Loans to directors under the Companies Act 2013 are governed by Section 185 of the Act. This section imposes restrictions on the grant of loans, advances, or guarantees by a company to its directors or relatives. The objective of this section is to prevent any misuse of funds and to ensure transparency in the financial dealings of the company.
Section 185 deals with restrictions on the parts of companies providing any loan, giving any guarantee, or providing any security. Additionally, the section offers relaxation to individuals and Entities from the provisions of Section 185, subject to specific conditions and punishment for those who contravene the same.
Section 185 (as amended by the Companies (Amendment) Act, 2017): Limits the prohibition on loans, advances, etc. to Directors of the company or its holding company or any partner of the Director or any firm in which the Director or a relative is a partner. As a limited company director, you can take out funds from the company. However, any money taken from the business bank account – aka the Director’s loan account – not relating to salary, dividends, or expense repayments will be classed as a director’s loan.
Through the Companies (Amendment) Act, 2017 (“Amendment Act”), the existing Section 185 of the Companies Act, 2013 (‘the Act’), which deals with loans to directors, etc, has been completely substituted with new provisions w.e.f. May 7, 2018.
Key Takeaways
- Loans to Directors Loans to directors under the Companies Act 2013 are governed by Section 185 of the Act.
This section imposes restrictions on the grant of loans, advances, or guarantees by a company to its directors or relatives. - Loans given to managing or whole-time directors, as a part of their employment agreement or under a scheme approved by the members of the company through a special resolution
- Relief was provided to private individuals by granting them exemption under Section 185 of the Section Act, 2013, through a notification issued on June 5, 2015.
- If any grants or loans are made on June 5 in contravention of any of the above legal provisions, then the person is liable to be punished by law as per the legal penal provisions.
As per the provisions of Section 185, a company cannot provide loans, advances, or guarantees to:
- Its directors or directors of its holding company, or any partner or relative of any such director;
- Any firm in which such a director or relative is a partner;
- Any private limited company in which such a director is a director or member;
- Anybody corporate whose Board of Directors, managing director, or manager is accustomed to acting in accordance with the directions or instructions of the Board of Directors or any director of the lending company.
However, there are certain exceptions to this rule, which allow a company to provide loans, advances, or guarantees to its directors or relatives under specific circumstances. These exceptions include:
- Loans given to managing or whole-time directors, as a part of their employment agreement or under a scheme approved by the members of the company through a special resolution;
- A holding company gives loans to its subsidiary company, or a subsidiary company offers loans to its holding company.
- Loans are given to directors of a company, who are not managing or whole-time directors, provided that they furnish a declaration stating that the amount of the loan is not being used for any purpose prohibited under Section 185.
Provisions dealing with loans to directors under the Companies Act 2013
In the previous Companies Act 1956, Section 295 was only applicable to Public Limited Companies and their subsidiaries. Before the enactment of the Companies Act, of 2013 the Compan Act, of 1956 was in force which allowed com,panies to give loans, securities, and guarantees to their directors or promoters, the public compa.I am publishing these to seek approval from the Central Government.
However, private companies could lend loans without taking approval from the Central Government.
After the enactment of the Companies Act, 2013, this legal provision was replaced by Section 185, which allows all kinds of companies to lend loans, including to their directors, relatives, and shareholders. The prohibition includes their relatives and their attorneys in obtaining loans, so that the directors hold a fiduciary position and are expected to make decisions for the benefit of the company.. This provision will prevent the directors from misappropriating the company’s assets for their benefit. Also, the funds are typically borrowed from financial institutions, which means that the company is utilizing public funds. Thus, this section also protects the interests of investors.
Exemptions
Since we’re opposing, both private and public companies are opposed to the legal provision. The legal provision required the government to provide some relaxation to companies in this respect. Relief was granted to the private company by exempting them under Section 185 of the Companies Act, 2013, issued on June 5, 2015. On
Companies had been facing problems in carrying out their operations due to the stringent provisions imposed on them by Section 185. Exemptions are given only if the following conditions are satisfied
- There should be no investment in the concerned company from any other body corporate.
- The company should not have any borrowings from banks, financial institutions, or other corporate bodies that exceed more than twice its paid-up share capital, or Rs. 50 crores, whichever is lower; and
- There should be no subsisting default at the time of making such a transaction, and the company should have the capability to pay off the loan.
Thus, as per the new notification issued in 2015, if a private company satisfies all the above three conditions, then it will be exempted entirely from the application of section 185 of the Companies Act, 2013.
However, to grant a loan to a director, he private company must pass a board resolution as per Section 186 of the Companies Act, 20,13, and the amount of the loan should be within the limits laid down under Section 186 of the Companies Act, 2013.
Companies (Amendment) Act, 2017
This amendment to the Companies Act, 2013, was made to ensure ease of doing business.
Through this amendment, the legal provision of section 185 was amended by a new legal provision, which removed the existing prohibition to an extent and imposed certain restrictions on a specific category of prohibited forms of loans to directors. The company (except the private companies which have been exempted through a notification issued on June 5, 2015) cannot 5ans securities, and
- Director of the Company
- Directors of the holding company
- Any partner of a director
- Any relative of a director
- A firm in which the Director partner
The secondary directives apply to those for whom a private company can lend, but certain restrictions are imposed. Prior to the enactment of the Amendment of 2017, the companies were prohibited from lending any loans to private companies of which any such director is a director or member, a body corporate in which suDirectortor controls more than 25% of the voting power, and any corporate body in which tDirectortor of company lending loans is empowered to give directions to the Key managerial personnel of the body corporate and such directions are duly followed by them.
The above entities can be granted loans but only on the p,,assing ofupon specpassageolution by the shareholders of tcomptcompany’seshareholdersfactiuptcompany’scondition the funds will be utilized by the borrowing company only for carryingsolely the principal busitsss activities. At the same time, the amount of the loan must comply with the limitation imposed by Section 186 of the Companies Act, 2013.
Another point is that the cases in which section 185 of the Companies Act, 2013 will not apply at all, and the companies can lend loans in an unrestricted manner in the following cases,
- When the members have approved a scheme by passing a special resolution, the loan is extended to the Director, in accordance with the said scheme.
- When a holding company extends a loan to a subsidiary company wholly owned by it. —rephrase
- A company which, in the ordinary course of its business, provides loans, granting guarantees or securities for the due repayment of any loan and at the same time interest is charged at a rate not less than the prevailing rate of interest, in respect of such loans.
Penalty for Contravention
If any company grants loans in contravention of any of the above legal provisions, then it is liable to be punished by law as peSubject toe legprovisions, punishaprovisionsons, tperson penalized is liable forgeliable a penalized, fine; theamount accordingumpenalized the prvisions,, extending to a maxiTpenalized individual maximum Tpenalizedidual maximumaTheshwhichiduimprisonment fored indivof up term of imprisonment for up to 6 months or a fine ranging between Rs. 5,00,000 and Rs. 25,00,000, if they are found to be defaulter. A director who defaults on a loan in contravention of law can also be penalized with a fine ranging between Rs. 5,00,000 and Rs. 25,00,000, or with imprisonment extending to a maximum period of 6 months.
Conclusion
It is important to note that any contravention of the provisions of Section 185 can result in penalties for the company, its directors, and any other officer of the company who is in default. Therefore, companies should seek professional advice and ensure compliance with the provisions of the Companies Act, 2013, when granting loans to their directors or their relatives.
