The Companies Act 2013 governs the norms concerning grants of loans to the company’s Director (s). Section 185 of the Companies Act 2013 underpins the directions relating to the same. Every company must abide by the norms of this section before rendering loans or guarantees or security linked to the loan. Section 185 of the Companies Act 2013 also comprises penal provisions that come into effect when any contravention comes to light.
Why the Section 185 of the Companies Act 2013 introduced?
Before the advent of the Companies Act 2013, the Companies Act 1956 was in force, which does not impose any limitation on how companies handle their funding arrangement and credit line. With no authoritative curbing, these companies could grant loans and securities after securing the central government’s approval. Owing to this loophole, companies willingly borrowed and transferred the firm to their subsidiary, leaving no trace of accountability. Section 185 of the Companies Act 2013[1] was introduced to patch this gap.
Provisions Relating To Loan to Directors
Section 185(1) of the Companies Act 2013 states that a company is not allowed to –
- Advance loans directly or indirectly,
- Advance loan comprising a loan manifested by a book debt,
- Accord guarantees or facilitates security relating to any loan taken
to a director, director managing affairs of the holding company, partner or relative of any director, or any company in which a director is a partner or a relative. Therefore, this section forbids the grant of loans to the Director (s) or relative(s), or partner(s) of the company’s Director (s)
Loan to an Individual Known to Director
Section 185 of the Companies Act 2013 does not restrain companies from granting advance loans comprising any loan manifested by a book debt or facilitating guarantee or security connected with any loan to a person known to the Director.
Section 185(2) enables a firm to accord a loan to any individual/firm in which the company’s Director has a keen interest. However, before doing so, the company must pass a special resolution in a general meeting affirming that the borrowing company shall use the loan or advance for its principal business activities.
The explanatory statement within the general meeting notice shall comprise the complete details of the loans or guarantee or security and the purpose for loan facilitation. The Act specifies the list of individuals that qualify as an interesting party to the company’s Director. Only these individuals have access to such loans and advances. Such individuals are as follows:
- Any private company in which the lending company’s Director is a director or member.
- Anybody corporate whose constituency structure comprises 25% of total voting power by the Director (s) of the lending company
- Anybody corporate, BODs, the managing directors tied to the directions of the boards or of any director(s) of the lending company
Exemptions Cited Under the Companies Act 2013
Section 185(3) of the Act underpins exemptions available to the companies concerning the limitations imposed on loan facilitation. As per the section, the company can advance loans or facilitate a guarantee or security to
- The managing or full-time Director if such credit arrangement is a part of services facilitated by the company to its employees or if such arrangement falls under the scheme having the members’ approval.
- A company that facilitates loans or securities or guarantees for the due repayment of any loans. The interest concerning such loans shall be equivalent to the interest applicable to government securities
- The wholly-owned subsidiary for fulfilling their financial needs that do not fall beyond the scope of principal business activities
Penalty for Breaching Norms under Section 185 of the Companies Act 2013
Section 185(4) of the Act underpins the penal provisions concerning violation of the above provisions. If the company breaches any norm, a penalty amounting to Rs 5 lakh shall be applied. The said penalty amount can go as high as Rs 25 lakhs in a worst-case scenario.
Every defaulting official in this context can face a jail term of up to 6 months or a fine ranging from Rs 5-25 lakhs, depending on the case-wise basis. The beneficiary, in such a case, can confront imprisonment of six months alongside a fine ranging from Rs 5-25 lakhs.
Key Facts to Ponders In Section 185 of the Companies Act 2013
This Act plays a pivotal role in the company’s constituency power for the grant of loans. Here is what we have gone through till now.
- A company is not allowed to render loans to directors, their partners, or relative, nor any security or guarantee linked with any loans can be accorded to them.
- A company is permitted to facilitate loans to a firm in which the Director is a partner or relative nor can facilitate any security or guarantee linked with any loan to them.
- A company can grant a loan or guarantee or security to a person (known to the Director as an interested party) after passing the special resolution. The loan amount cannot be utilized for purposes that have nothing to do with the principal business activities.
- The term “interested party” is interpreted as a person/entity cited in Section 185(2).
- The company can accord a loan or guarantee or security to the whole-time Director or managing Director meets the conditions under Section 185(3) of the Act.
- The company involves in the facilitation of loans or guarantees for the due repayment of any credit as part of their business affair can grant a loan.
- The holding company can accord a loan to its subsidiary if the firm meets the conditions of Section 185(3) of the Act.
Can A Company Grant Loans To Directors?
A company can accord loans to directors after the fulfillment of certain conditions. Section 185 of the Companies Act 2013 restrains companies from rendering loans directly or indirectly to any of their directors that does not comply with the conditions of the governing section.
Is Section 185 Of The Companies Act Applicable To NBFC?
Section 185(3)(b) of the Companies Act, 2013 does not encompass NBFCs if such entities facilitate loans in the ordinary course of their business.
Conclusion
Borrowing and transferring funds is a common practice in the corporate landscape. Companies falling under the Companies Act 2013 cannot lend funds as credit before meeting the conditions of Section 185 of the Companies Act 2013. Any non-conformity with this section can incur significant penalties for the defaulter.
Read Our Article: Loan to Directors: A Complete Checklist
