LOAN TO DIRECTOR (185)
BACKROUND:
This refers that "Companies Act likely to jolt Corporate
World". Section 185 of the Companies Act,
2013, which puts restrictions on inter-corporate loans, jolted the corporate
world. Until now, Companies were in the habit of borrowing funds from banks and
passing them on to subsidiaries and associate companies through inter-corporate
loans. The holding companies never bothered to comply with the terms of the
loan agreement when it concerned the deployment of the borrowed funds. The
banks never monitored such fund deployment either. The new provisions will not
hamper the working of transparent companies since loans to wholly-subsidiary
companies are exempted and parent companies can give a guarantee for the loans
taken by their subsidiaries. It is clarified that such a loan must be utilized
for the subsidiary’s principal business activities.
Section 185 of the 2013 Act is the new Section 295 of the 1956 Act. Upon a
cursory glance, the key points of departure from the 1956 Act that emerge are
the wiping out of any Central Government approvals and the applicability of the
restriction to private and public companies alike.
DETAILS ON LOAN:
Section 2 of Companies
Act, 2013, does not define “loan”. A loan is defined by the Oxford English
Dictionary as " 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 Supreme Court in the
case of Shree Ram Mills Ltd v. Commissioner of Excess Profit Tax,
MANU/SC/0054/1954 ;
Loan: If a Company wants to give Loan, make Investment, provide
Secuirity and guarantee then Company have to look at the following sections,
Rules and Circulars:
SECTIONS INVOLVED:
Ø Section 177 (4) (v): Every
Audit Committee shall scrutiny of inter-corporate loans and investments.
Ø Section 179(3) (e): The
Board of Directors of a company shall exercise the power to invest the funds of
the company by means of resolutions passed at meetings of the Board,
Ø Section 185: Loan to any
of its directors or to any other person in whom the director is interested. (Detailed Discussion Below)
Ø
Section 186: Loan and Investment by Company. (Detailed discussion in next Article)
EARLIER WAS SECTION 295,296 OF THE COMPANIES ACT, 1956
RULES INVOLVED:
Ø Rule 8 of the Companies
(Meetings of Board and its Powers) Rules, 2014.
Ø Rule 10 of the Companies
(Meetings of Board and its Powers) Rules, 2014]
Ø Rules 11, 12 and 13 of the
Companies (Meetings of Board and its Powers) Rules, 2014
CIRCULARS INVOLVED:
Ø CIRCULAR NO.4/2015
[NO.1/32/2013-CL.V], DATED 10-3-2015
Ø GENERAL CIRCULAR
NO.6/2015 [F.NO.5/3/13-CL.V], DATED 9-4-2015
Ø GENERAL CIRCULAR
NO.15/2014 [F.NO.5/6/2014-CL-I], DATED 9-6-2014
Ø ORDER [F. NO.
1/13/2013-CL.V-PART]/SO 504(E), DATED 13-2-2015
NON APPLICABILITY OF SECTION 185:
Below mention Companies by
fulfilling the given condition can give loan, make investment and made
guarantee respectively without restriction under section 185.
NOTIFICATION
NO. GSR 463(E)[F.NO.1/2/2014-CL-V], DATED 5-6-2015:
Section 185 Shall not apply to GOVERNMENT COMPANY in case such company obtains approval of the Ministry or
Department of the Central Government which is administratively in charge of the
company, or, as the case may be, the State Government before making any loan or
giving any guarantee or providing any security under the section.
NOTIFICATION
NO. GSR 464(E) [F.NO.1/1/2014-CL-V], DATED 5-6-2015:
Section
185 shall not apply to a PRIVATE COMPANY by fulfilling of three conditions
a)
In whose share capital no other body corporate has invested
any money;
b)
If the borrowings of such a company from banks or financial
institutions or any body corporate is less than [lower of (i) Two times of paid
up share capital or (ii) Rs. 50 Crore]; and
c)
Such a company has no default in repaymnt of such borrowings subsisting
at the time of making transactions under this section.
NOTIFICATION
NO. GSR 465(E)[F.NO.2/11/2014-CL.V], DATED 5-6-2015:
Section 185 shall not apply
to NIDHI
COMPANY;
provided the loan is given to a director or his relative in their capacity as
members and such transaction is disclosed in the annual accounts by a note.
Loan
Holding – Wholly Own Subsidiary
Any loan made by a Holding Company to its Wholly own Subsidiary
Company or any guarantee given or security provided by a Holding Company in respect
of any loan made to its wholly own subsidiary Company. Condition:
loan made under this clause utilized by the wholly own subsidiary company
for its principal business activity
only.
