Section 185 Of the Companies Act 2013

Introduction

Section 185 of the Companies Act 2013 governs a company’s lending and borrowing activities. The provision lays down certain conditions under which a company can provide loans, guarantees, or security to its directors or other persons in whom directors are interested. This blog highlights various aspects of Sec 185 of the Companies Act 2013 and its implications for companies.

What is Section 185 Of the Companies Act 2013

According to Section 185 of the Companies Act 2013, a company cannot directly or indirectly give any loan to its director or any other person in whom its director is interested or provide any guarantee or security in connection with a loan taken by such a person. However, there are certain exceptions to this rule.

Loan to directors section 185

Loans to directors Section 185 is a sensitive issue for companies and provides the legal framework for such loans. This section protects the interests of a company's shareholders and stakeholders and prevents company funds' misuse by directors or related parties.

What is the purpose of Section 185 of the Companies Act of 2013?

Now that you know what is section 185 of the Companies Act 2013, let’s see why it is necessary. Section 185 Companies Act ensures that companies do not provide loans or guarantees to directors or other related parties without appropriate checks and balances. The section lays down stringent conditions for companies to provide loans, guarantees or security to their directors or other interested parties.

Exemptions to the Loans that are given to the Directors

Under Section 185 of the Companies Act 2013, a company is prohibited from providing any loan, guarantee, or security concerning a loan to its director or any other person with whom its director is interested. The section defines a director as an individual appointed to the company’s board of directors. 

A person in whom a director is interested includes a firm or a company in which the director is a partner or director or a person who is a director’s relative. However, there are certain exemptions to this prohibition. 

1.    Loans to Managing Director or Whole Time Director

A company may grant any loan to its Managing Director (MD) or Whole Time Director (ETD) as a part of the conditions of service of the MD or WTD.  Such situations need the Board of Directors’ approval and must be disclosed in the company’s financial statements. 

The loan should not exceed 60% of the paid-up share capital, free reserves, and securities premium account or 100% of the free reserves and securities premium account, whichever is higher. 

2.    Loans to Other Directors

With prior approval from the Board of Directors, a company may grant any loan, guarantee or provide security in connection with a loan to a director who is neither an MD nor a WTD, subject to certain conditions. 

The loan should not exceed 25% of the paid-up share capital, free reserves, and securities premium account or Rs. 1 crore, whichever is lower. 

3.    Loans Subsidiaries 

A company can grant a loan to its wholly-owned subsidiary for its usage in its principal business activities only.

4.    Loan to Companies as part of the ordinary business

Loans can be provided to companies during their regular business operations as long as the interest rate charged is not lower than the rate mandated by RBI at that particular time.

5.    Loans given by Banks and Financial Institutions to Subsidiaries

Banks and financial institutions can lend money to their subsidiaries if they meet certain conditions. 

●    The holding company should provide security or guarantee for the loan given by the bank or financial institution to the subsidiary.
●    The loan must be used for the primary business activity of the subsidiary.
 

Penalties

The penalties for contravention of Section 185 Companies Act are as follows.

1.    Monetary penalty: The company shall be liable to pay a fine of at least Rs. 5 lakhs which may extend to Rs. 25 lakhs.

2.    Imprisonment: Punishable imprisonment can be for a term which may extend to 6 months or with a fine of at least Rs. 5 lakhs that may extend to Rs. 25 lakhs, or with both.

In addition to the above penalties, the company may face other consequences such as damage to its reputation, loss of investor confidence, etc. Therefore, companies must comply with the provisions of Section 185 to avoid any legal or financial repercussions
 

Checklist

Section 185 of the Companies Act of 2013 pertains to the prohibition of loans and guarantees to directors. To ensure compliance with this section, companies should follow a checklist that includes the following steps.

●    Check the company’s Articles of Association (AoA to determine the scope of the authority of the Board of Directors to grant loans.
●    Review the company’s financial position and assess whether it has sufficient funds to grant a loan or provide a guarantee.
●    Ensure that the transaction is in the ordinary course of business of the company, done on an arm's length basis.
●    Obtain prior approval from the Board of Directors for any proposed transaction with a director and record the same in the meeting’s minutes.
●    Verify the transaction is approved by a resolution passed at a meeting of the Board of Directors with the requisite majority.
●    Ensure that the director concerned does not participate in the Board of Directors meetings when the transaction is being considered.
●    Disclose the transaction details in the company’s financial statements and file the same with the Registrar of Companies.
●    Ensure the transaction complies with any other applicable laws, rules or regulations.
●    Periodically review all transactions with directors to ensure compliance with Section 185
●    In case of any violation of Section 185, take corrective action and report the same to the Registrar of Companies.

With the above checklist, companies can ensure compliance with Section 185 and avoid penalties or other legal consequences.