Explained: Section 185 of Companies Act, 2013

Author in present article has explained the nuances of Section 185 of the Companies Act, 2013 in detail. This article should not be construed as a Legal advise.

What is Section 185 of Companies Act, 2013?

185. Loan to directors, etc.— (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.]

Explanation of Section 185 of Companies Act, 2013

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) any body 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) 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 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.

Purpose of Section 185

Before the Companies Act, 2013; Companies Act 1956 was in force. Due to the previous Act, public companies on prior permission of the Central Government could grant loans, guarantees and securities.

As a result of it, Companies used to borrow funds and pass them to their subsidiaries. When compliances issues used to raise, subsidiaries were left on their own to tackle it.

To put a stop to this practice, Section 185 of the Companies Act, 2013 came into the force.

Section 185 of the Companies Act, put certain restrictions for granting loans to the Directors.

Section 185 after, Companies (Amendment) Act, 2017

• It limits the restriction on the loans to the Directors.
• Allows company to provide loan/guarantee/security to any person or entity in whom any of the Directors are interested, subject to:-
  • Special resolution shall be passed in the Company in the general meeting. (75% approval)
  • Utilization of loans by the borrowing company shall be solely for its principal business activities.
• Penalty provision’s ambit has been increased. It now extends to an officer in default of company (inclusive of Director, Manager, etc).

Penalty Provisions

• Fine not less than Rs. 5 Lakh extended up to Rs. 25 Lakh could be imposed upon the lending company
• Imprisonment for the officer in default, extendable up to 6 months along with fine not less than Rs. 5 Lakh and up to Rs. 25 Lakh.
• The recipient of the loan will be punishable with imprisonment which may extend to 6 months or with fine which shall not be less than Rs.5 lakhs but which may extend to Rs.25 lakhs or with both.

Exemption

As per Rule 10 of Companies (Meetings of Board and its Powers) Rules, 2014, s. 185 of the 2013 Act would not apply to

• A loan made by a holding company to its wholly owned subsidiary company;
• Guarantee given or security provided by a holding company; in respect of any loan given to its wholly owned subsidiary company;
• Guarantee given or security provided by a holding company; in respect of any loan given to its subsidiary company by any bank or financial institution.

Loans in Foreign Currency?

Indian companies in India may grant loans in foreign currency to the employees of their branches outside India; for personal purposes. Provided that the loan shall be granted for personal purposes in accordance with the; lender’s staff welfare scheme/loan rules and other terms and conditions as applicable to its staff resident in India and abroad.

[Regn. 5(7) of FEM (Borrowing or Lending in Foreign Exchange) Regulation, 2000 inserted vide Notfn. GSR 531(E), dt. 08-01-2003].

Note

Section 185 of the 2013 Act places a complete prohibition on loans to directors and any person in whom; the director is interested except the two exceptions provided in (a) and (b) of the proviso to s. 185(1) of the 2013 Act. There is no Central Government approval to such loans as they are prohibited. Punishment is given in s. 185(2) of the 2013 Act; which provides for imprisonment upto 6 months and fine of an amount up to rupee twenty five lakhs.

Section 20(1) of the Banking Regulation Act, 1949; also lays down the restrictions on loans and advances to the directors and the firms in which they hold substantial interest.

Person in whom the director is interested

Section 185 of the 2013 Act; provides an exhaustive list of who or what would be considered as a “person in whom the director is interested”. The list reads as follows:

• Any director of the lending company or of its holding company or any relative or partner of such director;
• Any firm in which the director or his relative is a partner;
• Any private company in which the director is a director or member;
• Any body corporate in which the director either singly or along with other directors, at any general meeting of the body corporate, exercises or controls not less than twenty five percent of the total voting power;
• Any body corporate, whose Board of directors, Managing Director or manager is accustomed to act in accordance with the directions or instructions of the Board, director or directors of the lending company

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