Section 186 Of Companies Act 2013 - Requirements
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Introduction

Section 186 of the Companies Act, 2013, is a critical provision that governs the loans and investments made by companies in India. This section plays a pivotal role in regulating how companies can lend money, make investments, provide guarantees, or offer security in connection with loans. The intent behind Section 186 is to ensure that companies operate within a framework that maintains transparency, accountability, and financial discipline, thereby safeguarding the interests of shareholders and other stakeholders.

Overview of Section 186 of the Companies Act, 2013

Section 186 of the Companies Act, 2013, lays down the guidelines and restrictions for companies when it comes to making investments through more than two layers of investment companies. It ensures that companies do not misuse their financial resources by placing stringent limits and conditions on lending, investing, and providing guarantees or security.

Key Provisions of Section 186

Prohibition on Loans, Guarantees, and Investments Beyond Limits: Section 186 prohibits a company from:

  • Lending money to any individual or entity, directly or indirectly.
  • Providing any guarantee or security in connection with a loan to another person or entity.
  • Acquiring, by subscription, purchase, or otherwise, the securities of any other body corporate.

Financial Limits: The total amount of loans, guarantees, and investments made by the company should not exceed:

  • 60% of its paid-up share capital, free reserves, and securities premium account, or
  • 100% of its free reserves and securities premium account, whichever is higher.

If the proposed investment, loan, guarantee, or security exceeds these limits, the company must seek approval from its shareholders through a special resolution.

You may also want to know Section 89A of Income Tax Act

Requirements Under Section 186

1. Approval of the Board of Directors

Approval from the company’s Board of Directors is mandatory for all cases, regardless of the amount involved in the investment, loan, guarantee, or security. The board must obtain this approval through a unanimous resolution passed at a duly convened meeting with the consent of all directors present.

It is important to note that directors must not rely on a resolution passed by circulation or a committee, as it is insufficient under this section.

2. Approval of Shareholders by Special Resolution

When the aggregate of the loans, guarantees, investments, or securities already made, along with the proposed transaction, exceeds the limits specified under Section 186(2), the shareholders must pass a special resolution.

The board must specify the total amount it is authorized to use for making loans, investments, guarantees, or securities in the special resolution. However, certain exceptions do not require shareholder approval, such as:

  • Loans given by the company to its wholly-owned subsidiary or a joint venture company.
  • Acquisition of securities of a wholly-owned subsidiary by the holding company through subscription.
  • Guarantees or security provided by the company to its wholly-owned subsidiary or joint venture company.

3. Approval of Public Financial Institutions (PFI)

If the company has taken a term loan from a public financial institution (PFI), it must obtain prior approval from the PFI before making any loans, guarantees, investments, or security. However, PFI approval is not required if:

  • The aggregate of loans, guarantees, investments, or security does not exceed the specified limit.
  • The company has not defaulted on any term loan repayments or interest payments to the PFI.

4. Interest Rate

The interest rate on loans provided by the company must be higher than the prevailing yield of government securities closest to the loan period. This requirement ensures that the company earns a reasonable return on its loans, thereby protecting its financial interests.

5. No Subsisting Default concerning Deposits

A company that defaults in repaying any deposits it has accepted or in paying interest on deposits cannot make any loans, guarantees, investments, or securities until it remedies the default.

In other words, if a company fails to repay deposits or interest on the due date, it can only make loans, investments, guarantees, or security after the default has been rectified.

6. Disclosures in Financial Statements

The company is required to disclose the following information in its financial statements:

  • Full particulars of loans given, guarantees provided, security offered, and investments made.
  • The purpose for which the loan, guarantee, or security is proposed to be used by the recipient.

These disclosures are essential for maintaining transparency and enabling shareholders and other stakeholders to understand the financial transactions undertaken by the company.

You may also want to know Section 154 of Income Tax Act

Penalties for Non-Compliance with Section 186

Companies that violate the provisions of Section 186, as well as the individuals responsible for such violations, are subject to penalties under Section 186(13) of the Companies Act, 2013. The penalties are as follows:

  • The company may be fined not less than ₹25,000 and up to ₹5,00,000.
  • Every officer of the company who is in default may face a fine of up to ₹1,00,000 and imprisonment for a term of up to two years.

These penalties underscore the importance of adhering to the regulations outlined in Section 186 and serve as a deterrent against non-compliance.

Exceptions to Section 186

Government CompanyA government-run business that manufactures weapons.
A Government company, other than a listed firm, if the company receives approval from the State Government, if appropriate, or the Ministry or Department of CG that is administratively in charge of the company.
Acquisition of SharesAny purchase of shares issued by the right shares.
Any purchase made by a business whose primary activity is buying securities (i.e., investment company).
Loans, Guarantee, or SecurityA financial institution conducting business as usual;
An insurance provider conducting business as usual;
A lender for housing acting in the regular course of its business;
A business that specializes in funding businesses or offering infrastructure facilities.
Loan AcquisitionAny purchase performed by a non-banking financial institution whose primary activity is the purchase of securities.
Regarding lending and investing activities, NBFCs are exempt.

Section 186 provides certain exceptions where the restrictions and requirements outlined above do not apply. These exceptions include:

  • Loans or guarantees given by a company to its wholly-owned subsidiary or a joint venture company.
  • Acquisition of securities of a wholly-owned subsidiary by the holding company through subscription or purchase.
  • Guarantees or security provided by a company to its wholly-owned subsidiary or joint venture company.

These exceptions recognize the unique nature of intra-group transactions and allow companies to manage their internal financial arrangements without facing undue regulatory burdens.

Conclusion

Section 186 of the Companies Act, 2013, is a crucial provision that governs the loans, guarantees, investments, and securities made by companies. By setting forth clear guidelines and limits, this section ensures that companies operate within a framework that promotes transparency, accountability, and financial discipline. Compliance with Section 186 is essential for protecting the interests of shareholders, creditors, and other stakeholders, and companies must take care to adhere to the requirements and restrictions imposed by this section.

Frequently Asked Questions

The purpose of Section 186 is to regulate the loans, guarantees, investments, and securities made by companies. It sets limits and conditions to ensure that companies use their financial resources responsibly and transparently, thereby protecting the interests of shareholders and other stakeholders.

Section 186 requires companies to obtain approval from the Board of Directors and, in certain cases, from the shareholders through a special resolution. Additionally, if the company has taken a term loan from a public financial institution (PFI), it must obtain prior approval from the PFI.

Yes, there are exceptions. The requirements of Section 186 do not apply to loans, guarantees, or securities provided by a company to its wholly-owned subsidiary or joint venture company, or to the acquisition of securities of a wholly-owned subsidiary by the holding company.

Non-compliance with Section 186 can result in penalties for both the company and its officers. The company may be fined between ₹25,000 and ₹5,00,000, while officers in default may face fines of up to ₹1,00,000 and imprisonment for up to two years.

Section 186 requires companies to disclose full particulars of loans, guarantees, security, and investments in their financial statements. These disclosures help maintain transparency and enable stakeholders to understand the financial transactions undertaken by the company.

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