Section 185 of the Companies Act, 2013, deals with loans and investments made by a company to its directors. It lays down certain restrictions and conditions that must be followed by the company while granting loans, guarantees or securities to its directors or any other person in whom the director is interested. The provision aims to ensure that the directors of a company do not take undue advantage of their position and use the company's resources for their personal benefit, which may be detrimental to the interests of the company and its shareholders. Along with prohibitions, section 185 also provide relaxation and exceptions to advance any loan as well.
1. Prohibition on advancing any loan:
“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 the 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. Relaxation on advancing any loan:
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 director of the company is interested, subject to the condition that—
(a) a special resolution is passed by the company in a 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 utilised 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.
The expression "any person in whom any of the director of the company is interested" means—
(a) any private company of which any such director is a director or member;
(b) any body corporate at a general meeting of which not less than twenty-five per cent. of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together; or
(c) any body 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. Exception on advancing any loan:
(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 and loans are utilised by the subsidiary company for its principal business activities; or
(d) any guarantee given or security provided by a holding company in respect of a loan made by any bank or financial institution to its subsidiary company and loans are utilised by the subsidiary company for its principal business activities.
4. Penalty for contravention of the provisions on advancing any loan:
If any loan is advanced or a guarantee or security is given or provided or utilised in contravention of the provisions of section 185,—
(i) the company shall be punishable with a 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 a 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.
5. Exemptions available to the class of companies
In the case of a private company - Section 185 shall not apply to a private company-
(a) in whose share capital no other body corporate has invested any money;
(b) if the borrowings of such a company from banks or financial institutions or any body corporate is less than twice of its paid-up share capital or fifty crore rupees, whichever is lower; and
(c) such a company has no default in repayment of such borrowings subsisting at the time of making transactions under this section.
In the case of Nidhi company - Section 185 shall not apply, provided the loan is given to a director or his relative in their capacity as members and such transaction is disclosed in the annual accounts by a note.
In case of Government company - Section 185 shall not apply to a Government Company in case such company obtains approval of the Ministry or Department of the Central Government which is administratively in charge of the company, or, as the case may be, the State Government before making any loan or giving any guarantee or providing any security under the section.
Conclusion
Section 185 of the Companies Act, 2013 aims to prevent directors of a company from using the company's resources for their personal gain. It lays down certain conditions and restrictions that must be followed by the company while granting loans, guarantees or securities to its directors or any other person in whom the director is interested. Any violation of this provision is considered a serious offence and is punishable with a fine and imprisonment. It is, therefore, important for companies to comply with the provisions of this section to avoid legal consequences.
Why Expert Guidance Matters
Navigating the complexities of Section 185 requires a thorough understanding of corporate law and financial regulations.PCA & Co. can provide expert advice on structuring transactions, ensuring compliance, and obtaining necessary approvals to avoid legal repercussions.
Contact us today to schedule a consultation and explore how we can help you build a scalable financial infrastructure for your startup.
Disclaimer: This blog post is for informational purposes only and should not be taken as legal or professional advice. Always consult for specific guidance.
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