the post. The Companies Act, 2013 recognizes a number of different director categories, including nominated directors, executive directors, non-executive directors, managing directors, and whole-time directors.

Read our Article on: Procedure for Appointment and Resignation of the Directors as per Companies Act, 2013

Loan to Directors as per Companies Act, 2013

The Section 185 of the Companies Act, 2013 addresses Loan to Directors. Director Loans: A company is prohibited from making an advance loan either directly or indirectly, making an advance loan that is expressed as a book debt, or providing a guarantee or security in connection with any loaned funds, per Section 185(1) of the Act.

• The Director
• Directors of its holding company
• To the Families of Directors
• If the Director is a partner in a business, to the partner
• To the partnership firm where the director or holding company is a partner.

A Director’s Loan to any Interested Person of Director

A company may advance loans, including any loan represented by a book debt, or offer a guarantee or security in connection with any loan made to any person in whom any of the company’s directors has an interest. Section 185(2) authorizes a corporation to make loans to any person or organization in which any of its directors has an interest, subject to specified requirements.

A special resolution in general meeting must be passed, and the borrowing company must use the loans awarded for its primary business activities, in order to advance loans or provide a guarantee or security to the person in whom the director has an interest. The full details of the loans, guarantees given, or security provided, as well as the intended use of the loan, guarantee, or security by the person receiving the loan, should be disclosed in the explanatory statement to the notice of the general meeting in which such a resolution for granting the loan is passed.

The Act lists the individuals who are deemed to be those in whom any director of a company has an interest. Only these individuals are eligible for loan advances or security provided by the company in question. It is they-

• Any private company where a lending company director serves as a member or director.
• Any entity whose general meeting permits the exercise or control of not less than 25% of the entire voting power by any director of the loan company, or by two or more such directors acting jointly.
• Any legal entity, managing director, the board of directors, or manager who is used to acting in accordance with the rules or guidelines established by the board or by one or more directors of the lending business.

Position of Article 185 of Companies Act, 1961 before and after the Amendment

Under the Companies Act, 1956, public companies may make loans, guarantees, and securities if they first received permission from the Central Government to do so. The companies used to borrow money and lend it to their subsidiaries and other linked companies through inter-corporate loans. However, the owning companies would often renege on their obligations under the loan arrangement, leaving the subsidiary helpless. To stop the misuse of the subsidiaries, Section 185 of the Companies Act, 2013 went into effect.

• Position of Article 185 of Companies Act, 1961 before the Amendment

The initial version of Section 185 prohibited the companies from making any loans, provide security for loans taken by the company’s directors or anybody else in whom the directors had an interest, or guaranteeing loans made by them. Only businesses or recipients of such a loan, security, or guarantee were subject to penalties if found in violation.

• Position of Article 185 of Companies Act, 1961 after the Amendment

The following amendments to Section 185 were made by the Companies (Amendment) Act of 2017:

• Restricts the prohibition on loans, advances, and other financial transactions to any partners of such Directors, any partners of such Directors, or any companies in which such Directors or relatives are partners.
• The company may lend money to, guarantee, or provide security for any person or entity in whom any of the Directors have an interest upon the adoption of a special resolution at a general meeting (permission of at least 75% of the members is required). Loans must only be used for the borrowing company’s primary business needs.
• A breach of the corporation addition to the Company by an official is now subject to the Section 185(4) penalties under the Companies Act, 2013.

Loan to Directors: Some Exemptions for Loans to Directors

The following are the exemptions with regard to Loans to Directors as per companies act under Section 185:

• Loans to the Managing Director or Whole-Time Director: The loans to the MD or WTD may only be issued if the following requirements are met: – Where it is a provision of the company’s Policy of Service to award loans to all workers. – In accordance with any plan that has been officially authorized by the members through a Special Resolution.
• Loans to Subsidiary Companies: When a holding company provides a loan, guarantee, or security to a fully owned subsidiary company, as the latter may utilize it solely for the purpose of carrying out the primary business activity.
• Loans to Companies in the Regular Course of Business: Loans to Companies may be made in the Regular Course of Business if the interest rate on such loans is not less than the rate set at the time by the RBI.
• Bank and financial institution loans made to subsidiaries: 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 company by a bank or other financial institution. The loan must be used for the primary business purpose of the subsidiary.

Loan to Directors: A Complete Checklist

The following factors should be kept in mind while extending loans or providing guarantees or security in connection with any Loans to Directors as per companies act under Section 185:

• A company cannot advance loans to directors, their families, or partners, nor may it give any guarantee or security in connection with any loan.
• The company cannot provide loans to a company whose director is a family or partner, nor can it give any guarantee or security in connection with a loan to them.
• Loans can be advanced, and any guarantee or security relating to any loan can be given to the person in whom the company’s director is interested, after a resolution in the general meeting is passed, and if the loan amount is used by the borrowing company for its primary business activities.
• Only the individuals and companies listed in Section 185(2) are considered people in whom the company’s director has an interest. As a result, the company must determine if the people to whom they wish to lend money are on the list of people named in this section as people in whom the director is interested.
• When a company meets the criteria specified in Section 185(3) of the Act, it may provide a loan or offer a guarantee or security in connection with any loan to the managing or full-time director.
• A loan can be granted by a company that offers loans or guarantees or securities for the timely repayment of any loan in the usual course of business.
• If the subsidiary company meets the conditions set out in Section 185(3) of the Act, the controlling company may make a loan to it.

Loan to Directors: Penalty provision regarding Loans to Directors

Section 185(4) of the Act establishes a penalty for violating the above-mentioned loan restrictions. If the company lends a loan in violation of Section 185, the company will be fined not less than five lakh rupees but not less than twenty-five lakh rupees. Every official of the company who is in default must be penalized with imprisonment for a term not less than six months or with a fine not less than five lakh rupees but not less than twenty-five lakh rupees.

The director or any other person related to the director who advances a loan or provides a guarantee or security shall be punished with imprisonment for up to six months or a fine of not less than five lakh rupees but not less than twenty-five lakh rupees, or both.

Looking Forward

The provision related to Loans to Directors as per Companies Act, is a critical component of corporate governance that aims to ensure transparency, accountability, and fairness in the financial transactions between a company and its directors or related parties. By imposing stringent restrictions and disclosure requirements, the Act seeks to strike a balance between enabling routine business operations and preventing potential conflicts of interest or misuse of company resources. Companies are advised to thoroughly understand and adhere to these provisions to avoid legal complications and maintain the integrity of their operations.

Connect to our Experts at Legal Window in case you need any assistance in understanding any provision of Companies Act, 2013 or any Notice issued by Ministry of Corporate Affair regarding the Directors of a Company.