Guarantee/
Security Holding –Subsidiary
Any guarantee given or security provided by a
Holding Company in respect of Loan made by any Bank or financial institution to
its subsidiary Company.
Condition: loan made
under this clause utilized by the subsidiary company for its principal business activity only.
Loan to
Managing Director & Whole Time Director:
There are two ways to give Loan to
Managing and Whole Time Director. The exception is extended to a particular
class of directors, i.e. to the managing or whole-time directors only.
i.
Loan can be
given to a Managing or Whole-Time Director as a part of the Policy
of their service.
Condition: Policy should be available for all the
employees of the Company.
ii.
Loan can be
given to a Managing or Whole-Time Director pursuant to any Scheme.
Condition: Scheme should be approved by Shareholders by
passing of Special Resolution.
Example: The Companies pass a resolution for appointment of
Managing Director and it approves the terms and conditions of its appointment
and if as a part of its terms, there is a loan which can be given to that
director, then it falls under the exception given in section 185 of the Act.
Loan
in Ordinary Course of Business:
A company which in the Ordinary
Course of its business provides:
-
Loans or
-
Gives guarantees or
-
Securities for the due repayment of any loan and
-
In respect of such loans an interest is charged
at a rate not less than the bank rate declared by the Reserve Bank of India.
Detailed discussion on word Ordinary Course of
Business is given below:
APPLICABILITY OF SECTION 185:
Individual
Entity:
i. Any director of the lending company;
or
ii. Any director of its holding company;
or
iii. Any partner of any such director;
or
iv. Relative of any such director;
Firm:
i. Any firm in which any 1such
director is a partner; or
ii. Any firm in which the relative of
any such director is a partner;
Company:
i. Any private company of which any such
director is a director; or
ii. Any private company of which any such
director is a 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:
i. Any such director; or
ii. By 2 or more such directors, together;
or
Any
Body Corporate, the board of directors, managing
director or manager, whereof is Accustomed to Act in accordance with the directions or instructions of the:
i. Board; or of
ii. Any director or directors of the lending
company
Meaning of word “SUCH” Director:
1Such’
would mean in reference to the director of the lending company and/ or in
relation to the director of its holding company
MEANING OF TERMS USES IN 185:
‘SAVE AS OTHERWISE PROVIDED IN THIS ACT’
This would mean that if anywhere else,
i.e. if any other section of the Companies Act, 2013 allows giving of loans
etc. to the persons covered in section 185 then that will be permitted. For the
information of the readers, there are no such sections that permit the same in
the Companies Act, 2013.
‘ORDINARY COURSE OF
BUSINESS’
The
phrase ‘ordinary course of business’ has also not been defined under the Act.
This is because there can be no universal meaning ascribed to it. What is
ordinary for one entity or one type of business or one sector or even one
region may not be so for another.
Example: There is
an NBFC Company which is registered in the category of a loan NBFC. If this
Company gives a loan and the rate of interest aspect is taken care of, then they
said loan will be falling in the exception clause and hence section 185 will
not be applicable.
Will it be applicable for all kinds of NBFC? Clearly
not. If suppose this Company in question is an Investment NBFC. Then surely
giving of loans for it will not classify in its ordinary course of business.
However,
based on Judicial Precedents and keeping in view the
intent and purpose of the provision, a transaction can be said to be in
‘ordinary course of business’, if:
v The Lending Company has in the
past provided loans/guarantees/securities to such entities as a matter of
routine. The frequency of such transactions and a certain amount of continuity
is imperative as ‘business’ itself implies carrying on a particular trade or
vocation as a ‘continuous’ activity by application of labour, skill and money
to earn the income. Also, important is that such transactions have been
appropriately disclosed in the financial statements of the Lending Company for
the past years. The disclosure of such
transactions in the financial statement indicate that such activities were
being carried on normally in the usual course of business, specifically
inclusion of the amounts involved as ‘business income’ gives further credence
to the fact.
v MOA should allot to grant loan (Object of the Company to give Loan):
The
memorandum of association of the Lending Company allows for such transactions
i.e. the providing of loans/guarantees/security to other entities should be
part of objects of the memorandum of association. The Courts have not been
uniform in their ruling with respect to the significance of the objects clause
of the memorandum of association in making this assessment. The Courts also
differ on whether an activity is in ‘ordinary course’ only if part of the main
objects is or whether an activity ancillary to the main objects may also be
considered so.
