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Restriction on granting of loan to its directors by a company and other entities in which directors are interested has been one of the most touching issues in the Companies Act, 2013, since 12th September 2013, when Ministry of Corporate Affairs notified 98 Sections of the Companies Act, 2013 to become effective and applicable from that date. Section 185 of the Companies Act, 2013 which contains provisions dealing with granting of loans & advances and providing of guarantees and securities by a company to its directors and other entities in which directors are interested got notified with effect from 12.09.2013. This section is applicable both to private and public companies.

This section in general prohibits a company to grant loans or advances or provide guarantees and securities, in any manner, to its directors or other entities in which directors are interested subject to few exceptions discussed below.

SCENARIO BEFORE 12.09.2013

Before 12.09.2013, Section 295 of the Companies Act, 1956 was in force.

Applicability of Section 295 of Companies Act, 1956:

By virtue of sub-section 2 of Section 295, Private Companies, not being subsidiary of any public company, were exempt from the applicability of this Section. This meant that Private Companies were free to lend any sum to their directors or other related entities without any regulatory control.

Section 295 was applicable only to Public Companies and Private Companies which were subsidiary of any public company. Coming to public companies, let us see what was regulated:

Transactions which were restricted, directly or indirectly:

• Advancing of any loan, and

• Giving of any guarantee or providing of any security in connection with any loan

Entities between which the above transactions were restricted:

A. Company, on one side, and

B. Any one or more of the following on the other side

• any director of the company

• any director of the holding company

• any partner or relative of director of company or holding company

• any firm in which any such director or relative is a partner

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

• any body corporate at a general meeting of which not less than 25% of the total voting power may be exercised or controlled by any such director, or by two or more such directors together

• 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.

Exceptions to the above restrictions

• Any loan made by a holding company to its subsidiary

• Any guaranty given or security provided by a holding company in respect of any loan made to its subsidiary

• Any loan made, guarantee given or security provided by a banking company

Nature of restriction

Public Companies or Private Companies, being subsidiary of public company, were required to obtain prior approval of Central Government for entering into any of the transaction between the entities as specified above.

SCENARIO AFTER 12.09.2013

The Ministry of Corporate Affairs had notified 98 Sections of the Companies Act, 2013 on 12.09.2013 to become applicable from 12.09.2013. One of the 98 Sections which have become effective from that date is Section 185 which corresponds to Section 295 of the Companies Act, 1956. This means that effective, 12.09.2013, Section 295 of Companies Act, 1956 has lost it applicability and Section 185 of the Companies Act, 2013 has become applicable.

Applicability of Section 185 of Companies Act, 2013:

Section 185 is applicable to all kinds of Companies, i.e. to both Private and Public Companies.

Transactions which are prohibited, directly or indirectly:

• Advancing of any loan, including any loan represented by a book debt, and

• Giving of any guarantee or providing of any security in connection with any loan.

Entities between which the above transactions are prohibited:

A. Company, on one side, and

B. Any one or more of the following on the other side Practising Company Secretaries

• any director of the company

• any director of the holding company

• any partner or relative of director of company or holding company

• any firm in which any such director or relative is a partner

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

• any body corporate at a general meeting of which not less than 25% of the total voting power may be exercised or controlled by any such director, or by two or more such directors together

• 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.

PROHIBITED TRANSACTIONS

Exceptions to above prohibition:

• Giving of any loan to a managing or whole-time director as a part of the conditions of service extended by the company to all its employees or pursuant to any scheme approved by the members by a special resolution

• 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.

Nature of Prohibition

There is an absolute prohibition on granting of loans/guarantees/securities to directors and other entities in which directors are interested. No provision for Central Government approval has been made in the Section.

VERBATIM COMPARISON OF SECTION 295 OF COMPANIES ACT, 1956 AND SECTION 185 OF COMPANIES ACT, 2013

Basis of Comparison

Section 295 of Companies Act,  1956

Section 185 of Companies Act, 2013

Impact of the Change

Section Title

Loans to directors, etc.

Loan to directors, etc.

No Change

Opening remarks of Section

Save as otherwise provided in sub- section (2), no company (hereinafter in this section referred to  as  "the  lending  company") without obtaining the previous approval of the Central Government  in  that  behalf  shall directly  or  indirectly,  make  any loan to, or give any guarantee or provide any security in connection with a loan made by any other person to, or to any other person by (Sub-Section 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 (Sub- Section 1)

1. Under Section 185 loan includes, book debts also.

2. Possibility of entering the transaction with Central  Government approval has been done away with.

Entities with whom transaction is restricted

(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

(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

No Change

(e) any body corporate, the Board of directors, managing director, managing agent, secretaries and treasurers, 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. (Sub- Section 1)

(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. (Explanation given under sub-section 1)

 

Exemption available

Sub- section (1) shall not apply to- (a) any loan made, guarantee given or security provided-

(i) by a private company unless it is a subsidiary of a public company, or

(ii) by a banking company;

(b) any loan made-

(i) by a holding company to its subsidiary, or

(ii) by a company which is the managing agent or secretaries and treasurers of another company to that other company;

(c) any guaranty given or security provided-

(i) by a holding company in respect of any loan made to its subsidiary, or

(ii) by a company which is the managing agent or secretaries and treasurers of another company in respect of any loan made to that other company. (Sub-section 2)

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. (Proviso to sub-section 1)

1. Exemption available to Private Companies has been removed.

Section 185 is applicable to all companies, Public or Private.

