All About Loan to Directors under Company Act

All About Loan to Directors

Brief Introduction

• It is said that shareholders are owners of the corporate. However, really it’s the Board of Directors who exercise great control.
• Board of directors only take decisions regarding day to day operations and routine affairs of the corporate.
• And it is very well said, that with control, there come risks of misuse as well. So to forestall directors from using the funds of the corporate simply at their will,
• Section 185 of Companies Act, 2013 was introduced to supply rules and regulations for Loans to Directors or related parties of directors by a corporation. During this article we’ll discuss Section 185 of Companies Act,2013 thoroughly.

After the Amendment of Company Act 2013

Section 185 (amended Co. (Amendment) Act, 2017):

• This section 185 Limits the restriction on loans, advances, & other financial transactions to Directors of the company or its holding company, or any partner of such Director, or any firm where such Director or relative is a partner.
• Allows the company to make a loan, guarantee a loan, or provide security in connection with a loan to any person or entity in which any of the Directors has an interest, subject to the following conditions: — The corporation passing a Special Resolution in a General Meeting (Approval of at least 75 % of the members is required). –
• The borrowing company’s use of loans must be limited to its primary business activity.
• In addition to the Company, the penalty requirements of Section 185 (4) of the Act now apply to an officer who is in default of the company. (which includes any Manager, Director or key managerial personnel or any person in accordance with whose directions A board of directors are accustomed to act)

Section 185 of Companies Act, 2013

• Under section-185 of Companies Act, 2013 the provisions in respect of giving loans to  directors, or any security or guarantee to loans taken by directors, has been provided for.
• The section tells mainly the situations within which loans cannot be given and conditions under which loans is given but subject to certain conditions.
• It also states that during which conditions concurrence of shareholders is mandatory by way of a resolution.

Ineligible Person

According to this section an organization isn’t allowed to supply any form of loan (not even a book debt), security and guarantee to any of the subsequent persons-

• Any director of the corporate or its company.
• In case any firm during which the director or relative could be a partner.
• Any of their relative or partner.

So, it’s prohibited by law to grant any loan. Guarantee, security to those persons mentioned above. Well it’s not that simple; law has got other provisions also future for us. So, allow us to proceed further.

Conditions for Grant of Loan

Now, the law was very strict in Section-185 (1) above, but during this subsection it loosened itself a bit and allowed certain transactions but subject to conditions. in step with this section company can advance loan (including a book debt), security, guarantee in connection to a loan taken by an individual in whom the director of the corporate is interested.

The main two parts of this provision are “person in whom director is interested” and “conditions to be satisfied”. So, allow us to understand these two parts-

“Person in whom director is interested” includes-

• A private company within which such director could be a director or member.
• Anybody corporate in whose general meeting a minimum of 25% of the voting rights are exercised or controlled by one or more directors together.
• Where the director, manager or Board of Directors of a body corporate act per the instructions of Board or anybody or more directors of the lending company.

In short if the lending company significantly controls operations or voting rights of the corporate then it’ll be allowed subject to conditions.

“Conditions to be satisfied” are-

• Company should pass a special resolution during a general meeting. The explanatory statement to the notice should include full details about such proposed loan, guarantee or security and therefore the purpose that it’s supposed to be utilised.
• The borrowing company can use it just for its principal business activities.

Exemptions With Regard to Loans & Advance given to Directors:

{Cases where 185(1) & (2) needn’t be followed : Section-185 (3)}

• • In case of Loans to Subsidiary Company:
  • Loans to the Managing Director or Whole Time Director:
  • When Loans given by Banks and Financial Institutions to Subsidiaries:
  • Loans to Companies as part of Ordinary Business:
• This section provides about the cases where the provisions of the subsections discussed above won’t be applicable.
• Section 185 lays down the foundations where loan, security, guarantee are often given if some conditions are satisfied.

Given by	Given to/In respect of	Conditions
The Company	Managing or Whole Time Director	· Such facility is available to all the employees of the company. · The said scheme is required to be approved by the members, by passing of a special resolution.
Company which provides loans, guarantees, securities in ordinary course of business	Can be provided in respect of specified loans	· Interest charged on the loan should not be less than rate of the yield on a 1 year, 3 year, 5 year or ten year Government Security. · Term closest to the tenure of loan can be taken for comparison.
Loan/Guarantee/Security given by Holding Company for a loan given by itself	Wholly Owned Subsidiary Company	· Loan to be used only in respect of principal business activities by subsidiary
Guarantee/Security given by Holding Company for a loan given by Bank or a Financial Institution	Wholly Owned Subsidiary Company	· When Loan to be used only in respect of principal business activities by subsidiary

• Now, last a part of the section is what happens if the provisions of the section don’t seem to be followed-

Applicable Penalties under Section-185(4)

• As we see the law has laid down detailed provisions on what an organization should do and not do.
• However, if an organization still fails to abide by the provisions of Section 185 of Companies Act, 2013 & contravenes any of the provisions then it’ll subject to penalties.
• Lending Company will be punishable with a fine Minimum INR 5,00,000/- which can be extended to INR 25,00,000/- (maximum).

Penalty will be levied on	Minimum	Maximum
Company	In this case Fine of Rs.5 lakhs	In this case  Fine of Rs.25 lakhs
Every Officer in default	Fine of Rs.5 lakhs or Imprisonment up to 6 months	Fine of Rs.25 lakhs or Imprisonment up to 6 months
Borrower	Face Fine of Rs.5 lakhs or 6 months imprisonment / Both	Face Fine of Rs.25 lakhs or 6 months imprisonment/Both

Brief Sum up

• Looking at provisions of Section-185 of Companies Act, 2013, we are able to understand intention of the law. The intention of the law is to supply safety to the shareholders’ rights.
• In most of the permitted cases resolution from members is compulsory. business mustn’t be hindered due to very stringent provisions. that’s the rationale, why the loan to subsidiaries is permitted.
• If an organization wants to supply loans as a facility to its employees, as a regular policy than that’s also permitted.
• In the Company law is taking care of the interests of all parties involved in the transaction.
• Companies are also required to abide the provisions of law and avoid unnecessary penalty and litigations.

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