Section 185 — The Strict Prohibition on Loans to Directors
Section 185 of the Companies Act, 2013 places a near-absolute prohibition on companies providing loans, guarantees, or security to their directors or to persons connected with directors. The provision exists to prevent directors from misusing company funds for personal benefit — a widespread practice under the old Companies Act, 1956 that led to significant governance failures.
The consequences of violating Section 185 are among the harshest in the Companies Act: the company faces a fine of Rs. 5 lakh to Rs. 25 lakh, the director who receives the loan faces imprisonment of up to 6 months AND fine of Rs. 5 lakh to Rs. 25 lakh, and the loan must be repaid within 60 days. This is one of the few provisions where directors face IMPRISONMENT — not just a monetary penalty.
What Is Prohibited Under Section 185(1)?
No company shall directly or indirectly advance any loan (including loan represented by a book debt) to, or give any guarantee or provide any security in connection with any loan taken by:
(a) Any director of the company
(b) Any director of a company which is the holding company of the lending company
(c) Any partner of such director (partner in a firm where the director is also a partner)
(d) Any relative of such director (as defined under Section 2(77) — spouse, father, mother, son, daughter, son's wife, daughter's husband, brother, sister)
(e) Any firm in which any such director or relative is a partner
(f) Any private company in which any such director is a director or member
(g) Any body corporate at a general meeting of which not less than 25% of the total voting power may be exercised by such director or by two or more directors together
Exceptions — When Loans to Directors ARE Permitted
Exception 1: Loan to Managing Director or Whole-Time Director — Section 185(2)
A company CAN give a loan to its MD or WTD as part of the conditions of service applicable to ALL employees — or pursuant to a scheme approved by members by special resolution. Example: company offers housing loan to all employees at concessional rate — MD is also eligible since it applies to all employees equally. The loan amount must be disclosed in the financial statements.
Exception 2: Private Company Exemption (Most Important)
Under MCA notification dated June 5, 2015 (Exemption Notification), private companies are exempt from Section 185 provided:
(a) The loan is given with the prior approval of all members by special resolution in a general meeting or by written consent
(b) The loans are utilized by the borrowing company for its principal business activities (if the borrower is a company)
This exemption is the reason most private company directors CAN receive loans from their companies — but ONLY with unanimous shareholder approval (not majority, not ordinary resolution — ALL members must agree). This is a critical compliance point: if even one shareholder does not consent, the loan is prohibited.
Exception 3: Guarantee/Security for Subsidiary Company — Section 185(2)
A company CAN provide guarantee or security in connection with a loan taken by a subsidiary company from a bank or financial institution, provided:
(a) The subsidiary utilizes the loan for its principal business activities
(b) Prior approval by special resolution of the lending/guarantor company
Practical Scenarios
Scenario 1: Director Needs Personal Loan from Company
Public company: Strictly prohibited (unless MD/WTD under conditions of service for all employees). No exceptions.
Private company: Possible — if ALL members approve by special resolution, the director can receive a loan. The loan must be at arm's length terms (reasonable interest rate — benchmark against SBI lending rate). Disclosure in financial statements mandatory.
Scenario 2: Company Guarantees Director's Personal Home Loan
Public company: Prohibited — guarantee for director's personal loan is covered by Section 185(1)(b).
Private company: Possible with ALL members' approval. But practically rare — banks typically don't need corporate guarantee for personal housing loans if the director has sufficient personal income.
Scenario 3: Company Lends to Another Company Where Director Is a Member
If Director A of Company X is also a member (shareholder) of Company Y: any loan from Company X to Company Y is covered by Section 185(1)(f) — prohibited unless the private company exemption is used (ALL members of Company X must approve, and Company Y must use the loan for principal business).
Distinction: Section 185 vs Section 186
This is a frequently confused area:
| Parameter | Section 185 — Loan to Directors | Section 186 — Loan/Investment/Guarantee |
|---|---|---|
| To whom | Directors and connected persons | Any person/body corporate |
| Nature | Prohibition (with exceptions) | Restriction (within limits) |
| Limit | No monetary limit — prohibited entirely (except exemptions) | 60% of (paid-up + free reserves + securities premium) or 100% of free reserves, whichever is more |
| Approval | ALL members for private company exemption | Board resolution (within limit), special resolution (beyond limit) |
| Penalty | Imprisonment + fine | Fine only (no imprisonment) |
| Private co exemption | Yes — with ALL members' consent | Exempt for private companies (fully) |
Penalty for Violation
Company: Fine of Rs. 5 lakh to Rs. 25 lakh
Director who receives the loan: Imprisonment up to 6 months AND fine of Rs. 5 lakh to Rs. 25 lakh
Every officer in default: Imprisonment up to 6 months AND fine of Rs. 5 lakh to Rs. 25 lakh
Loan repayment: The loan, along with interest at the prevailing bank rate, must be repaid within 60 days of the violation being identified
Note: Section 185 violation carries IMPRISONMENT — it is one of the non-compoundable offences (cannot be settled by paying a fine). However, the Companies (Amendment) Act, 2020 partially decriminalized Section 185 — imprisonment may be replaced by monetary penalty for certain cases handled by ROC/RD under the adjudication framework.