SECTION 185 OF THE COMPANIES ACT, 2013

[CA C M JAIN]

SECTION 185 OF THE COMPANY ACT, 2013

1. Restriction on providing loan to a director or to a person connected with a director

Section 185(1) provides that save as otherwise provided in the Company Act, 2013 no company are directly or indirectly shall:

1. advance any loan ;
2.  any loan represent by a book debt ;
3. give any guarantee ;
4. provide any security in connection with any loan taken ;

to any director of the company or  to such other person in whom director is interested.

2. Meaning of word "indirect":

The word 'indirect' used means that the company does not give a loan to director through the agency of one or more intermediaries. The word 'indirect' cannot be read as converting what is not a loan into a loan.

[Dr. Fredie Ardeshir Mehta V Union of India 1989 (8) TMI 293 - HIGH COURT OF BOMBAY]

3. Meaning of phase "to other persons in whom directors are interested"

1. Individual
2. Director of lending company ;

[ABC Limited has given the loan to A, Director of ABC Limited]

2. Director of a company which is its holding company ;

[PQR Limited is holding company of ABC Ltd, ABC Ltd has given the loan to P, director of PQR Limited]

3. Any partner of any such director ;

[ABC Limited has given the loan to D, Partner in AD Partnership Firm in which A and D are partner and A is also director of ABC Limited]

4. Relative of any such director ;

[ABC Limited has given the loan to E, Relative of A, Director of ABC Limited]

2. Firm
3. in which any such director is a partner;

[ABC Limited has given the loan to AD Partnership Firm in which A and D are partners and A is also director of ABC Limited]

2. in which any relative of such director is a partner

[ABC Limited has given the loan to DE Partnership Firm in which E and D are partners and E is Relative of director of ABC Limited]

3. Private Limited Company :
   1. of which such director is a director

[ABC Limited has given the loan to XYZ Limited in which A is director of ABC Limited and XYZ Limited i.e. common director]

2. of which such director is a member;  

[ABC Limited has given the loan to XYZ Limited, where A is member of XYZ Limited and is also director of ABC Limited]

[Note - Relative of Director are not covered under this sub clause]

4. Body Corporate at a general meeting of which at least 25 percent of voting power may be exercised or controlled by such director, or by two or more such directors, together;

[ABC Limited has given the loan to Body corporate in which A, or AB or ABC ( A, B and C are directors of ABC Limited)hold is more than 25 percent of voting power of Body corporate at a general meeting either individually or jointly.]

[Note - Relative of Director also not covered under this sub-clause]

5. Body Corporate, Board of Directors, MD or manager, where of is accustomed to act in accordance with directions or instructions of Board, or of any director or directors, of lending company.

[ABC Limited has given the loan to Body corporate, BOD, MD, Manger who are working in accordance with A, B or C as the directors of ABC Limited]

4. Definition of Relative : ( Sec 2(77) + Rule 4 Companies (Specification of definitions details) Rules, 2014

1. Member of HUF
2. Husband and wife
3. Father
4. Mother
5. Son
6. Son’s wife
7. Daughter
8. Daughter’s husband
9. Brother
10. Sister

5. Definition of “body corporate’’

Body corporate means as defined u/s 2(11) of the act. It is inclusive definition. Section 2(11) of the companies act 2013 defines ’body corporate’ or “corporation” includes a company incorporated outside India, but does not include-

1. a co-operative registered under any law relating to co-operative societies: and
2. any other body corporate (not being company as defined in this act), which the central government may, by notification, specify in this behalf:

The term “body corporate “is wider than the expression  “company “and is used in several section of  the act to denote not only a company incorporated in India but also a foreign company .it includes a corporation formed under any special law of Indian or a foreign country ,except as expressly excluded by the definition. It includes all public financial institutions mentioned in section 4A of the act as well as  nationalized banks incorporated under section 3(4) of the banking companies (acquisition and transfer of undertaking) Act.1970.  However, it excludes a body corporate, which is not a company under the act and which is specified by the central government in the notification in official gazette. [Vibank  housing finance ltd., in re 2005 (7) TMI 374 - HIGH COURT OF KARNATAKA]

6. Meaning of Word “Loan”:

Loan has not been defined under Company Act., 2013. Any transaction of giving money to be returned in money with or without interest can be treated as "loan".

