Introduction
When legislators enacted the Companies Act, they allowed public companies to grant loans, guarantees, and securities, provided these companies obtained prior approval from the Government. However, companies often borrowed funds and passed them to subsidiaries and other associate companies through inter-corporate loans. This practice led to compliance issues, particularly when the holding company failed to honor loan agreements, leaving subsidiaries in financial distress. To prevent such exploitation, Section 185 of Companies Act 2013 was introduced.
What is Section 185?
Section 185 of the Companies Act 2013 initially prohibited companies from advancing loans or providing security or guarantees for loans taken by the Company’s directors or individuals connected to the directors. The original provision was strict, with penalties applied only to companies or recipients violating these regulations.
The Companies (Amendment) Act of 2017 modified Section 185 to provide more flexibility while safeguarding subsidiaries and the company’s financial health.
Key Provisions of Section 185 After the Amendment:
1. Applicable to Directors and Interested Parties: Section 185 now applies to the directors of the company or its holding company, any partner of such a director, or any firm in which the director or their relative is a partner.
2. Loan to Interested Parties: The company may lend money to any person or firm in which a director has an interest, provided it meets certain conditions.
- The company must pass a special resolution in a general meeting with at least 75% of the members’ approval.
- The loan must be utilized solely for the principal business activities of the borrowing entity.
3. Penalties: If a company, its directors, or any officer acts in violation of these provisions, they are subject to penalties under Section 185(4) of the Act. This includes penalties for the company, the directors, and any officer in default.
Loan to Directors
Section 185(1) specifies that a company is prohibited from directly or indirectly:
- Advancing loans to its directors.
- Representing a loan by way of book debt.
- Given or Security provided concerning any loan taken by its directors.
You may also want to know Section 16 of Income Tax Act
Exemptions on Loans Given to Directors:
1. Loans to Managing Directors (MD) or Whole-Time Directors (WTD):
It may be provided if it is part of the company’s service policy to extend such loans to all employees.
Loans must be by any scheme approved by the members through a special resolution.
2. Loans Given by Banks and Financial Institutions:
The holding company may offer security or a guarantee for any loan that a bank or financial institution grants to its subsidiary, ensuring the subsidiary uses the loan for its principal business activities.
3. Loans Given to Subsidiary Companies:
When a holding company provides a loan, guarantee, or security to a wholly-owned subsidiary, and the subsidiary uses it exclusively for its commercial activities.
4. Loans to Directors by Private Companies:
The private company may grant loans if it operates in the ordinary course of business and charges an interest rate not less than the prevailing rate set by the Reserve Bank of India (RBI).
Penalties
Non-compliance with Section 185’s provisions results in severe penalties:
- For the Company: If the company violates any loan provisions under Section 185, authorities can fine it between ₹5 lakh and ₹25 lakh.
- For Officers in Default: Any officer of the company who is in default may face imprisonment for up to six months, or a fine between ₹5 lakh and ₹25 lakh, or both.
- For the Director or Interested Party: The director or any person in connection with any loan, guarantee, or security in violation of Section 185 may also face imprisonment which may extend to six months, a fine between ₹5 lakh and ₹25 lakhs, or both.
You may also want to know Donations Under Section 80G and 80GGA
Conclusion
Section 185 of the Companies Act 2013, prevents directors or persons in whom the directors have an interest from misusing company funds. The amendments made in 2017 provided a balance between maintaining corporate governance and allowing companies some flexibility in their financial dealings.
Once companies understand the provisions of Section 185, they can ensure compliance while avoiding hefty penalties.
Frequently Asked Questions
What is the primary objective of Section 185 of the Companies Act 2013?
The primary objective of Section 185 is to prevent companies from misusing their funds by advancing loans, guarantee given, or security offer to directors or entities in which directors have an interest, thereby protecting subsidiaries and the company’s financial health.
Can a company provide loans to its directors under Section 185?
Generally, a company cannot provide loans to its directors. However, there are specific exemptions where loans can be granted, such as loans to managing directors or whole-time directors if it is part of the company’s service policy.
What are the penalties for violating Section 185 of the Companies Act 2013?
Penalties for violation include a fine for the company ranging from ₹5 lakh to ₹25 lakh, imprisonment for officers in default for up to six months, and fines for the director or interested party ranging from ₹5 lakh to ₹25 lakh, or both.
Are there any exemptions under Section 185 for loans to subsidiary companies?
Yes, loans, guarantee or security is provided by a holding company to its wholly-owned subsidiary are exempt if the loan is used exclusively for the subsidiary’s principal business activities.
How did the Companies (Amendment) Act, 2017, change Section 185?
The Companies (Amendment) Act, 2017, introduced more flexibility by allowing companies to lend money to entities in which directors are interested, subject to conditions such as passing a special resolution and ensuring the loan is used for the borrowing entity’s principal business activities.
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