Detailed discussion of Section 185 of the Companies Act 2013

This refers that the “Companies Act likely to jolt Corporate World”. Section 185 of the Companies Act, 2013, which puts restrictions on inter-corporate loans, jolted the corporate world. Until now, Companies were in the habit of borrowing funds from banks and passing them on to subsidiaries and associate companies through inter-corporate loans. The holding companies never bothered to comply with the terms of the loan agreement when it concerned the deployment of the borrowed funds. The banks never monitored such fund deployment either. The new provisions will not hamper the working of transparent companies since loans to wholly-subsidiary companies are exempted and parent companies can give a guarantee for the loans taken by their subsidiaries. It is clarified that such a loan must be utilized for the subsidiary’s principal business activities.

Section 185 of the 2013 Act is the new Section 295 of the 1956 Act. Upon a cursory glance, the key points of departure from the 1956 Act that emerge are the wiping out of any Central Government approvals and the applicability of the restriction to private and public companies alike.

DETAILS ON LOAN:

Section 2 of Companies Act, 2013, does not define “loan”. A loan is defined by the Oxford English Dictionary as ” a thing lent; something the use of which is allowed for a time, on the understanding that it shall be returned or an equivalent given, a sum of money lent on these conditions and usually with interest.

The Supreme Court in the case of Shree Ram Mills Ltd v. Commissioner of Excess Profit Tax, MANU/SC/0054/1954 ;

Loan: If a Company wants to give a Loan, make Investment, provide Security and guarantee then Company has to look at the following sections, Rules, and Circulars:

SECTIONS INVOLVED:

Ø  Section 177 (4) (v): Every Audit Committee shall scrutiny of inter-corporate loans and investments.

Ø  Section 179(3) (e): The Board of Directors of a company shall exercise the power to invest the funds of the company by means of resolutions passed at meetings of the Board,

Ø  Section 185: Loan to any of its directors or to any other person in whom the director is interested. (Detailed Discussion Below)

Ø  Section 186: Loan and Investment by Company. (Detailed discussion in next Article)

EARLIER WAS SECTION 295,296 OF THE COMPANIES ACT, 1956

RULES INVOLVED:

Ø  Rule 8 of the Companies (Meetings of Board and its Powers) Rules, 2014.

Ø  Rule 10 of the Companies (Meetings of Board and its Powers) Rules, 2014]

Ø  Rules 11, 12 and 13 of the Companies (Meetings of Board and its Powers) Rules, 2014

CIRCULARS INVOLVED:

Ø  CIRCULAR NO.4/2015 [NO.1/32/2013-CL.V], DATED 10-3-2015

Ø  GENERAL CIRCULAR NO.6/2015 [F.NO.5/3/13-CL.V], DATED 9-4-2015

Ø  GENERAL CIRCULAR NO.15/2014 [F.NO.5/6/2014-CL-I], DATED 9-6-2014

Ø  ORDER [F. NO. 1/13/2013-CL.V-PART]/SO 504(E), DATED 13-2-2015

NON APPLICABILITY OF SECTION 185:

Below mention Companies by fulfilling the given condition can give loan, make investment and made guarantee respectively without restriction under section 185.

       NOTIFICATION NO. GSR 463(E)[F.NO.1/2/2014-CL-V], DATED 5-6-2015:

 Section 185 Shall not apply to GOVERNMENT COMPANY in case such company obtains approval of the Ministry or Department of the Central Government which is administratively in charge of the company, or, as the case may be, the State Government before making any loan or giving any guarantee or providing any security under the section.

       NOTIFICATION NO. GSR 464(E) [F.NO.1/1/2014-CL-V], DATED 5-6-2015:

Section 185 shall not apply to a PRIVATE COMPANY by fulfilling of three conditions

1. a)In whose share capital no other body corporate has invested any money;
2. b)If the borrowings of such a company from banks or financial institutions or any body corporate is less than [lower of (i) Two times of paid-up share capital or (ii) Rs. 50 Crore], and
3. c)Such a company has no default in repayment of such borrowings subsisting at the time of making transactions under this section.

       NOTIFICATION NO. GSR 465(E)[F.NO.2/11/2014-CL.V], DATED 5-6-2015:

Section 185 shall not apply to NIDHI COMPANY; provided the loan is given to a director or his relative in their capacity as members and such transaction is disclosed in the annual accounts by a note.

       Loan Holding – Wholly Own Subsidiary

Any loan made by a Holding Company to its Wholly own Subsidiary Company or any guarantee given or security provided by a Holding Company in respect of any loan made to its wholly own subsidiary Company. Condition: loan made under this clause utilized by the wholly own subsidiary company for its principal business activity only.

       Guarantee/ Security Holding –Subsidiary

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.

Condition: loan made under this clause utilized by the subsidiary company for its principal business activity only.

      Loan to Managing Director & Whole Time Director:

There are two ways to give Loan to Managing and Whole Time Director. The exception is extended to a particular class of directors, i.e. to the managing or whole-time directors only.

