Loan to Directors - Deep Analysis of Section 185 - Part 1

The Companies Amendment Act, 2017 has replaced the entire section 185 of Companies act which governs the provisions relating to loan to directors.

The Amended section came into force from May 7, 2018.

Section 185 can now broadly be divided into three categories:-

Section 185(1):- Prohibitive Section

Section 185(2):- Restrictive Section

Section 185(3):- Unrestricted Section

Section 185(1):- Any company (listed or unlisted, private or public, small, OPC, startups) shall not give loan/guarantee/security (LGS) to-

    # Any Director of company (WTD, Nominee, SSD, MD or else);

    # Any Director of its Holding Company;

    # Any partner of such Director of the lending Company;

    # Any relative of such Director of the lending Company;

    # Any firm in which any such Director is a partner;

    # Any firm in which any relative of such Director is a partner.

Here for particularly this sub-section the term "firm" includes LLP or not is not provided anywhere & only Individuals and Firms are covered and Companies and other body corporates are not.

Example on sec 185(1)

Let us take case of X Ltd.

Does section 185 allow LGS to 

Mr. A, Director of X Ltd, being Director - NO

Mrs. A, Spouse of Mr. A, being Relative of Director - NO

Mr. B, Partner of Mr. A, being Partner of Director - NO

Mrs. B, Spouse of Mr. B, being Relative of director’s partner - YES

Mr. C, Director of holding company of X ltd, being Director of holding company- NO

Mrs. C, Spouse of Mr. C, being Relative of Director of holding company- NO

Mr. D, Partner of Mr. C, being Partner of Director of holding company- NO

Mrs. D, Spouse of Mr. D, being Relative of holding company director’s partner - YES

ABC & Co. [where Mr. A is a partner], being Firm in which director is a partner- NO

BMW&Co. [where Mr. B is a partner], being Firm in which holding company’s director partner is partner- YES

CNN&Co. [where Mr. C is a partner], being Firm in which director of the holding company is a partner- NO

DNA&Co. [where Mr. D is a partner], being Firm in which holding company’s director partner is partner- YES

[So we can say that basically section 185(1) is not allowing loans by company to its directors and related persons i.e. individuals] 

(Section 185(1) applies on Individuals only)

So, section 185 isn't saying that it will not allow loans to directors and other companies where it is interested, yes somewhere it is saying so.

But, then 185(2) comes into the picture.

Section 185(2):- Restrictive Section (allowed but not fully)

A Company CAN give LGS to any person in whom director of the company is interested subject to the upon satisfaction of below conditions:

# A Special resolution has to be passed by the lending company in a general meeting in this regard;&

# The funds of loans has to utilised by the borrowing company for its principal business activities.

# Explanatory statement shall disclose following:    

  ~ Full particulars of given loan/guarantee/security

  ~ Purpose of utilisation of loan/guarantee/security 

 ~ Any other relevant fact. (please take care in deciding what is relevant fact to the loans and what is not, do not forget the material facts to disclose)

Sec 185(2) says that 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......

So here who would be "any person in whom any of the director of the company is interested"

(a) Any private (borrowing) company of which any such director (of lending company) is a director (of borrowing company)

means if the lending and borrowing company has common directors

here lending company can be public/ private company but borrower has to be a private company. or,

(b) Any private (borrowing) company of which any such director (of lending company) is a member(of borrowing company)

means if the Director of the lending company is the member of borrowing company at the same time.

here lending company can be public/ private company but borrower has to be a private company. 

further, for member there is no shareholding percentage is prescribed therefore even holding one share would make him qualify under the section.or,

(c) any body corporate at a general meeting of which not less than 25 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

(d) 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.

means any body corporate (borrower) is accustomed to act as per the orders of the lending company.

here again accustomed to act can be interpreted that the body corporate in the past has done something on the orders of the lending company.

Section 185(3):- Unrestrictive Section (allowed)

Basically, section 185(3) says that in sub-section 1 & 2 whatever the conditions and restrictions I have placed, in sub-section (3) I am removing them.

but yes for some specified transactions only and also to be read in consonance with section 186.

# Loan to MD/WTD:

• As conditions of service extended to ALL its employees; or

• Pursuant to a scheme approved by SR.

(Say if there is a company which has kept a policy to grant loans and advances to the employees of the company. So in this case 185(3) says that a company can give loans to director but only MD or WTD, and not to other directors.

Further, if the company has no such policy to grant loans all the employees in place then another criteria through which a company can give loans is that to frame a scheme for giving loans in specific, the scheme has to be framed specifically only for giving loans and to get this scheme passed through a SR of members of the Company. Here also this scheme only for giving loans to MD and WTD only)

# Companies providing LGS in their ordinary course of business where interest charged not less than prevailing yield of G sec of 1 year, 3 year, 5 year or 10 year. 

(Means any Bank or NBFC providing loans and for that loans also charging interest, both conditions to be satisfied simultaneously)

(It also be the case where the NBFC providing loans to group of Companies for free, then it might lose the exemption)

# LGS provided by holding to WOS [for principal business activities]

# Guarantee or security provided by holding to its subsidiary [for principal business activities]

APPLICABILITY OF SECTION 185

Punishment Provisions

Company: Rs. 5 lakhs to Rs. 25 lakhs

Officer in default: Imprisonment upto 6 months OR fine Rs. 5 lakhs to Rs. 25 lakhs

Director or the person to whom the loan is advanced:  Imprisonment upto 6 months OR fine Rs. 5 lakhs to Rs. 25 lakhs.

