Loans to Directors (Section 185 Companies Act 2013)

Section 185 deals with the Loans to Directors under the Companies Act 2013 (Bare Act). The following article is an detailed analysis of Loans to Directors Under Companies Act 2013, including latest MCA Amendments. Section 185 of the Companies Act, 2013 which has been notified on 12th September 2013 corresponds to section 295 of the Companies Act, 1956 which deals in loan to directors.

Loans to Directors (Section 185 Companies Act 2013)

This section is more restrictive than that of old Companies Act, 1956. Section 185 prohibits any company from giving loans, guarantees and securities in favor of its directors or to any other person in whom the director is interested in. Also read our Previous articles on Directors Appointment in casual Vacancy, Appointment of Additional Director  and Appointment of Alternate Director.

Loans to Directors Section 185

According to section 185(1) save as otherwise provided in the act, no company shall directly or indirectly 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 director is interested or give any guarantee or provide any security in connection with any loan taken by him or such other person.

The above provisions shall not apply in the following cases:

(a) the giving of any loan to a managing or whole-time director –

  1. as a part of the conditions of service extended by the company to all its employees; or
  2. 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.

Explanation : For the purposes of this section, the expression “to any other person in whom director is interested” means –

  1. any director of the lending company, or of a company which is its holding company or any partner or relative of any such director;
  2. any firm in which any such director or relative is a partner;
  3. any private company of which any such director is a director or member;
  4. 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; or
  5. 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.

The companies (meeting of boards and its power) Rules, 2014 also Prescribe various provisions related to loan to directors

Loans To Directors – Rule 10 of the Companies – Rules 2014

  1. Any loan made by a holding company to its wholly owned subsidiary company or any guarantee given or security provided by a holding company in respect of any loan made to its wholly owned subsidiary company is exempted from the requirements under this section; and
  2. Any guarantee given or security provided by a holding company in respect of loan made by any bank or financial institution to its subsidiary company is exempted from the requirements under this section:

Provided that such loans made under sub-rule(1) and (2) are utilised by the subsidiary company for its principle business activities.

Loans to Directors section 185 – Analysis

Section 185 of companies act 2013  applies to both private and public companies

Indirect Lending

No company can directly or “indirectly” advance loan to its “directors” or to “other persons in whom directors are interested”. Indirect lending means that the company does not give a loan to director through the agency of one or more intermediaries. But, this word of ‘indirect’ cannot be read by converting what is not a loan into a loan as was discussed in Dr Fredie Ardeshir Mehta Vs Union of India (1991) 70 Comp Case 210

Loan Definition

Definition of loan is not mentioned in the companies act. Therefore in layman language, it can be said that all transactions where sum of money is given to a person to be returned with or without interest can be termed as loan,

Advances

But advance is not covered in the definition of loan as it is a kind of prepayment. For e.g, if the company gives advance to a person against purchase of materials, this will not be treated as loan,

Share Application money received is also not covered in the definition of Loans,

Guarantee

Company cannot give any guarantee or provide any security in connection with any loan taken by him or such other person.

Now, this is restrict a very common situation of holding company that used to give guarantee of its subsidiary company, so that the later could avail bank funding and loans (if holding company and subsidiary company have common directors).

But, it is to be taken into consideration that here guarantee or security is covered but not letter of comfort.

The basic difference between guarantee and letter of comfort is that in case of guarantee, guarantor undertakes the liability of principal debtor, whereas in letter of comfort, guarantor does not undertake any liability of principal debtor but instead introduces him to the third party.

Book debts

Also, company cannot give loan which is represented under the head ‘book debts’ to directors or persons in whom directors are interested, i.e. if a company advances a loan/ sum of money to directors and shows the same under the head of ‘book debts’, i.e. director is debtor from whom company has to receive money is also prohibited.

It is to be noted that Section 296 of Companies Act, 1956 considered a book debt as loan for the purpose of Section 295. Time for repayment & other terms & conditions should be considered to consider any debt as a loan.

Loan given before 12.08.2013 is not covered under section 185 of companies act 2013 as the act says “no company shall ‘advance’ any loan or ‘give’ any guarantee or ‘provide’ any security…….” which is in future tense and therefore section 185 of companies act 2013 applies prospectively. But, the same loan should not be renewed or altered.

Loan Register

Company shall maintain a register in Form MBP 2 and enter therein separately, the particulars of loans and guarantees given, securities provided and acquisitions made as aforesaid in chronological order in respect of each such transaction within seven days of making such loan or giving guarantee or providing security or making acquisition.

The entries in register is to be signed and authenticated by the company secretary employed in the company or by any other person authorised by the Board for the purpose.

Penalty : Section 185 Companies Act 2013

Lender Company – Fine Rs. 5 lakhs to Rs. 25 lakhs &

Receiver: Director or other person to whom any loan is advanced or guarantee or security is given -Imprisonment upto 6 months or fine Rs. 5 lakhs to Rs. 25 Lakhs, or both i.e. both receiver and lending company is covered here