• The loan can be given to a Managing or Whole-Time Director as a part of the Policy of their service.

Condition:  Policy should be available for all the employees of the Company.

• The loan can be given to a Managing or Whole-Time Director pursuant to any Scheme.

Condition:  Scheme should be approved by Shareholders by passing of Special Resolution.

Example: The Companies pass a resolution for appointment of Managing Director and it approves the terms and conditions of its appointment and if as a part of its terms, there is a loan which can be given to that director, then it falls under the exception given in section 185 of the Act.

Loan in Ordinary Course of Business

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.

Detailed discussion on word Ordinary Course of Business is given below:

APPLICABILITY OF SECTION 185

• Individual Entity

• • Any director of the lending company; or
  • Any director of its holding company; or
  • Any partner of any such director; or
  • Relative of any such director;

• Firm:

1. 1. Any firm in which any¹such director is a partner; or
   2. Any firm in which the relative of any such director is a partner;

• Company

1. 1. Any private company of which any such director is a director; or
   2. Any private company of which any such director is a 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:

1. 1. Any such director; or
   2. By 2 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:

1. 1. Board; or of
   2. Any director or directors of the lending company

Meaning of word “SUCH” Director:

¹Such’ would mean in reference to the director of the lending company and/ or in relation to the director of its holding company

MEANING OF TERMS USES IN 185:

“SAVE AS OTHERWISE PROVIDED IN THIS ACT”

This would mean that if anywhere else, i.e. if any other section of the Companies Act, 2013 allows giving of loans etc. to the persons covered in section 185 then that will be permitted. For the information of the readers, there are no such sections that permit the same in the Companies Act, 2013.

“ORDINARY COURSE OF BUSINESS”

The phrase ‘ordinary course of business’ has also not been defined under the Act. This is because there can be no universal meaning ascribed to it. What is ordinary for one entity or one type of business or one sector or even one region may not be so for another.

Example: There is an NBFC Company which is registered in the category of a loan NBFC. If this Company gives a loan and the rate of interest aspect is taken care of, then they said loan will be falling in the exception clause and hence section 185 will not be applicable.

Will it be applicable for all kinds of NBFC? Clearly not. If suppose this Company in question is an Investment NBFC. Then surely giving of loans for it will not classify in its ordinary course of business.

However, based on Judicial Precedents and keeping in view the intent and purpose of the provision, a transaction can be said to be in ‘ordinary course of business’, if:

The Lending Company has in the past provided loans/guarantees/securities to such entities as a matter of routine. The frequency of such transactions and a certain amount of continuity is imperative as ‘business’ itself implies carrying on a particular trade or vocation as a ‘continuous’ activity by application of labour, skill and money to earn the income. Also, important is that such transactions have been appropriately disclosed in the financial statements of the Lending Company for the past years.  The disclosure of such transactions in the financial statement indicate that such activities were being carried on normally in the usual course of business, specifically inclusion of the amounts involved as ‘business income’ gives further credence to the fact.

MOA should allot to grant loan (Object of the Company to give Loan)

The memorandum of association of the Lending Company allows for such transactions i.e. the providing of loans/guarantees/security to other entities should be part of objects of the memorandum of association. The Courts have not been uniform in their ruling with respect to the significance of the objects clause of the memorandum of association in making this assessment. The Courts also differ on whether an activity is in ‘ordinary course’ only if part of the main objects is or whether an activity ancillary to the main objects may also be considered so.

But loans business in its main object clause doesn’t qualify under the phrase-‘ordinary course of Business’. This is also not going to help, unless the other special acts allow such activities and the Company has all proper registrations for being called so.

“INCLUDING ANY LOAN REPRESENTED BY A BOOK DEBT”

The phrase ‘including any loan represented by a book debt’ is a very smart move by the law makers to ensure that the directors and/or any other person in whom the director is interested do not circumvent the law by juggling with the words.

To elaborate this with an Example

Say a Company manufactures Computer. One of the Directors of the Company is setting up an Office for which he will also need to buy Computer. The director in the erstwhile situation (when section 185 was not applicable) could have taken a loan from the Company for buying the same. But in the present situation, since he is not able to take that loan, he asks the Company to give him 20 Computers for a long credit period. If the credit period extended by the Company is as per the normal period and in the normal terms and conditions, as extended to its other buyers, then there is no problem but as soon as it is biased and tilted to give undue benefit to the director and/or other person in whom the director is interested, then such transaction will be considered to be loan.

“SUBSIDIARY COMPANY”

Subsidiary Company’ mean ‘a company in which the holding company control the composition of the Board of Director or exercises/controls more than one-half of the total share capital either at its own or together with one or more of its subsidiary companies’.