2. Exemption available in respect of transaction between holding and subsidiary companies has also been removed.

3. New exemptions have been introduced by virtue of which loans can be granted to MDs or WTDs by seeking members’ approval by means of special resolution or as part of condition of service extended to all employees.

Transitional provision

Where any loan made, guarantee given or security provided by a lending company and outstanding at the commencement of this Act could not have been made, given or provided, without the previous approval of the Central Government, if this section had  then been in force, the lending company shall, within six months from the commencement of this Act or such further time not exceeding six months as the Central Government may grant for that, purpose either obtain the approval of the Central Government to the transaction or enforce the repayment of the loan made, or in connection with which the guarantee was given or the security was provided, notwithstanding any agreement to the contrary.

(Subsection 3)

No Provision

1. There is no clarity in the Companies Act, 2013 regarding the transactions which were given entered prior to 12.09.2013 and which are still  continuing after the commencement of Section 185. This remains a grey area owing to the fact that the new Act does not provide any transitional provision.

Penal Provisions

Every person who is knowingly a party to any contravention of subsection (1) or (3), including in particular any person to whom the loan is made or who has taken the loan in respect of which the guarantee is given or the security is provided, shall be punishable either with fine which may extend to five thousand rupees or with simple imprisonment for a term which may extend to six months:

Provided that where any such loan, or any loan in connection with which any such guarantee or security has been given or provided by the lending company, has been repaid in full, no punishment by way of imprisonment shall be imposed under this sub-section; and where the loan has been repaid in part, the maximum punishment which may be imposed under this sub-section by way of imprisonment shall be proportionately reduced. (Subsection 4)

All persons who are knowingly parties to any contravention of subsection (1) or (3) shall be liable, jointly and severally, to the lending company for the repayment of the loan or for making good the sum which the lending company may have been called upon the pay in virtue of the guarantee given or the security provided by such company. (Sub-section 5)

No officer of the lending company or of the borrowing body corporate shall be punishable under subsection (4) or shall incur the liability referred to in sub- section (5) in respect of any loan made, guarantee given or security provided after the 1st day of April 1956 in contravention of clause (d) or (e) of sub- section (1), unless at the time when the loan was made, the guarantee was given or the security was provided by the lending company, he knew or had express notice that that clause was being contravened thereby. (Subsection 6)

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. (Subsection 2)

1. Monetary penalty has been substantially increased from a maximum of Rs. 5,000/- to Rs. 25,00,000/-

2. No penalty for company was prescribed earlier. But now, even the company will be punishable with fine ranging between rupees 5- 25 Lakhs.

3. Provision regarding no imprisonment in case of full repayment of loan or reduction in imprisonment for partial repayment of loan has been removed.

CIRCULARS & NOTIFICATIONS ISSUED BY MCA RELATING TO SECTION 185 OF COMPANIES ACT, 2013

(Just for reference sake)

Circular/Notification Reference

Effect of the Circular

Commencement  Notification  Of  Companies Act 2013 dated 12.09.2013

MCA notifies 98 Sections of Companies Act, 2013 to become applicable from that date. Section 185 forms part of the notified sections

General  Circular  number  16/2013  dated 18.09.2013 - Clarification on the notification dated 12.9.2013

MCA  clarifies  that  with  effect  from 12.09.2013,  the  relevant  provisions  of  the companies Act, 1956, which correspond to provisions of 98 sections of the companies Act, 2013 brought into force on 12.09.2013, cease to have effect from that date. Thus, Section 295 of Companies Act, 1956 ceases to have effect from 12.09.2013

General  Circular  number  3/2014  dated 14.02.2014  -  Clarification  with  regard  to Section 185 of the Companies Act, 2013.

MCA clarifies that till the time Section 186 of the Companies Act, 2013 is notified, Section 372A of Companies Act, 1956 will remain in force.

In order to bring harmony between Section 185 of  Companies  Act,  2013  and  372A  of Companies Act, 1956, it is clarified by MCA that any guarantee given or security provided by a holding company in respect of loans made by a bank of financial institution to its subsidiary company, exemption as provided in clause (d) of sub-section 8 of Section 372A of the Companies Act, 1956 shall be applicable till Section 186 of the Companies Act, 2013 is notified.

WRAP UP

Section 185 of the Companies Act, 2013 has imposed a very strict restriction on corporates whereby they are completely prohibited from giving any loans to their directors or other entities in which directors are interested, barring some negligible exemptions. The applicability of this Section to Private Companies and even to transactions with subsidiary companies has made matters even worse. Let us wait and see how corporate are strictly aligning to these requirements in the days to come.


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Category Corporate Law, Other Articles by - CS DHANAPAL 



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