SUMMARY OF SECTION 185(2)

Section 185(2) is the most important part of the entire section 185. Basically it provides a relationship or sort of related party criteria for the purpose of giving of LGS. 

Basically the legislature will see any loan giving transactions that whether it can be covered within 185(2).

So, the basic concept of section 185(2) says that you have to pass SR for any of the related party loans transaction (related party here means any of the persons in whom any of our directors is interested). We have to pass SR for each of the transactions. And also irrespective of the fact that we already have a unutilised limit under section 186 

Say for ex. ABC Ltd is already having a limit of about 1500 crore and so it need not to pass SR for each of loans giving transactions. Say our company ABC ltd want to give loans to another company, so it can simply pass a BR and grant loans to that company.

BUT if the other company falls within the scope of 185(2), I.e. it is related party to the lending company as per 185(2) then the lending company although have limits under section 186, but still needs to pass SR. 

Why SR, because that another company is basically the related party as per 185(2) and so it needs to follow the additional compliance as mentioned in the section 185(2).

Similarly goes with section 179(3)(f) which provides a general power to grants loans by a company simply by passing a BR.

So to summarise section 185(2) basically says that if you want to give LGS to another company and that company does falls within the interested persons scope(related party scope) then you HAVE to pass SR for such transactions, irrespective that the company has limits under section 186 or not. 

So, before giving any loans as such we have to check whether we have a sort of relationship in the parties involved in the picture. If yes, then we have to Pass SR otherwise you can happily go with a simple BR.

Because section 186 & 179(3)(f) are general in nature, through the use of these sections a company can give LGS to any company in the world. But when there comes a company where there is certain relationship between the borrower and the lending company then we have to comply the additional compliance of section 185.

Some thoughts

1. Section 185 disallows that a Company to give loans to its directors but loan can be given to a MD or WTD under service conditions or ESOP like scheme. So, any director wants to take any loans from the Company, first appoint as MD or WTD and take loans under service conditions legally.

Further, if the lender Company is a private Company and falls under the exemption criteria then they can give Loans to any Directors. 

2.Whether 185 section disclosure comes in Board report?

Not specifically mentioned, but for the sake of Good Corporate Governance, it should be mentioned in the Board report. 

3. What is the meaning of "Loans" under Companies Act, 2013, 

the act does not define "Loans". So in a general meaning  "a thing lent; something the use of which is allowed for a time, on the understanding that it shall be returned or an equivalent given, a sum of money lent on these conditions and usually with interest, usually under an agreement and a promise to repay (oral or written). 

So the common elements of a loan are:

The amount in money or kind; 

Placing with other i.e. borrower; 

Agreement to repay; 

Recognition of liability on borrower to return in cash, with or without interest. 

4. Section 185(1) says No company shall, directly or indirectly advance any loan.......

So, what is the meaning and extent of the Indirect route available and also to how much extent.

For example, Sec. 185(1) provides that a Company can't give loans to its directors, so for indirect mode Company can look for: it can give loans to other person and that other person can give loans to that director, ultimately director received that money which originated from the Company, but yes Indirect mode is disallowed.

So what would be the case if between the Company and the Directors there are a number of people like 10 or 20, then it would really be difficult to ascertain the non-compliance of the Company. 

5. Loans to a Trust or HUF- allowed or disallowed?

Giving LGS to a trust [in which director(s) / member(s) are trustees or beneficiaries] or

Giving LGS to a HUF [in which director(s) / member(s) are karta or member]

are not covered any of the conditions or modes provided under section 185, and moreover not covered under indirect modes, so we can interpret that giving Loans to Trust / HUF are allowed. 

6. Please note that the prior approval by Special resolution has to be obtained under section 185(2).

7. Under which circumstances a Company can give loans by passing a Board Resolution under section 185 of the Companies Act, 2013?

To be precise, a Company can give loans in general under section 179(3)(f) by passing a BR, but if the transaction got covered under section 185(2), it has to pass a SR for the transaction.

8. There is also a concept of deemed dividend under the Income Tax Act. Here, if any private limited company gives any amount as loan or advance to a shareholder, holding a minimum 10% of Voting power and is a beneficial owner, then this amount shall be considered as Deemed Dividend under Section 2(22)(e) of the Income Tax Act, 1961.

Here, Income Tax act provides the deemed dividend scenario in case of shareholder only. But for the purpose of section 185, we also check whether that shareholder is also a director in the company or not. 

Kindly recollect that loans to directors is not allowed generally but if the company fulfills the exemption criteria or it provides to MD or WTD, then it may give loans to Directors and hence consequently get covered under the Deemed Dividend category.

Concepts like Trade advances, Travelling allowances, reimbursement of expenses to directors, rent advances, procedure of giving and taking loans to a Company/by a Company; and many more concepts are waiting to be told in the next article of the series.