Section 185 of Companies Act 2013- Loan to Directors

Section 185 Of Companies Act 2013 is essential for company rules about loans to directors. This prevents conflicts of interest. This can be done by restricting loans, guarantees, and securities to directors and their related entities. In other words, it is a vital provision for maintaining financial discipline. It protects shareholders from the misuse of company funds.  So, it is important to follow these rules to avoid heavy penalties and follow the rules. In this blog, you will learn about Section 185 of the Companies Act, 2013.

What is Section 185 of Companies Act 2013?

Section 185 regulates the granting of loans, guarantees and securities by a company to its directors and to persons in whom directors are interested. A company shall not directly or indirectly advance any loan (including loan represented by book debt), or give any guarantee or provide any security to its director, director of its holding company, partner or relative of such director, or any firm in which such director or relative is a partner. This avoids conflicts of interest and keeps funds safe. Here are the following exceptions:

a) Managing directors

b) Holding company-subsidiary loans

c) Business-related loans under certain conditions.

However, the Companies Act, 2013, handles the provision about granting of loans to directors of the company. A company may give a loan, guarantee or security to any person in whom a director is interested (including a private company where such director is a director or member) subject to compliance with Section 185(2) conditions. Compliance with these provisions is mandatory before granting any loan, guarantee or security. There can be penalties for the company, any responsible officer, and the directors who give loans against these rules.

Persons to whom Loans are prohibited under Section 185(1)

Loans to the following persons are absolutely prohibited under Section 185(1):

a) Company Directors

Any person who is a director of the lending company or its holding company

b) Partners and Relatives

Any partner or family member of that director.

c) Associated Firms

Any business where such a director or their family member is a partner.

d) Book Debts

Trade advances or credit sales not in ordinary course or beyond usual credit terms may be treated as indirect loans.

Statutory Exemptions under Section 185 of Companies Act 2013

The following key exemptions under Section 185 of the Companies Act, 2013:

a) Ordinary Course of Business

A company whose ordinary business includes lending of money may provide loans, guarantees or security in the ordinary course of business subject to minimum interest rate requirement. Where a company is engaged in the business of lending, loans may be given in ordinary course at an interest rate not lower than the prevailing yield of Government Security as prescribed under Section 186.

b) Managing or Whole-time Directors

Loan to Managing Director or Whole-time Director is permitted if it is given as part of conditions of service extended to all employees or pursuant to a scheme approved by the members by a special resolution.

c) Wholly-Owned Subsidiaries (WOS)

A holding company can provide financial support. They grant loans, provide guarantees, or offer security to its wholly-owned subsidiary companies. It is applicable when the funding will be used for the subsidiary's principal business activities. Thus, the funds must be used for the main business activities of the subsidiary.

d) Holding-to-Subsidiary Guarantee/Security

A holding company can give a guarantee or security for a loan. The loan comes from a bank or a financial institution. The subsidiary does not need to be wholly-owned.

e) Private Companies (Special Conditions)

Certain private companies are exempted from the restrictions under Section 185(1) subject to fulfilment of conditions prescribed in MCA Notification dated 5 June 2015:

a) No other body corporate has invested any money in the share capital of the private company.

b) The borrowings of such private company from banks, financial institutions or anybody corporate shall be less than twice of its paid-up share capital or Rs- 50 crore, whichever is lower.

c) The private company has no default in repayment of such borrowings subsisting at the time of transaction.

Penalty for Contravention of Section 185

Contravention of Section 185 shall make the company punishable with fine ranging from Rs- 5 lakhs to Rs- 25 lakhs, and every officer in default or recipient director shall be punishable with imprisonment up to six months or fine ranging from Rs-5 lakhs to Rs-25 lakhs or both.

Conditions for Loans to Any Interested Person of a Director under Section 185(2)

Below are the conditional permissions for loans under Section 185(2):

1) Mandatory Conditions for Loans, Guarantee, or Security

Every company needs to fulfill the required criteria to give financial assistance to an interested person:

a) Passing of Special Resolution

The company needs to get a special resolution during a general meeting. This will help to approve the loan, guarantee, or security.

b) Utilization of Loan

The loans shall be utilised by the borrowing company for its principal business activities.

c) Disclosure in Explanatory Statement

The notice of the general meeting shall contain an explanatory statement specifying full particulars of the loan, guarantee or security and the purpose for which it is proposed to be utilised.

• Full particulars of the loans, guarantees, or security provided.

• The reason that the borrower plans to use the loan, guarantee, or security.

2) Definition of "Persons in Whom Director is Interested"

The company has the right to advance loans or give guarantees or security to a certain persons or entities:

a) Private Companies

Any type of private company where any director of the lending company is a director or member.

b) Bodies Corporate with Significant Voting Power

Anybody corporate in which not less than 25% of total voting power is exercised or controlled by any such director, or by two or more such directors together.

c) Entities Acting on Directions

Anybody corporate who’s Board, Managing Director or Manager is accustomed to act in accordance with directions of the lending company’s Board or any director.

Conclusion

Knowing Section 185 of the Companies Act 2013 is crucial for maintaining corporate transparency and avoiding heavy penalties. This prevents directors from misusing corporate funds. It also protects stakeholders' interests. It sets clear rules about loans, guarantees, and securities for directors and related parties. Thus, companies must follow these rules to avoid serious fines.

FAQ

Q1. What is Section 185 of Companies Act 2013?

Section 185 of companies Act 2013 is considered as a statutory safeguard against conflict of interest. It prevents companies from giving loans, guarantees, or security to their directors. This also applies to other related entities. It confirms that company funds are not used for personal use.

Q2. Who is strictly restricted from receiving loans under Section 185 of Companies Act 2013?

The following entities are strictly restricted from receiving loans by a company:

1. Any Director of the lending company or its holding company.
2. Partners or relatives of such directors.
3. Firms in which the director or their relative is a partner.
4. However, loans to a private company in which such director is a director or member may be granted subject to compliance with Section 185(2).

Q3. What are the major exemptions for Section 185 of Companies Act 2013?

The major exemptions for Section 185 of the Companies Act, 2013 are:

1. Managing/Whole-time Directors (WTD)
2. Ordinary Course of Business
3. Holding to Wholly-Owned Subsidiary (WOS), etc

Q4. Can a company give a loan to another entity where a director is "interested"?

Yes, a company can give a loan to another entity where a director is interested. There is a condition. According to Section 185(2) of the Act, loans are allowed if a Special Resolution is approved and the funds must be utilised for principal business activities.

Disclaimer

This article is for informational purposes only and does not constitute legal advice. Online Legal India is a digital platform. If you require legal assistance, we strongly recommend consulting a qualified lawyer or law firm.