Sec 185: Loan to Directors etc.

No Loan or Guarantee to Directors

No company shall, directly or indirectly,

• advance any loan or
• give any guarantee or
• provide any security in connection with any loan taken
• to any of its Directors or any other person in whom the Director is interested.

“Any other person in whom Director is interested” shall  mean

• Any Director of the lending company or its holding company or any partner or relative of such Director.
• Any firm in which such Director or relative is a partner.
• Any private limited company in which such Director is a Director or member.
• Body corporate in which such Director or Directors hold more than 25% shares.
• Body Corporate, MD, BOD or manager accustomed to act in accordance with direction of Board or Director of lending company.

Non-applicability

The above provision shall not apply

• When a loan is given by a company to its Managing or Whole-time Director
  • as a part of conditions of service extended by the company to all its employees or
  • pursuant to any scheme approved by the members by a special resolution.
• When the loan/guarantee/security is provided by the company in its ordinary course of business and a rate of interest not less than the bank rate declared by the RBI (Reserve Bank of India) is charged on such loans.
• When the loan/guarantee/security for loan taken is provided by a holding company to its wholly owned subsidiary company.
• When the holding company provides the guarantee/security in respect of loan made by bank or financial institution to its subsidiary company.

The loans made under the last two points above should be utilized by the subsidiary company for its principle business activity.

Penalties for contravention

• For Company: Fine > Rs 5,00,000 but < Rs 25,00,000
• For Directors or such other person to whom loan/guarantee/security is given:
  • Imprisonment which may extend to 6 months, or,
  • Fine > Rs 5,00,000 but < Rs 25,00,000, or,
  • both

Conclusion

On plain reading of the Companies Act, 2013, the restriction on providing loans to any other person in whom a Director is interested is worded broadly and would apply to subsidiaries and other companies within the same group with common Directors. Such restriction would create significant difficulties for companies which provide loans, or guarantee/ security to their subsidiaries or associate companies for operational purposes. The MCA (Ministry of Corporate Affairs) attempted to address this concern by issuing various circulars which complicated the matters further on account of ambiguous language of the circulars. However, with the enactment of the Rules, companies are now permitted to give loans, guarantee or security with respect to a loan taken by a wholly owned subsidiary, if the loan is utilized by such subsidiary for its principal business activities. This has to be contrasted with the position under the Companies Act 1956, which permitted companies to give loans, guarantee or security to any of its subsidiaries which may be utilized by the subsidiary for any purpose. Further, the Companies Act, 2013 does not provide any indication as to what activities would amount to principal business activities of the subsidiary. In view of the above, the ability of associate companies and other subsidiaries to access capital from their parent company shall be restricted. However, the Companies Act, 2013 permits holding companies to give guarantees or provide security for a loan provided by any bank or financial institution to any of its subsidiaries.

Section 186: Loan and Investment by Company

Restrictions on loans and investments by a company

• A company shall make investment through not more than 2 layers of investment companies

However, this shall not affect

• A company from acquiring another company incorporated outside India which has investment subsidiaries beyond 2 layers as per the laws of such country
• A subsidiary company from having any investment subsidiary for the purpose of meeting the requirements of law

• Limit for investment and guarantee

A company cannot give loan, guarantee or security (in connection with a loan) to a body corporate or a person or acquire securities of a body corporate of an amount exceeding

• 60% of its paid-up share capital + free reserves + securities premium account or,
• 100% of its free reserves + securities premium account,

whichever is more.

• Special Resolution
  • In case the company gives loans/guarantee/security or acquires shares of a value higher than the above limits, a prior approval of the same by means of a special resolution at a general meeting will be necessary.
  • The total amount up to which the BOD is authorized to give loan/guarantee/security or make investment shall be specified in the special resolution.
  • Such special resolution is not required when the loan/ guarantee/ security is provided by a company to its wholly owned subsidiary or joint venture, or when the holding company buys shares of its wholly owned subsidiary company.
• Board Resolution
  • A resolution sanctioning the investment, loan, guarantee or security to be given must be passed by the Board with the consent of all the directors present.
  • Prior approval of the public financial institution, where any term loan of the company is subsisting.
  • However, no prior approval of the public financial institution required where,
    • the total loans and investments so far made along with those proposed to be made do not exceed the limits as per the limits set out under the heading “Limit for Investment and Guarantee” and
    • there is no default in repayment of loan instalments and interest thereon by the company.
  • Rate of interest

No loan shall be given at a rate of interest lower than the prevailing yield of 1 year, 3 year, 5 year or 10 year government security closest to the tenure of the loan.

• Companies under default:

A company which is in default for repayment of deposits or interest thereon shall not give any loan/guarantee/security or make an acquisition till such default is subsisting.

• For Companies registered under SEBI (Securities and Exchange Board of India):
  • Companies registered with SEBI will not take inter-corporate loans or deposits exceeding the limits set out under the heading “Limit for Investment and Guarantee” above.
  • Such companies shall furnish in their financial statements the details of the loan or deposits.

Disclosure

The company shall disclose in its financial statements full particulars of

• loan given, investment made, guarantee given or security provided,
• purpose for which the loan/ guarantee/ security is proposed to be utilized by its recipient.

Register

• Each company making an investment or giving a loan/guarantee/security shall maintain a register of such transactions in Form MBP 2 at its registered office, which shall be open for inspection by the members of the company.
• The entries shall be made chronologically and within 7 days from the date of making loan, giving guarantee, providing security or making acquisition.
• Such register shall be preserved permanently and shall be kept in the custody of the CS (Company Secretary) of the Company or any other person authorised by the Board.
• Entries in the register can be either manual or electronic and shall be authenticated by the CS.

Non-applicability

No restrictions except the ones listed in the first point under the heading “Restrictions on Loans and Investments by a Company” shall apply in the following cases:

• Loan/guarantee/security provided in ordinary course of business by
  • Banking company
  • Insurance company
  • Housing finance company
  • Company engaged in business of
    • financing of companies (includes NBFC (Non Banking Financial Corporation), registered with the RBI (Reserve Bank of India), which is engaged in business of giving loans/ guarantee/ security in ordinary course of its business) or
    • of providing infrastructural facilities.
  • Any acquisition
    • By NBFC registered with the RBI, whose principle business is acquisition of securities (exemption to them shall be for investment and lending activities),
    • By a company whose principle business is acquisition of securities, or
    • Of shares allotted pursuant to Sec 62(1)(a) of the Companies Act, 2013.

Penalties for contravention

• For Company: Fine > Rs 25,000 but < Rs 5,00,000
• For every officer who is in default:
  • Imprisonment which may extend to 2 years, and
  • Fine > Rs 25,000 but < Rs 1,00,000

Conclusion

The decision to impose a limit on number of investment subsidiaries was taken by the Ministry of Corporate Affairs with a view to increase transparency in corporate transactions. This restriction is set to significantly affect a variety of corporate transactions in India, especially with respect to companies that operate across multiple sectors with an investment company at the top; a structure common in the real estate and infrastructure sectors.

The Companies Act, 2013 has introduced greater disclosure and compliance requirements in regulating access of capital by companies via loans, borrowings and investments. The enhanced standards aim at protecting the rights of the all stakeholders, specifically by facilitating greater shareholder participation when companies obtain/provide loans or invest in securities. However, the move towards increased regulation of corporate loans, borrowings and investments under the Companies Act, 2013 shall significantly affect the ability of companies (specifically private companies) to access funds.