Corporate Loans & Applicability of Section 185 & 186

Applicability of Section 185 & 186 of Companies Act, 2013

After introduction of Companies Act, 2013 and specifically section 185 and 186, transactions related to inter-company loans and guarantees become complicated to go ahead along with the compliance to such provisions.

I have tried to summaries the relevant provisions from both the sections in the ensuing paragraphs.

Section 185 can be complied with in one of the three ways;

1. Exemption from Section 185
2. Relaxation with compliance to conditions
3. Exclusion list of transaction

And Section 186 can be complied with in one of the two ways;

1. By complying with the provisions for not exceeding limit
2. By complying with the provisions for exceeding limit

Detailed provisions for both the sections are mentioned below;

Section 185 stats that No company shall, directly or indirectly, advance any loan, including any loan represented by a book debt to, or give any guarantee or provide any security in connection with any loan taken by,

1. Any director of company, or of a company which is its holding company or any partner or relative of any such director; or
2. Any firm in which any such director or relative is a partner.

However, considering the practical difficulties that many other corporate face even for genuine transactions; following exemption conditions were issued by the authorities. Thus, companies which fulfill all the following conditions are granted exemption from applicability of the Section 185.

1. In whose share capital, no other body corporate has invested;
2. The borrowings from banks/financial institutions or corporate bodies is less than lower of the following twos: (I) two times its paid up share capital (II) INR 500 Million.
3. There are no defaults in the repayment of such borrowings subsisting at the time of the proposed transaction.

If any of the above mentioned conditions are not complying for the company then it cannot claim exemption from section 185; however, it can still may advance any loan including any loan represented by a book debt to, or give any guarantee or provide any security in connection with any loan taken by any person in whom any of the director of the company is interested subject to fulfillment of following two conditions;

1. a special resolution is passed by the company in general meeting*

*(Explanatory statement to the notice for the relevant general meeting must disclose the full particulars of the proposed transaction and details of its utilization by the recipient and any other relevant fact)

2. The loans are utilized by the borrowing company for its principal business activities.

For the purposes of this sub-section, the expression "any person in whom any of the directors of the company is interested" means

• any private company of which any such director is a director or member; or
• 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
• 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.

Although, any such transaction, as mentioned above, made by holding company with its wholly owned subsidiary is permissible in the Act and is section 185 does not apply to it but the only condition is such loan shall be used by subsidiary company for its business purpose.

Apart from this, there are certain special transactions that are excluded from the applicability of the section 185 which can be referred from the attachment which contains the excerpt from the Act for the relevant provisions including amendments for the section.

Section 186 states that, 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;

Exceeding higher of the following two;

1. Exceeding 60% of its paid-up share capital, free reserves and securities premium account.
2. 100% of its free reserves and security premium account.

paid-up share capital or ―share capital paid-up‖ means such aggregate amount of money credited as paid-up as is equivalent to the amount received as paid-up in respect of shares issued and also includes any amount credited as paid-up in respect of shares of the company, but does not include any other amount received in respect of such shares, by whatever name called;

free reserves means such reserves which, as per the latest audited balance sheet of a company, are available for distribution as dividend: Provided that— (i) any amount representing unrealized gains, notional gains or revaluation of assets, whether shown as a reserve or otherwise, or (ii) any change in carrying amount of an asset or of a liability recognized in equity, including surplus in profit and loss account on measurement of the asset or the liability at fair value, shall not be treated as free reserves;

Compliance where the aggregate of the loans and investment so far made, the amount for which guarantee or security so far provided to or in all other bodies corporate along with the investment, loan, guarantee or security proposed to be made or given by the Board, exceed the limits :

• Prior resolution sanctioning the transactions is passed at a meeting of the Board with the consent of all the directors present at the meeting.
• Special resolution authorizing the said transactions must be passed in a general meeting of the company before entering into any such transaction.
• Prior consent of Public Financial Institution is required for the transaction if there is any live loan from it.
• The company shall disclose to the members in the financial statement the full particulars of such transactions along with the purpose for which the loan or guarantee or security is proposed to be utilized by the recipient of the loan or guarantee or security
• Keep a register which shall contain such particulars and shall be maintained in such manner as may be prescribed.

Compliance where the aggregate of the loans and investment so far made, the amount for which guarantee or security so far provided to or in all other bodies corporate along with the investment, loan, guarantee or security proposed to be made or given by the Board, does not exceed the limits :

• Prior resolution sanctioning the transactions is passed at a meeting of the Board with the consent of all the directors present at the meeting.
• Prior consent of Financial Institution is required if there is a default in the live loan or payment of installment or interest or both.
• The company shall disclose to the members in the financial statement the full particulars of such transactions along with the purpose for which the loan or guarantee or security is proposed to be utilized by the recipient of the loan or guarantee or security
• Keep a register which shall contain such particulars and shall be maintained in such manner as may be prescribed.

Provided that where a loan or guarantee is given or where a security has been provided by a company to its wholly owned subsidiary company or a joint venture company, or acquisition is made by a holding company, by way of subscription, purchase or otherwise of, the securities of its wholly owned subsidiary company, the requirement of this sub-section shall not apply:

No company which is in default in the repayment of any deposits accepted before or after the commencement of this Act or in payment of interest there on, shall give any loan or give any guarantee or provide any security or make an acquisition till such default is subsisting.

Apart from these, there are certain companies which are excluded from the applicability of these provisions such as Banks, Investment companies etc. Details of which can be referred from the attachment which contains excerpt from the Act for the relevant provisions including amendments for the section.

To conclude, both the sections can be complied with by following combination of relevant provisions of the section from following table depending on its applicability.