But
loans business in its main object clause doesn’t qualify under the
phrase-‘ordinary course of Business’. This is also not going to help, unless
the other special acts allow such activities and the Company has all proper
registrations for being called so.
‘INCLUDING ANY LOAN REPRESENTED BY A BOOK DEBT’
The
phrase ‘including any loan represented by a book debt’ is a very smart move by
the law makers to ensure that the directors and/or any other person in whom the
director is interested do not circumvent the law by juggling with the words.
To elaborate this with an Example:
Say a
Company manufactures Computer. One of the Directors of the Company is setting
up an Office for which he will also need to buy Computer. The director in the
erstwhile situation (when section 185 was not applicable) could have taken a
loan from the Company for buying the same. But in the present situation, since
he is not able to take that loan, he asks the Company to give him 20 Computers
for a long credit period. If the credit period extended by the Company is as
per the normal period and in the normal terms and conditions, as extended to
its other buyers, then there is no problem but as soon as it is biased and
tilted to give undue benefit to the director and/or other person in whom the
director is interested, then such transaction will be considered to be loan.
‘SUBSIDIARY COMPANY’
Subsidiary
Company’ mean ‘a company in which the holding company control the composition
of the Board of Director or exercises/controls more than one-half of the total
share capital either at its own or together with one or more of its subsidiary
companies’.
PRINCIPLE
BUSINESS ACTIVIY:
Even
though ‘principal business activity’ has not been defined under the Act,
generally the activities provided under the main objects of the memorandum of
association should qualify as a principal business activity of that company
IMPORTANT POINTS:
Ø Section 185 completely ruled out the
possibility of giving any loan (including a loan representing a book debt), a
guarantee or a security, either directly or indirectly, to any director or to
any other pension in whom Director is interested.
Ø Interest Rate:
No loan may be
given by the Lending Company at an interest rate lower than the prevailing
yield of one year, three year, five year or ten year government security
closest to the tenor of the loan
Ø Allowable Loan Foreign Holding to Indian
Subsidiary.
Section 185 is applicable only when a
‘company’ gives loan to its director or any person in whom the director is
interested. However, the definition of a ‘company’ under Section 2(20) means
only a company incorporated under 2013 Act or any previous company law. So, the
restriction in Section 185 will not apply when a holding company incorporated
outside India gives a loan, guarantee or security to its Indian subsidiary.
Restriction applies only at the time of entering into the transaction.
Ø If a Private limited Company has given
loan/ guarantee or security which was exempted under Section 295 of the
Companies Act, 1956 shall continue to be exempted under Section 185.
Ø If a person only an employee of the
Company and later he becomes director of the Company, section 185 would not
apply.
Restriction applies only at the time of entering into the transaction.
The Lending Company (not if it is a
banking company or an insurance company or a housing finance company providing
the loan/security/guarantee in ordinary course of business or company engaged
in business of financing of companies or of providing infrastructural facilities)
should have complied/should comply with the conditions under Section 186 of the
Act.
LIMIT OF LOAN AND PROCEDURE:
Limit of
Loan/Investment/Guarantee:
No company shall give loan, invest fund,
and give guarantee more than 60% (sixty per cent) of its paid-up share capital
free reserves and securities premium account or 100% (one hundred per cent) of
its free reserves and securities premium account, whichever is more. Approval
required Board of Directors by passing of Unanimous Board
Resolution:
If Company wants to give loan/, invest
fund, and give guarantee more than above limit then follow the below given
process:
Requirement of Special Resolution:
Where the giving of any loan or guarantee or providing any security or
the acquisition under sub-section (2) exceeds the limits specified above prior
approval by means of a special resolution passed at a general meeting shall be
necessary
Secretarial Compliance:
As
per Section 179(3) (e) procedure will be as follow:
·
Company
will call Board Meeting.
·
Hold
Board Meeting as per Secretarial Standard- I.
·
Pass
unanimous Board Resolution for investment of funds/give loan and will file
e-form MGT-14 with such resolution.
REGISTER:
Every company Giving Loan or giving a guarantee or
providing security or making an acquisition under this section shall keep a
register in FORM NO. MBP-CK A2
which shall contain particulars of:
·
Loan
·
Guarantee Given
·
Security provided
·
Investment made
MAINTANANCE & INSPECTION:
·
The register shall be
kept at the registered office of the company.
