Loan to Directors– Provisions of Section 185 of Companies Act, 2013



The Companies Act, 2013 (Act) has introduced provisions relating to the granting of loans to company directors, their relatives, entities in which such Directors are interested and also Loan to Subsidiaries of the lending company. Each company must comply with the conditions outlined in this section before making a loan or providing a guarantee or security in connection with any loan. This section also provides for the penalty of the company, the defaulting officer, and the directors who grant loans in contravention of the conditions set out in this section.

Section 185 in its entirety was substituted to its present form by the Companies (Amendment) Act, 2017 with effect from May 07, 2018. This new section allows companies to issue loans, guarantees, and securities to organizations in which directors are involved in certain situations, subject to the prior approval of shareholders by special resolution and on the condition that the loans are used by the borrower for the main business of the company.

Prohibitions under Sub-section (1) of Section 185 -

According to sub-section (1) of Section 185, a company is prohibited from directly or indirectly advancing loans or providing guarantees or securities in connection with loans to:

  1. Directors of the company or director of its holding company, partners or relatives (defined below) of any such director.

  2. any firm in which any such director or relative is a partner.

Definition of Relative

“Relative’’, with reference to any person, means any one who is related to another, if—

  1. they are members of a Hindu Undivided Family;

  2. they are husband and wife; or

  3. one person is related to the other in following manner:

    1. Father (Provided that the term “Father” includes step-father).

    2. Mother (Provided that the term “Mother” includes the step-mother).

    3. Son (Provided that the term “Son” includes the step-son).

    4. Son’s wife.

    5. Daughter.

    6. Daughter’s husband.

    7. Brother (Provided that the term “Brother” includes the step-brother).

    8. Sister (Provided that the term “Sister” includes the step-sister).

Restrictions under Sub-section (2) of Section 185 -

Sub-section (2) allows a company to provide loans, guarantees, or securities to individuals in whom any director of the company has an interest (defined below), subject to certain conditions:

  1. The company must pass a special resolution in a general meeting. The explanatory statement for the meeting should provide full details of the loans, guarantees, or securities, including their purpose and other relevant information.

  2. The borrowing company must utilize the loans for its principal business activities.

Definition of “any person in whom any of the director of the company is interested”

Any person in whom any of the director of the company is interested” means:

  1. Private Company in which such director is member/director .

  2. Body Corporate in which director holds more than equal to 25% voting power.

  3. Body Corporate which is accustomed to act as per direction of such Director.

Exemptions available under Sub-section (3) of Section 185 -

Sub-section (3) outlines certain exceptions to the restrictions on loans, guarantees, and securities:

  1. Loans to Managing or Whole-Time Directors, Loans to Directors for Employee Welfare.

  2. In the ordinary course of business of providing loans or guarantees, charging an interest rate not lower than the prevailing yield of government securities.

  3. Loans or guarantees provided by a holding company to its wholly owned subsidiary company.

  4. Guarantees provided by a holding company in respect of loans given to its subsidiary by a bank or financial institution.

Penalty -

Sub-section (4) provides for penalty in case of violation of the above-mentioned provisions on the provision of loans. If a company extends credit in contravention of section 185, it shall be punishable with a fine which shall not be less than five lakh rupees but may extend to twenty-five lakh rupees. Any officer of the company who is in default shall be punished with imprisonment for a term which may extend to six months or with a fine which shall not be less than five lakhs of rupees but which may extend to twenty-five lakhs of rupees.

A director or any other person related to a director to whom any loan or security or guarantee is given shall be punished with imprisonment for a term which may extend to six months or with a fine which shall not be less than five lakhs of rupees but which may extend to twenty-five thousand rupees or with both.

 

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