Loans to Directors

When the Companies Act, 1956 was in force, public companies were permitted to grant loans, guarantees, and securities as long as they obtained prior permission from the Central Government to do so. The companies used to exercise a practice of borrowing funds and passing them to subsidiaries and other associate companies through inter-corporate loans. However, when it came to compliance with the terms of the loan agreement, the holding companies used to take a step back, leaving the subsidiaries in the lurch. In order to put a stop to the exploitation of the subsidiaries, Section 185 of the Companies Act, 2013 came into force.

Understanding Section 185

Section 185 of the Companies Act, 2013 lays down certain restrictions with regard to the granting of loans to Directors in order to monitor their working.

Before the Amendment

The original Section 185 prohibited the companies from advancing any loan and/or giving any security or guarantee in relation to the loan taken by the Directors of the company or any other person in whom the Director is interested. If found guilty of non-compliance, penalties were allowed only to companies or to any recipient to whom such a loan, security, or a guarantee is provided.

After the Amendment

Section 185 (as amended by the Companies (Amendment) Act, 2017):

• Limits the prohibition on loans, advances, etc. to Directors of the company or its holding company or any partner of such Director or any partner of such Director or any firm in which such Director or relative is a partner
• Allows the company to give a loan or guarantee or provide security in connection with any loan to any person/ entity in whom any of the Directors are interested, subject to:- – Passing of Special Resolution by the company in a General Meeting (Approval of at least 75% of the members is required). – Utilization of loans by the borrowing company shall be solely for its principal business activities
• The penalty provisions as set out under Section 185 (4) of the Act, in addition to the Company, now extends to an officer in default of the company (which includes any Director, Manager or KMP or any person in accordance with whose directions BODs are accustomed to act)

Exemptions With Regard to Loans Given to Directors

• Loans to the Managing Director or Whole Time Director: The loans to MD or WTD may be given only if the following conditions are met with:- – Where it is part of the Policy of Service of the company to grant loans to all employees. – Pursuant to any scheme which is duly approved by the members by way of a Special Resolution
• Loans to Subsidiary Company: Where the holding company grants the loan, guarantee or security to its wholly-owned subsidiary company, which uses the same for its principal activity of business only
• Loans to Companies as part of Ordinary Business: If the rate of interest charged on such loans is not lesser than the rate prescribed by RBI at the time, loans may be given to companies in the ordinary course of business
• Loans given by Banks and Financial Institutions to Subsidiaries: Grant of loan is permitted based on:- – Where the holding company provides the security or guarantee with respect to the loan made by the bank or any financial institution to the subsidiary company. – The loan must be utilised for the subsidiary’s principal activity of the business

Penalty Provisions

In any case where Section 185 is not complied with:- – The Lending Company will be punishable with a fine not less than Rs. 5 lakh which can be extended to Rs 25 lakh (maximum).
– Any officer in default will be punishable with imprisonment for a term which may extend to 6 months or fine which shall not be less than Rs.5 lakh but which may extend to Rs.25 lakh.
– The recipient of the loan will be punishable with imprisonment which may extend to 6 months or with fine which shall not be less than Rs.5 lakhs but which may extend to Rs.25 lakhs or with both. 

Disclaimer: The materials provided herein are solely for information purposes. No attorney-client relationship is created when you access or use the site or the materials. The information presented on this site does not constitute legal or professional advice and should not be relied upon for such purposes or used as a substitute for legal advice from an attorney licensed in your state.