·
The Register shall be
open to inspection at such office by Members;
·
Extracts may be taken by
any member,
Copies may be furnished
to any member of the company on payment of such fees as prescribed in AOA not
exceeding Rs. 10(TEN) for each page
EXAMPLES:
If a subsidiary company is desirous of availing
a loan from its holding company or vice versa,
A check must be carried out under
clauses (c), (d) and (e) of the Explanation to Section 185 to see if the
borrowing company is a person in whom the director of the lending company is
interested. This brings us to the scenarios in which inter-corporate loans
between holding and subsidiary companies are permitted:
Scenario 1: If the borrowing company is a private company,
not being a subsidiary of a public company, then, there must be no common
directors between the boards of directors of the borrowing and lending
companies and none of the directors of the lending company should be
shareholders in the borrowing company.
Scenario 2: One or more of the directors of the lending
company must not be able to exercise or control twenty five percent or more of
the voting power of the borrowing company at its general meeting.
Scenario 3: The board of directors of the borrowing
company must not be accustomed to act in accordance with the directions or
instructions of the board or of any director(s) of the lending company.
PENAL PROVISION:
On Lending Company
In case of contravention of this
section, the Lending Company shall be punishable with a minimum fine of Rs.5
lacs but which may extend to Rs.25 lacs;
On Recipient Director/ Entity
In case of contravention of this
section, the recipient Director or other entity shall be punishable with
imprisonment which may extend to six months or with a minimum fine of Rs.5 lacs
but which may extend to Rs.25 lacs, or with both.
CONCLUSION:
With the new regime in place with
respect to loans to directors, it can be concluded that no company can offer
loan to its directors except in the conditions discussed earlier. The
provisions of Section 185 of the Companies Act, 2013 does not provide any exemption
to a private company as provided in the provisions of Section 295 earlier. The
said change is anticipated to bring the better governance & transparency in
the affairs of the Companies in the light of the applicable laws keeping in
view the fiduciary character of the directors of the Company. The objective was
not to hinder business and financing of businesses but was to discourage
related party lending transactions which bred favouritism and nepotism
COMPLETE SECTION(After all
Circulars and Resolution):
185. (1) Save
as otherwise provided in this Act, no company shall, directly or indirectly, advance
any loan, including any loan represented by a book debt, to any of its
directors or to any other person in whom the director is interested or give any
guarantee or provide any security in connection with any loan taken by him or
such other person:
Provided that
nothing contained in this sub-section shall apply to—
(a) the giving of any loan to a managing or whole-time director—
(i) As a part of the conditions of service extended by the company to all
its employees; or
(ii) Pursuant to any scheme approved by the members by a special
resolution; or
(b) A company which in the ordinary course of its business provides loans
or gives guarantees or securities for the due repayment of any loan and in
respect of such loans an interest is charged at a rate not less than the bank
rate declared by the Reserve Bank of India.
[(c) any loan made by a holding company to its wholly owned subsidiary
company or any guarantee given or security provided by a holding company in
respect of any loan made to its wholly owned subsidiary company; or
(d) any guarantee given or security provided by a holding company in
respect of loan made by any bank or financial institution to its subsidiary
company:
Provided
that the loans made under clauses (c) and (d) are utilised by the subsidiary company
for its principal business activities.]23
Explanation.—for
the purposes of this section, the expression “to any other person in whom
director is interested” means—
(a) Any director of the lending company, or of a company which is its
holding company or any partner or relative of any such director;
(b) Any firm in which any such director or relative is a partner;
(c) Any private company of which any such director is a director or
member;
(d) Anybody corporate at a general meeting of which not less than twenty-
five per cent. of the total voting power may be exercised or controlled by any
such director, or by two or more such directors, together; or
(e) 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 of any director or directors, of the lending
company.
(2)
If any loan is advanced or a guarantee or security is given or provided in
contravention of the provisions of sub-section (1), the company shall be
punishable with fine which shall not be less than five lakh rupees but which
may extend to twenty-five lakh rupees, and the director or the other person to
whom any loan is advanced or guarantee or security is given or provided in
connection with any loan taken by him or the other person, shall be punishable
with imprisonment which may extend to six months or with fine which shall not be
less than five lakh rupees but which may extend to twenty-five lakh rupees, or
with both.
(Author – CS Divesh Goyal, GOYAL DIVESH & ASSOCIATES
Company Secretary in Practice from Delhi and can be contacted at
csdiveshgoyal@gmail.com).
Disclaimer: The entire contents of this document have been
prepared on the basis of relevant provisions and as per the information
existing at the time of the preparation. The observations of the author are personal view and the authors do not take
responsibility of the same and this cannot be quoted before any authority
without the written
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