7. Meaning of Advance not covered in Section 185: Normally an advance is not repayable as an advance .It usually conveys an idea of a prepayment, that is, paying something in advance before it is actually due
8. Exception of section 185

• MD/WTD: 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;
• Ordinary Course

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 RBI.

There is Two Test:  

1. If the company is engaged in lending activities regularity and
2.  Lend not only to directors/directors' entities but also to "arms' length parties/unrelated parties

Hence, All NBFCs may not be engaged in lending activities in Ordinary Course.

9. Guarantee covered not letter of comfort:

Guarantee is covered by sec 185, however, letter of comfort is not covered by sec 185.In case of Guarantee, guarantor undertakes the liability of principal debtor, whereas letter of Comfort, intention is to give introduction of debtor, without undertaking the liability of principal debtor.

10. Loan given before 12^th September, 2013 is not affected by Section 185:

It is a well accepted principle that any amendment to an existing provision or a new provision would apply prospectively unless specified otherwise. Further, the wording of the section states that "no company shall 'advance' any loan or 'give' any guarantee or 'provide' any security......." Since these words imply present (or future) actions, it can be argued that the prohibitions in the section would apply to only new loan/guarantee/security.

1. Existing loan/guarantee/security provided before 12^th Sep. 2013 is not affected by above provisions. However, it should not be renewed & should be repaid on due date.
2. Loan repayable on demand should be repaid on demand.
3. Loan repayable after fixed period should be repaid on expiry of fixed period.
11. Share Application and Advance have not covered in section 185

There is no contravention of sec 185 if share application money/advance for property/goods/services is given to specified person u/s 185. However, private placement provisions have to be complied, if share application money is given on or after 1st April, 2014.

12. Holding Company given loans, guarantee and provided security to its subsidiary company

Example 1: When subsidiary company is a Private Limited Company and some shares of subsidiary company is held by one or more director(s) of holding Company

Example 2: When subsidiary company is a Private Limited Company and one of the directors of holding company is also a director in subsidiary Company

Example 3: When one or more of such directors hold 25 percent or more of total voting power in the subsidiary company
 
In such cases, Rule 10 provides specific exemptions from attractions of sec 185 provisions subject to some conditions mentioned in the said Rule. Rule 10 of the Companies (Meetings of Board and its Powers) Rules, 2014 states
the following:

(1) 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 is exempted from the requirements under this section; and

(2) 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 is exempted from the requirements under this section:

Provided that such loans made under sub-rule (1) and (2) are utilised by the subsidiary company for its principle business activities.

13. Loan given by Subsidiary company to Holding Company and Vice or Versa

The directors of subsidiary company do not hold any shares in holding company or is not directors of holding company. Section 185 is not attracted.

14. Loan given by company to member of company

The Company can give the loan to member of the company subject to not relative of director of the company.

15. Loan given by company to partnership firm in which that company is partner

The Company can give the loan to partnership firm in which that company is partner subject to director or relative of director of that company is partner.

16. Loan given by company to associates company

Directors of Associates Company are not director of lending company or BOD, MD, Manager whereof is accustomed to act in accordance with the directions of the BOD or directors of the lending company. The section 185 is not attracted.

As per Section 2(6) of The Act, associate company”, in relation to another company, means a company in which that other company has a significant influence, but which is not a subsidiary company of the company having such influence and includes a joint venture company.

