Addressing the Lapses in Section 186(2) of the Companies Act, 2013

Kotte Murali Krishna | Last updated: 04 March 2025

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Quick Summary

Section 186(2) of the Companies Act, 2013, intended to regulate company loans and investments, has inadvertently contributed to a rise in defaults, particularly among listed companies. The core issue is that companies often use working capital loans, meant for operational needs, to fund investments and loans to other entities, exceeding their actual financial capacity. This practice weakens their financial health, leading to significant losses for banks and investors, and has resulted in substantial debt defaults and liquidations.

I want to discuss a crucial issue that has been significantly contributing to the rise of defaulted companies, particularly among listed companies. This issue stems from certain lapses in Section 186(2) of the Companies Act, 2013, which governs loans and investments made by companies.

Understanding Section 186

As per Section 186(2) of the Companies Act, 2013:No company shall, directly or indirectly-(a) Give any loan to any person or other body corporate;(b) Give any guarantee or provide security in connection with a loan to any other body corporate or person; and(c) Acquire by way of subscription, purchase, or otherwise, the securities of any other body corporate,in excess of 60% of its paid-up share capital, free reserves, and securities premium account or 100% of its free reserves and securities premium account, whichever is higher.

Intended Objective vs. Ground Reality:The intention behind this law is to regulate corporate investments and loans to ensure financial stability. However, in practice, its application has led to companies defaulting on loans. The core issue lies in where the money for these investments is coming from.

Companies Act 2013: Section 186 Lapses and Defaults

The Key Lapse in Section 186

The law permits investments up to 60% of net worth or 100% of free reserves. However, companies rarely maintain cash or cash equivalents up to these limits.
So, where do they get funds to invest in other companies? They divert working capital loans from banks, which are meant for regular business operations.
This misuse of borrowed funds weakens financial health, leading to companies becoming sick and eventually defaulting.

The ultimate burden falls on investors and banks, causing financial losses amounting to lakhs of crores of rupees.

Some of the losses to the banks and investors

1) 60 Listed companies disclosed debt default of Rs 75,000 Cr

2) 49 Listed companies disclosed debt default of Rs 69,140 Cr

3) 8 Listed companies have defaulted for 50.93US$ Billion equal to Rs 4.32 Lakh Cr

4) 2263 Listed companies have defaulted for Rs 1.96 Lakh Cr

5) 50 wilful Defaulted companies owe Rs 87,925 Cr to Banks

7) 88 Listed companies have been referred for liquidation as per the NSE website.

8) The list of wilful defaulters as of 30th June 2024 spans 1517 pages.

The Need for Reform

Given the widespread misuse of Section 186, we must act decisively:

1. Amend the Act to restrict companies from using working capital loans for intercorporate investments or loans.

2. Introduce stringent monitoring mechanisms to track the source of funds used for investments.

Conclusion

The lapses in Section 186 of the Companies Act, 2013, have been exploited, resulting in huge financial distress for stakeholders. Addressing this issue is critical to safeguarding India's corporate and banking ecosystem.

FAQ :

Section 186(2) of the Companies Act, 2013, governs loans and investments made by companies, stipulating that no company shall give loans, guarantees, or acquire securities beyond a certain percentage of its paid-up share capital, free reserves, and securities premium account.

Companies often divert working capital loans, which are intended for business operations, to make investments or provide loans to other entities. This misuse of funds, permitted within certain limits by the Act, weakens their financial stability and can lead to defaults.

The key lapse is that companies rarely have sufficient cash reserves to cover the permitted investment limits. Consequently, they resort to using borrowed working capital, which is meant for day-to-day operations, for these investments.

The defaults resulting from these lapses have a significant impact on investors and banks, leading to substantial financial losses.

It is proposed to amend the Act to prevent companies from using working capital loans for intercorporate investments or loans, and to introduce stricter monitoring of the sources of funds used for such investments.