Understanding the provision of inter-corporate loans and the loans advanced to the directors in terms of amended Section 185 of Companies Act, 2013

A company in its early stage receives investment from the angel investors and venture Capitalists (VCs), and subsequently from the Private Equity (PE) investors. And in the later stages of growth, the company borrows money from the banks and financial institutions.

However, there might be certain situations in which the companies cannot borrow money from the banks or financial institutions, for example, due to some statutory or regulatory restrictions on the borrowing limit, or on the purpose for which the money is proposed to be borrowed. In such circumstances, the company can choose to borrow money from other companies in the shape of inter-corporate loans. This is an attractive option, especially as the rate of interest is also comparatively quite lower than that charged by the banks or other financial institutions.

However, one must bear in mind that the inter-corporate borrowing is highly regulated. There are a lot of restrictions and prohibitions on the power of one company to lend money to the other company. Therefore, it becomes imperative to understand the provisions of inter-corporate borrowings.   

Please note, in this article, we will discuss the provisions of inter-corporate borrowings, only in terms of Section 185 of the Companies Act, 2013 (post-2017 amendment). 

Introduction

The Companies (Amendment) Act, 2017, which got the President’s assent on January 03, 2018, substituted the erstwhile Section 185 of the Companies Act, 2013 (“Act”) with a completely new section. The amended Section 185 of the Act relates to the provision of the advancement of loan to the directors and persons related to the directors. 

Provision of Section 185 of the Act

Section 185 of the Companies Act, 2013 prohibits a company from advancing loan, or guaranteeing a loan repayment, or providing security for the repayment of the loan obligation of the following persons: 

a)     its director;

b)    the director of its holding company; and 

c)     the relative or partner of such directors.

What does the term ‘any other person in whom director is interested’ include?

The term ‘any other person in whom director is interested’ is well defined within Section 185 of the Act, and includes the following:

• A private company of which any such director is a director or a member; or
• Any body corporate at a general meeting of which, not less than 25% of the total voting power may be exercised/controlled by any such director or by two or more of such directors, together; or
• Any body corporate, Board of Director (BOD), Managing Director (MD), or manager, who is accustomed to act under the directions or instructions of the BOD, or of any director of the lending company. 

How to provide a loan to the person in whom the director of the company is interested?

Sub-section 2 of Section 185 of the Act provides a workaround from the above-mentioned prohibition against the person in whom the director is interested. 

Section 185(2) of the Act provides that a company may advance any loan, 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 following conditions:-

(a)   Approval from the members of the company in the general meeting, by passing a special resolution (i.e. consent of at least three-fourth members)

(b)  The loan provided by the company shall be utilized by the borrowing company for its principal business activity. 

Note: The explanatory statement to the notice for the 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

Exceptions to the provision of Section 185 of the Act

Subsection 3 of Section 185 of the Act expressly states that the prohibitory provisions of Section 185(1) and (2) shall not apply to the following:

Managing Director or Whole-time Director:

The loan given to a managing director (MD) or to a 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 by a special resolution;

Company in the business of providing loans/guarantees/security:

A company which in the ordinary course of its business provides loans or gives guarantees or securities for the due repayment of any loan. 

However, the rate of interest in respect of such loans shall not be less than an interest rate that is equivalent to the prevailing rate for the government securities of corresponding duration.

Loan advanced to a Whole-owned Subsidiary (WOS):

The loan advanced by a holding company to its wholly-owned subsidiary company (i.e. the company in which the holding company owns 100% stake) or any guarantee given or security provided by a holding company in respect of any loan made to its wholly-owned subsidiary company.

However, such loan shall be utilized by the borrowing company for its principal business activities only.

Guarantee/Security provided to a Subsidiary:

The guarantee given or security provided by a holding company in respect of the loan advanced by any bank or financial institution to its subsidiary company.

However, such loan shall be utilized by the borrowing company for its principal business activities only.

Punishments in case of contravention of the provisions of Section 185 of the Act

According to Section 185(4) of the Act, if any loan is advanced or any guarantee or security is given or provided or utilized in contravention of the provisions of Section 185, in that case, there shall be the following punishments:-

Punishment for the company:

The company shall be punishable with fine which shall not be less than INR 5 lakh, but which may extend up to INR 25 Lakh 

Punishment for the officer of the company:

Every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to 6 months or with fine which shall not be less than INR 5 lakh, but which may extend up to INR 25 lakh

Punishment for the director or the other person:

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 6 months or with fine which shall not be less than INR 5 lakh, but which may extend to INR 25 lakh, or with both.