Detailed Analysis of Section 185 of Companies Act 2013

The Companies Act of 2017 has completely replaced the old Section 185 of the Companies Act 2013, which covers provisions concerning loans to companies’ directors.

Section 185 of Companies Act 2017 replaces Section 185 of Companies Act 2013, which outlines the limitations on the company’s advance or guarantee of any loan, and delineates institutions and individuals that can be offered such loans, guarantees, and securities subject to act compliance.

Section 185 of the Companies Act, 2013

Section 185 of the Companies Act 2013 governs requirements of loan grants and outlines the terms and circumstances of granting loans to directors.

Before providing loans or a guarantee or security in connection with any loan, every company should adhere to conditions outlined in Section 185.

The Section imposes penalties on the company, the defaulting official, and the directors who provide loans in violation of its provisions.

Purpose of Section 185 of Companies Act, 2013

Prior to the implementation of Section 185 of Companies Act of 2013, public companies used to grant loans, guarantees, and securities with the authority of the Central Government under the provisions of the Companies Act of 1956. Companies would borrow money and distribute it to subsidiary companies. In the event of a problem, the subsidiaries companies had to deal with it independently.

Section 185 of the Companies Act 2013 was enacted to establish some loan restrictions. The act discusses company law provisions related to the firm’s direct or indirect loans or advances to its directors, and Section 185(4) explains the punishment for violating its provision.

Loans to directors

According to Section 185 of the Companies Act of 2013, a company cannot loan an amount to its directors or individuals. Therefore, the law bans a company:

• From making any loan represented by book debt to any of its directors or any other person in whom the director has an interest, or
• From providing any guarantee or security in connection with such a loan

Provisions of Section 185(1)

Section 185(1) of the act states that a company cannot:

• Grant direct or indirect advance loan
• Grant advance loan represented by a book debt
• Guarantee or offer security in connection with any loan issued

Provisions of Section 185(2)

Section 185 (2) of the Companies Act authorises a company to grant loans to any organisation in which one or more of the directors has an interest subject to specified requirements. The company is eligible to issue loans or provide security or guarantee only to the following:

• Any private company in which a director or member of the lending company is involved
• Any legal entity in which any director of the loan firm, or two or more such directors, controls or exercises at least 25% of the total voting power
• Any managing director, body corporate, board of directors, or management accustomed to acting consistent with the board’s or any directors’ or directors’ instructions or orders

Provisions of Section 185(3)

This section provides exceptions to the company’s loan-granting regulation. A company can grant a guarantee, advance loans, or security to the following:

• The full-time director or managing director, as part of the company’s service conditions, extended to all of its employees or under any scheme established by the company’s members by special resolution
• A loan was previously issued by the holding company to its wholly owned subsidiary firm
• A company that grants loans or provides securities or guarantees for loan repayment in the ordinary course of business
• A holding company may provide any security or guarantee in exchange for a loan provided to its subsidiary company by any financial institution or bank. These loans must be used for primary business purposes by the subsidiary company

Penalty provisions section 185(4)

• The lending company will get fined less than Rs. 5 lakhs, with a maximum amount of Rs. 25 lakhs.
• Any officer who violates the law is subject to imprisonment for up to six months or a fine of not less than Rs. 5 lakhs but not more than Rs. 25 lakhs.
• Any individual or person related to the director who receives a loan or security will be sentenced to six months in prison or a fine of not less than Rs. 5 lakhs but not less than Rs. 25 lakhs, or both.

Before amendment

The old Section 185 banned companies from providing any loan or security or guaranteeing a loan obtained by the company’s directors or any other person in whom the directors have a conflict of interest. Penalties were only authorised for companies or recipients who received such a loan, security, or guarantee if they were proven to be in violation of the act.

After amendment

Section 185 (as amended by the Companies Act, 2017):

• Limits the prohibition on loans, advances, among others to directors of the company, holding company and any firm in which the director or relative is a partner
• Allows the company to give a loan, guarantee, or provide security in connection with any loan to any person/entity in which any of the directors are interested, subject to passing of special resolution by the company in a General Meeting (Approval of at least 75% of the members is required)
• Loans granted to the borrowing company should be solely used for its principal business activities.
• The penalty provisions as set out under Section 185 (4) of the Act to the Company now extend to an officer in default of the company, including any Director, Manager, or KMP or any person by whose Board of Directors are accustomed to the act.

Conclusion

Section 185 of the Companies Act 2013 completely prohibits lending to directors and other individuals and organisations linked with directors. Subsequently, the law was improved for enhanced responsibility and governance of Companies’ businesses.

The changes were implemented to ensure the fiduciary character of the directors of companies. The firm and its officers could now provide loan directors with sufficient protections and increased liability under Section 185 of Companies Act 2013