Checklist Of Section 185 Of Companies Act, 2013

The Companies Act, 2013 (“Act”) regulates the provisions relating to grants of loans to directors of the company. Section 185 of the Act provides the conditions and restrictions of granting loans to the directors. Every company must follow the conditions laid down in this Section before granting loans or giving guarantee or security in connection with any loan. This Section also provides a penalty to the company, officer in default and the directors who grant loans in contravention to the conditions laid down in this Section.

Loan To Directors

Section 185(1) of the Act states that a company cannot –

• Advance loan directly or indirectly,
• Advance loan which includes a loan represented by a book debt,
• Give guarantee or provide security with connection to any loan taken

by a director, director of its holding company, partner or relative of any director, or any firm in which a director is a relative or a partner. 

Thus, this Section prohibits granting loans to the directors or relatives or partners of the directors of the company.

Loan To Any Interested Person Of A Director

A company may advance loans including any loan represented by a book debt or give guarantee or provide security in connection with any loan taken to any person in whom any of the directors of the company is interested. Section 185(2) allows a company to give loans to any person/entity in whom any of the directors are interested in subject to certain conditions.

The conditions which are to be fulfilled for advancing loans or providing guarantee or security to the person in whom the director is interested is-

• The company must pass a special resolution in general meeting.
• The borrowing company must utilise the loan granted for its principal business activities. 
• The explanatory statement to the notice of the general meeting in which such a resolution for granting the loan is passed should disclose: 
  • full particulars of the loans or guarantee given or security provided and 
  • purpose for which the loan or guarantee or security is proposed to be utilised by the person receiving the loan.

The Act provides the list of the persons who are considered as persons in whom any of the directors of the company is interested. The company can advance the loans or give the guarantee, or security only to these persons. They are-

• Any private company of which any director of the lending company is a director or member.
• Any body corporate at whose general meeting not less than 25% of the total voting power may be exercised or controlled by any director of the lending company, or by two or more such directors together.
• Any body corporate, managing director, the board of directors, or manager, which is accustomed to act in accordance with the directions or instructions of the board, or of any director or directors, of the lending company.

Exemptions

Section 185(3) of the Act provides exceptions to the restrictions on the company to grant loans to directors. The company can advance loans or give a guarantee, or security to-

• The managing or whole-time director as a part of the conditions of service extended by the company to all its employees or pursuant to any scheme approved by the members of the company by a special resolution.
• A company that provides loans or gives guarantees or securities for the due repayment of any loan in the ordinary course of its business. The interest in respect of such loans advanced is charged at a rate not less than the rate of prevailing yield of one year, three years, five years or ten years government security closest to the tenor of the loan.
• Any loan is given 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. The subsidiary company must utilise such loans provided for its principal business activities.
• Any guarantee is given or security provided by a holding company in respect of a loan made by any bank or financial institution to its subsidiary company. The subsidiary company must utilise such loans provided for its principal business activities.

Penalty

Section 185(4) of the Act lays down penalty if the provisions mentioned above relating to providing loans are contravened. If the company advances loan in contravention to Section 185, the company shall be punishable with fine which shall not be less than Rs.5 lakh but which may extend to Rs.25 lakh. 

The director or any other person related to the director, to whom any loan is advanced or guarantee or security is given shall be liable to be punished with imprisonment which may extend to six months or with fine which shall not be less than Rs.5 lakh but which may extend to Rs.25 lakh or with both.

Checklist

The points to be remembered under Section 185 of the Act while advancing loans or providing guarantee or security with connection to any loan are-

• A company cannot advance loans to directors, their relatives or partners, nor any guarantee or security with connection to any loan can be provided to them.
• A company cannot advance loans to a firm in which a director is a relative or partner nor can provide any guarantee or security with connection to any loan to them.
• Loans can be advanced, and any guarantee or security with connection to any loan can be given to the person in whom the director of the company is interested after passing a resolution in the general meeting and if the loan amount is utilised by the borrowing company for its principal business activities.
• Only the persons and entities mentioned in Section 185(2) are considered as persons in whom the director of the company is interested. Thus, the company needs to check if the persons to whom they want to grant loan comes under the list of persons mentioned in this section as persons in whom the director is interested.
• The company can grant a loan or provide guarantee or security with connection to any loan to the managing, or whole-time director when the company satisfies the condition mentioned in Section 185(3) of the Act.
• The company which provides loans or gives guarantees or securities for the due repayment of any loan in its ordinary course of business can grant a loan.
• The holding company can grant a loan to its subsidiary company if the company satisfies the condition mentioned in Section 185(3) of the Act.

Frequently Asked Questions

What is the purpose of Section 185 of the Companies Act, 2013?

When the Companies Act 1956 was in force, the public companies would grant loans, securities and guarantees upon prior permission of the Central Government. The companies used to borrow funds and transfer them to the subsidiaries. However, in case of any issue, the subsidiaries were left to tackle it on their own. That’s why Section 185 of the Companies Act, 2013 was introduced containing certain restrictions for granting loans.  

Can a company grant loans to directors?

A company can grant loans to directors subject to certain conditions. Under Section 185 of the Companies Act, 2013, the company cannot provide loans directly or indirectly, including any loans represented by credit cards:

• To any of its directors
• To any partner or relative of the director
• Provide security in respect of loans taken by the director or any such person

Does an LLP need to follow the provision of Section 185 of the Companies Act 2013?

No, LLP is not covered under the Companies Act, 2013. An LLP needs to follow the provisions of the Limited Liability Partnership Act, 2008 and not the Companies Act, 2013. Thus, they do not have to follow the provisions laid down under Section 185 of the Companies Act, 2013 while granting loans to its partners.

What is the loan limit as per the Companies Act, 2013?

A company cannot directly or indirectly give a loan to any other person or body corporate exceeding 60% of its paid-up share capital, free reserves and share premium. 

Can a company give a loan to its subsidiary? 

In the Companies (Amendment) Act, 2015, the exemption is given to the company that provides a loan, security or guarantee to its wholly-owned subsidiary. The subsidiary can use the loans granted for its principal commercial activities. 

Can a Private Limited Company (PLC) grant a loan to a director?

Yes, a Private Limited Company can grant a loan only to a managing/whole-time director of the company if it is approved by a special resolution in the meeting and if this facility is given by the PLC to all its employees.
 

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