Section 185 – Loans to Directors

I. Introduction

From the time Section 185 of the Companies Act, 2013 came into force all it attracted was ambiguity and confusion. Hence Circulars regarding the clarification of applicability of the Section has been published by Ministry of Corporate Affairs and now there also comes an amendment in the Companies (Amendment) Act, 2015.

II. Section 185 according to Companies Act, 2013

Section 185 of the Companies Act, 2013 is as follows:

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 –
   1. 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
   2. 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. 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
   5. 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.

III. Issues with the Section

Questions were raised regarding the definition of “ordinary business” used in the section and also whether a holding company can give guarantee or security in respect of any loan taken by its subsidiary.

While the rule 10 of the Companies (Meetings of Boards and Its Powers) Rules, 2014 stated that the following transactions are exempted provided that such loans are utilized by the subsidiary companies for it principal business activities:

• 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
• 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.

The Circular on the other hand that was issued on February 14, 2014 expressly mentioned that Section 185 of the Companies Act, 2013 prohibits guarantee given or any security provided by a holding company in respect of any loan taken by its subsidiary company except in the ordinary course of business.

IV. Amendments According to 2015 Act

Recently The Companies (Amendment) Act, 2015 has come to rescue to solve this problem by bringing an amendment in section 185. The amendment is as follows:

In section 185 of the principal Act, in sub-section (1), in the proviso, after clause (b) the following clauses and proviso shall be inserted, namely:

“(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 utilized by the subsidiary company for its principal business activities.”

V. Conclusion

It is relevant to note that 2013 Act did not provide any specific definition defining the term “wholly owned subsidiary”. It is a natural proposition that all wholly owned subsidiaries are subsidiaries but all subsidiaries may not be wholly owned subsidiaries. Therefore in accordance with the amendment, it is clear that the exemption is only for the loans made by the holding companies to its “wholly owned subsidiary” companies and not to include “subsidiaries” as defined in Companies Act, 2013. It should also be noted that the amendment is not covering the subsidiaries incorporated outside India.

The purpose for this amendment cannot be brought under the ambit of just a matter of abundant caution as the Hon’ble Supreme Court decided in District Magistrate (Rev.) Delhi Administration Vs. Shri Siri Ram [AIR 2000 SC 2143] that the exemption should come under the Act itself and Rules should not provide what is not provided in the Act. Therefore, to avoid Judicial Review of the Constitutional validity of the Rules, the said amendment is necessary.