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Critical analysis of Section 185 and Section 186 of the Companies Act, 2013

Section 185 of the Companies Act, 2013 ( herein after referred as the Act ) deals with giving of  loans to directors and others  and section 186 of the Act deals with giving of loans and investments by the companies .

Section 185 of the Act specially imposes a blanket ban on companies on providing loans to directors and persons in whom the director is interested  as defined under  this section ( interested persons )  subject to certain exceptions mentioned under the section .

Further this section saves everything which is otherwise laid down under any section of the Act.

The framers of the Act might have the  objective in their mind while framing this section  “ to protect the assets of the company and to ensure that property which belongs  to the public should not be taken away by someone else”.

Explanation to sub-section (1) of section 185 of the Act defines Interested persons as follows:

(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 twentyfive 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.

Although the objective of the section was good and to prohibit the companies to provide loan to directors etc   , but the interpretation of this section becomes so absurd that while objective of this section is to prohibit to give  loan to directors and interested persons , but  it also interpreted to  prohibit the promoters’  companies to provide loan / guarantees to other  companies . This interpretation is giving much problems to the financial institutions which demands guarantees from promoter companies .

Let me explain the section with an example :

There are two companies one is listed one , X Ltd  in which Mr A is Managing Director  and  promoter of the company and holding more than 25% share-holding in this company .

Another company is a closely held company , Y Ltd which is controlled  by Mr A ,  in which he holds more than 50% of holding and also director in that company.

X Ltd has taken a loan from banks and banks  asked for guarantee from Y Ltd being promoter company .

The  section 185 of the Act deals with all the companies private , closing held public companies  , listed public companies etc.

Now as per interpretation  of clause (d) of Explanation of section 185 (1) of the Act, for Mr A director of Y Limited,  X Limited  becomes a interested person, as its director Mr A also holds more than 25% holding in X Limited. Thus Y Limited cannot provide guarantee in favour of Banks on behalf of X Limited.

In this case , Y Limited is nothing but a closed held public company controlled  by promoters and public have not much  interest in it. In this case if Y Limited is giving the guarantee then indirectly the promoters are providing guarantee through their company in the interest of listed company, and giving of guarantee by promoters is not prohibited by the Law.

From this it comes out that section 185 of the Act be amended in such a way that it should not be applicable to the private and closing held public companies ( which are not listed )  that is companies in which majority of shareholding is held by directors or promoters for giving of loans etc to other  companies. This will protect the interest of the public at large.

So the question arises, but should be done and how the promoter company can provide guarantee  on behalf of listed company to the banks, while section 185 of the Act  prohibits it to provide the same as explained above.

Intentionally or unintentionally section 185 of the Act read with sub-section (2) of section  186 of the Act  provides the solution  for that.

Sub-section (1) of section 185 of the Act commences with “Save as otherwise provided under this Act” . Here it is to be noted that it saves  as otherwise provided under “ this Act” in place of  under “this section” as provided under section 295 of Companies Act , 1956.  Thus it  saves whatever is written not only under this section but also under any provisions of other sections of the “Act”. It is  thereby meant that every section of the act overrides this section. It may be agreed that the framers may not have intended for that . But whatever the intention of framers may be, unless there is amendment of section 185, till that date , everything whatever provided under any provisions of other sections of the Act , will remained saved.

Sub-section (1) of section 186 of the Act commences with “Without prejudice to the provisions contained in this Act” .So the provisions other sections of the Act have  overriding effect to whatever mentioned under any provision of this sub section of section 186 .

But sub section (2) of section 186 of the Act does not commence with the aforesaid words , thus this sub-section of section 186 of the Act has effect independently .  So sub section (2) of section 186 of the Ac t  read with sub  section  (1) of section 185 of the Act , means that whatever is provided under this section , it has been saved and have overriding effect.

Sub section (2) of section 186 of the Act provides 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 sixty per cent. of its paid-up share capital, free reserves and securities premium account or one hundred per cent. of its free reserves and securities premium account, whichever is more.

Sub section (3) of section 186 provides that

Where the giving of any loan or guarantee or providing any security or the acquisition under sub-section (2) exceeds the limits specified in that sub-section, prior approval by means of a special resolution passed at a general meeting shall be necessary.

Thus the provisions of sub  section (2) and (3) of 186 of the Act, authorises a company to  give loan or guarantee etc to any person in compliance with the provisions of this section.

So even if, section 185 of the Act prohibits a company to give any loan / guarantee to any person , even then a company can legally provide loan / guarantee by complying the provisions of sub section (2) and (3) of 186 of the Act.

Submitted for kind comments please.

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Category Corporate Law, Other Articles by - Krishan Singla 



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