Loans to Directors under Companies Act, 2013

Loans to Directors under Companies Act, 2013

Section 185 of the Companies (Amendment) Act, 2017 read as follows:-

“(1) No company shall, directly or indirectly, advance any loan, including any 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 company, or of a company which is its holding company or any partner or relative of any such director; or

 (b) any firm in which any such director or relative is a partner. 

(2) A company may advance any loan including any loan represented by a book debt, or give any guarantee or provide any security in connection with any loan taken by any person in whom any of the directors of the company is interested, subject to the condition that— 

(a) a special resolution is passed by the company in general meeting: Provided that the explanatory statement to the notice for the relevant general meeting shall disclose the full particulars of the loans given, or guarantee given or security provided and the purpose for which the loan or guarantee or security is proposed to be utilized by the recipient of the loan or guarantee or security and any other relevant fact; and 

(b) the loans are utilised by the borrowing company for its principal business activities. 

Explanation.—for the purposes of this subsection, the expression "any person in whom any of the directors of the company is interested" means—

  1. any private company of which any such director is a director or member;

(b) anybody corporate at a general meeting of which not less than twenty-five percent. of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together; or 

(c) 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. 

(3) Nothing contained in sub-sections (1) and (2) 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 rate of prevailing yield of one year, three years, five years or ten years Government security closest to the tenor of the loan; or 

(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. 

(4) If any loan is advanced or a guarantee or security is given or provided or utilized in contravention of the provisions of this section,— (i) 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; (ii) every officer of the company who is in default shall be punishable with imprisonment for a term 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; and (iii) 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.”[I]

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. 

The original section 185 of the Act prohibited the companies from advancing any loan & 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.

Section 185 The Companies (Amendment) Act, 2017, describes the following things:[II]

  • It limits the restriction 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.  
  • It allows the company to give loan or guarantee or provide security in connection with any loan to any person/ entity in whom any of the directors are interested except bypassing of a special resolution by the company in a general meeting, utilization of loans by the borrowing company shall be solely for its principal business activities.  
  • Section 185(4) gives the provision for punishment, the earlier company can be held liable for the act but now it extends to the officer in default of the company.  

Certain cases where loan can be given to Directors:[III]

  • Loans to the Managing Director or Whole Time Director: the loan to such person can be given only, where it is the part of the policy of service of the company to grant loans to all employees following any such scheme which is duly approved by the members by way of a special resolution. 
  • Loan to subsidiary CO.: The holding company can grant the loan, guarantee, or security to its wholly-owned subsidiary company, which is to be used for its principal business activity only. 
  • Loans to Co. as a part of the ordinary business: If the rate of interest is charged on such loan as prescribed by the RBI, then the loan can be given in the ordinary course of business.  

Case law:

Pennwalt India Ltd. v. RoC[IV]

“The Hon’ble High Court of Bombay has held that to ascertain whether a transaction is a loan or not, surrounding circumstances, relationship and character of the transaction and the manner in which parties treated the transactions will have to be considered. Therefore, with reference to each transaction with Directors and another person in whom the Directors are interested, the nature of transactions has to be studied, in case they relate to book debts.”

Conclusion: 

Earlier when the section was introduced in the Act of 2013, there was a complete prohibition on giving loans to its directors and other persons. It was felt that changes are required for better governance and transparency in the affairs of the companies keeping in view the fiduciary character of the directors. However, the section was seen to be quite restrictive as the deserving and genuine cases were debarred from raising loans from the companies. Therefore “The Companies (Amendment) Act, 2017” amended section 185 for ease of doing business and safeguarding the interest of the company and its officers. 

References

I- Section 185 of The Companies (Amendment) Act, 2017, Loans to Directors. Also available at: https://www.mca.gov.in/Ministry/pdf/CAAct2017_05012018.pdf

II- Loan to Directors, Clear Tax, Available at: https://cleartax.in/s/loans-to-directors (Accessed on 11 May, 2021)

III- Loan to Directors, Clear Tax, Available at: https://cleartax.in/s/loans-to-directors (Accessed on 11 May, 2021)

IV- 1987 62 CompCas 112 Bom, Also available at: https://indiankanoon.org/doc/1991781/