Explanation. - For the purposes of this clause, “significant influence” means control of at least 20 percent of total share capital, or of business decisions under an agreement;

17. At the time of granting the loan, the section 185 is not applicable, subsequently covered this transaction

Our View, the section is applicable only at the time of granting the loan and any change in circumstances thereafter will not make the section applicable. Thus, section 185 will not be attracted in respect of a loan given to an employee, who does not fall within the ambit of specified persons as listed above, but who subsequently becomes a member of the board, because at the time of the loan, no contravention was involved.

18. Penalty

• Lender Company: Fine Rs. 5 lakhs to Rs. 25 lakhs
• Receiver: Director or other person to whom any loan is advanced or guarantee or security is given -Imprisonment upto 6 months or fine Rs. 5 lakhs to Rs. 25 Lakhs, or both.

Since the penal provisions for non-compliance with the requirements of section 185 extend not only to the lending company but also to the borrower (including a borrowing company), compliance should be ensured by both the lender and the borrower.

19. Validity of Rule 10 of Companies (Meeting of Board) Rule, 2014

Section 185 is not provided for making the rule relating to Loan to Director etc. However, Rule has drawn the line of exemption in case of loan given by Holding company to wholly own subsidiary company.

20. Compounding offence

The offence committed under this section is compoundable in accordance with the provisions of section 441 of the Act.

21. Requirement of Disclosure in the financial statements

As per Schedule III to The Act, a company is required to make the following disclosures separately:-

1. Loans and advances due by directors or other officers of the company or any of them either severally or jointly with any other persons or amounts due by firms or private companies respectively in which any director is a partner or a director or a member should be separately stated.
2. Loans and advances due by directors or other officers of the company or any of them either severally or jointly with any other person or amounts due by firms or private companies respectively in which any director is a partner or a director or a member shall be separately stated.

22. Checklist of making loan to director

Check whether provisions contained in section 185 of the Act are applicable. If not check whether :-

1. Any loan has been made to
   1. Any director of the lending company;
   2. Any director of the holding company;
   3. Any partner of any such director;
   4. Any relative of any such director is a partner;
   5. Any firm in which any such director is a partner;
   6. Any firm in which a relative of such director is a partner;
   7. Any private company of which any such director is a director or member;
   8. Anybody corporate of which not less than 25 percent of the total voting power may be exercised or controlled by such director, or by two or more such directors, together;
   9. Body Corporate, Board of Directors, MD or manager, where of is accustomed to act in accordance with directions or instructions of Board, or of any director or directors, of lending company.
2. Provisions 179 (Power of Board) and 186 (Loan and Investment by Company) are complied with if applicable.
3. Necessary entries are made in the Register of loans.
4. The Requisite resolutions are recorded in the minutes of Board/ Committee meeting.

23. Planning for Section 185 
    1. Convert both Lender company and receiver company to LLP or 
    2. Convert other company (to whom loan is given) to public Ltd to enjoy 25 percent limit or
    3. Rearrange shareholding pattern & directorship pattern
       1. Appointment new directors in lender Company, who personally neither hold any share in other company nor are directors in other company. If their relatives holds shares or are directors than there is no problem or
       2. One can gift shares to other relative to rearrange shareholding pattern
24. Benefit if Private Limited Company is converted into LLP as mentions above:
    1. LLP is not a company; hence limit of audit of 20 companies will not be applicable.
    2. Companies Act, 2013 will not be applicable, you can transfer fund from one LLP to another group LLP.
    3. Compliances under new companies Law for Private Limited company has been substantially increased, which are not applicable for LLPs.
    4. There is heavy penalty for non compliances under New Companies Law. Penalty of Rs 50,000 is a small amount for a single violation.
    5. Cost benefit analysis suggests that these should be converted into LLP.
    6. As per Sec 47(xiiib) of Income tax Act, for tax neutrality of such conversion, turnover of Private Limited Company in any of last 3 years must not exceeds 60 lakhs. So, if turnover exceeds 60 lakhs than such conversion will be subject to income tax.