Loan to Director – Section 185 of Companies Act, 2013 – Provisions

When the Companies Act, of 1956 was in effect, public companies may offer loans, guarantees, and securities if they acquired prior authorization from the Central Government. The companies used to borrow cash and pass them on to subsidiaries and other related companies via inter-corporate loans. When it came to complying with the terms of the loan arrangement, however, the holding companies used to back down, leaving the subsidiaries in the lurch. Section 185 of the Companies Act, 2013 went into effect to prevent the exploitation of subsidiaries. So, this article will discuss Section 185 of the Companies Act, 2013.

Short Glimpse

The Companies Act, 2013(Act) makes provisions relating to the granting of loans to company directors. Section 185 of the Act sets out the conditions and restrictions on the provision of loans to directors. Each company must comply with the conditions outlined in this section before making a loan or providing a guarantee or security in connection with any loan. This section also provides for the penalty of the company, the defaulting manager, and the directors who grant loans in contravention of the conditions set out in this section.

Understanding Section 185

Section 185 of the Companies Act, 2013 imposes specific limitations on the issuing of loans to Directors in order to monitor their performance.

Prior to the Amendment

The old Section 185 banned firms from extending any loan and/or providing any security or guarantee in regard to a loan taken out by the company’s directors or any other person in whom the director had an interest. Penalties were only authorized if a company or any beneficiary of such a loan, security, or guarantee was found to be in violation.

After the Amendment

Section 185 of the Companies Act (as amended by the Companies (Amendment) Act, 2017):

• Limits the restriction on loans, advances, and the like to Directors of the company or its holding company, or any partner of such Director, or any firm in which such Director or relative is a partner.
• Allows the company to make a loan, guarantee a loan, or provide security in connection with a loan to any person or entity in which any of the Directors is interested, subject to the following conditions: – The Company passing a Special Resolution in a General Meeting (approval of at least 75% of the members is required). – Loans must be used strictly for the borrowing company’s primary business activity.
• The penalty requirements of Section 185 (4) of the Act now extend to an officer in default of the company, in addition to the Company (which includes any Director, Manager or KMP or any person in accordance with whose directions BODs are accustomed to act).
• To avoid confusion as to whether the provision of section 186, which begins with the words “without prejudice to other provisions”, can exclude section 185, the new section omits the words “unless otherwise provided by law”.
• This new section allows companies to issue loans, guarantees, and securities to organizations in which directors are involved in certain situations, subject to the prior approval of shareholders by special resolution and on the condition that the loans are used by the borrower for the main business of the company.
• The interest rate referred to in section 185(3) clause (b) is under the rate established in Section 186, Paragraph 7 of the Act. Before the amendment, it was “interest at a rate not lower than the bank rate declared by the Reserve Bank of India”.
• The scope of penalties has been widened and as a result, the duties of each company’s “director” (as set out 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 a company defaulter liable for criminal acts and may also be liable for criminal liability. A special wrong of violation of regulations when using a loan was also added to the list of crimes under this section.

Loan for Directors

Loans can be granted to the directors subject to certain situations. According to Section 185 of the Companies Act, 2013, a company may not provide loans directly or indirectly, including any loans represented by credit cards.

• To any of its directors
• Any person in whom the director of the lending company is interested, or
• To provide any security in respect of loans taken by a director or any such person

Section 185 of the Companies Act, 2013 read with Act 10 of the Companies (Board Meetings and Powers) Act 2014 provides that a company may not guarantee or lend to directors or any other person related to a director of the company. The rules and the above provisions clearly state that a director must not engage in any activity that is personally beneficial to him.

Loan to any interested person of the director

The company may make loans including any loan represented by book debt or give guarantee or provide a guarantee in respect of any loan made to any person in which the company’s director is interested. Section 185(2) allows the company under certain conditions to provide loans to any person in whom one of the executives is interested.

The conditions that must be met for the provision of loans or the provision of guarantees or security to a person in whom the director is interested are the adoption of a special resolution of the general meeting and the fact that the credit company uses the loans provided for its main business activity. The explanatory memorandum to the notification of the general meeting at which such a resolution to grant a loan is passed should contain full details of the loans or guarantees granted or the security provided and the purpose for which the loan or guarantee or security is proposed used by the person receiving the loan.

The statute establishes a list of persons who are considered to be persons in whom any of the company’s executives have an interest. The Company may grant loans or provide a guarantee or security only to such persons. They are-

• Any private company to which the lending company’s director is a member or director.
• Any corporate in whose general meeting not less than twenty-five percent 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 corporate, executive director, board, or manager who is accustomed to acting under the direction or instructions of the board or any director or directors of the Lending Company.

Exemption provisions

Section 185(3) of the Act provides for exceptions to the restriction of the company providing loans. The company may provide loans or provide a guarantee or collateral

• A full-time executive or director under the terms of service extended by the company to all its employees or under any plan approved by the members of the company by special resolution.
• A company that, in the ordinary course of business, makes loans or gives guarantees or guarantees for the proper repayment of any loan. Interest on such loans made shall be charged at a rate not less than the prevailing rate of return for one year, three years, five years, or ten years of the government security closest to the maturity of the loan.
• Any loan made by the holding company to its wholly-owned subsidiary or any guarantee given or guaranteed by the holding company in connection with any loan made to its wholly-owned subsidiary. The subsidiary must use the loans granted in this way for its main business activity.
• Any guarantee is given or provided by the holding company in connection with a loan made by any bank or financial institution of its subsidiary. The subsidiary must use the loans granted in this way for its main business activity.

Penalty 

Section 185(4) of the Act provides for a sanction in case of violation of the above-mentioned provisions on the provision of loans. If a company extends credit in contravention of section 185, it shall be punishable with a fine which shall not be less than five lakh rupees but may extend to twenty-five lakh rupees. Any officer of the company who is in default shall be punished with imprisonment for a term which may extend to six months or with a fine which shall not be less than five lakhs of rupees but which may extend to twenty-five lakhs of rupees.

A director or any other person related to a director to whom any loan or security or guarantee is given shall be punished with imprisonment for a term which may extend to six months or with a fine which shall not be less than five lakhs of rupees but which may extend to twenty-five thousand rupees or with both.

Final words

The implementation of Section 185 leads to a complete ban on the provision of loans to directors and other natural persons and organizations affiliated with directors. Later it was felt that improvements should be made in the section for greater accountability and management of company affairs. The adjustments were made to reflect the fiduciary nature of the directors of the company. The section has been updated to make it easier to do business. Section 185 of the Companies Act 2013 now allows a company and its officers to lend to directors with sufficient protection and additional liability.

Our Expert will guide you through the complex procedure enshrined in Section 185 of the Act. Connect to us at Legal Window.