“PRINCIPLE BUSINESS ACTIVIY”

Even though ‘principal business activity’ has not been defined under the Act, generally the activities provided under the main objects of the memorandum of association should qualify as a principal business activity of that company

IMPORTANT POINTS

Ø  Section 185 completely ruled out the possibility of giving any loan (including a loan representing a book debt), a guarantee or a security, either directly or indirectly, to any director or to any other pension in whom Director is interested.

Ø  Interest Rate:

No loan may be given by the Lending Company at an interest rate lower than the prevailing yield of one year, three year, five year or ten year government security closest to the tenor of the loan

Ø  Allowable Loan Foreign Holding to Indian Subsidiary.

Section 185 is applicable only when a ‘company’ gives loan to its director or any person in whom the director is interested. However, the definition of a ‘company’ under Section 2(20) means only a company incorporated under 2013 Act or any previous company law. So, the restriction in Section 185 will not apply when a holding company incorporated outside India gives a loan, guarantee or security to its Indian subsidiary.

“Restriction applies only at the time of entering into the transaction.”

Ø  If a Private limited Company has given loan/ guarantee or security which was exempted under Section 295 of the Companies Act, 1956 shall continue to be exempted under Section 185.

Ø  If a person only an employee of the Company and later he becomes director of the Company, section 185 would not apply.

Restriction applies only at the time of entering into the transaction.

The Lending Company (not if it is a banking company or an insurance company or a housing finance company providing the loan/security/guarantee in ordinary course of business or company engaged in business of financing of companies or of providing infrastructural facilities) should have complied/should comply with the conditions under Section 186 of the Act.

LIMIT OF LOAN AND PROCEDURE:

Limit of Loan/Investment/Guarantee

No company shall give loan, invest fund, and give guarantee more than 60% (sixty per cent) of its paid-up share capital free reserves and securities premium account or 100% (one hundred per cent) of its free reserves and securities premium account, whichever is more. Approval required Board of Directors by passing of Unanimous Board Resolution:

If Company wants to give loan/, invest fund, and give guarantee more than above limit then follow the below given process:

Requirement of Special Resolution:

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

Secretarial Compliance:

As per Section 179(3) (e) procedure will be as follow:

• Company will call Board Meeting.
• Hold Board Meeting as per Secretarial Standard- I.
• Pass unanimous Board Resolution for investment of funds/give loan and will file e-form MGT-14 with such resolution.

REGISTER:

Every company Giving Loan or giving a guarantee or providing security or making an acquisition under this section shall keep a register in FORM NO. MBP-CK A2 which shall contain particulars of:

• Loan
• Guarantee Given
• Security provided
• Investment made

MAINTANANCE & INSPECTION:

• The register shall be kept at the registered office of the company.
• The Register shall be open to inspection at such office by Members;
• Extracts may be taken by any member,

Copies may be furnished to any member of the company on payment of such fees as prescribed in AOA not exceeding Rs. 10(TEN) for each page

EXAMPLES:

If a subsidiary company is desirous of availing a loan from its holding company or vice versa,

A check must be carried out under clauses (c), (d) and (e) of the Explanation to Section 185 to see if the borrowing company is a person in whom the director of the lending company is interested. This brings us to the scenarios in which inter-corporate loans between holding and subsidiary companies are permitted:

Scenario 1: If the borrowing company is a private company, not being a subsidiary of a public company, then, there must be no common directors between the boards of directors of the borrowing and lending companies and none of the directors of the lending company should be shareholders in the borrowing company.

Scenario 2: One or more of the directors of the lending company must not be able to exercise or control twenty five percent or more of the voting power of the borrowing company at its general meeting.

Scenario 3: The board of directors of the borrowing company must not be accustomed to act in accordance with the directions or instructions of the board or of any director(s) of the lending company.

PENAL PROVISION:

On Lending Company

In case of contravention of this section, the Lending Company shall be punishable with a minimum fine of Rs.5 lacs but which may extend to Rs.25 lacs;

On Recipient Director/ Entity

In case of contravention of this section, the recipient Director or other entity shall be punishable with imprisonment which may extend to six months or with a minimum fine of Rs.5 lacs but which may extend to Rs.25 lacs, or with both.

CONCLUSION:

With the new regime in place with respect to loans to directors, it can be concluded that no company can offer loan to its directors except in the conditions discussed earlier. The provisions of Section 185 of the Companies Act, 2013 does not provide any exemption to a private company as provided in the provisions of Section 295 earlier. The said change is anticipated to bring the better governance & transparency in the affairs of the Companies in the light of the applicable laws keeping in view the fiduciary character of the directors of the Company. The objective was not to hinder business and financing of businesses but was to discourage related party lending transactions which bred favouritism and nepotism

COMPLETE SECTION(After all Circulars and Resolution):

185. (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:

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.

[(c) 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; or

(d) 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:

Provided that the loans made under clauses (c) and (d) are utilised by the subsidiary company for its principal business activities.]23

Explanation.—for the purposes of this section, the expression “to any other person in whom director is interested” means—

(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) Anybody 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

(e) Anybody 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.

(2) 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.