Loan 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. 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 part of the Companies providing any loan or giving any guarantee or providing any security. Also, the section provides relaxation for Individuals and Entities from the provisions of Section 185 subject to certain 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 such Director or any partner of such Director or any firm in which such Director or 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 Loan to directors, etc has been completely substituted with the new provisions w.e.f 7th May 2018.
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;
- Loans are given by a holding company to its subsidiary company or by a subsidiary company 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 Companies Act of 1956 was in force which allowed companies to give loans, securities, and guarantees to their directors or promoters, the public companies for giving these loans had 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 is applicable to all kinds of companies from lending loans to its directors, their relatives, and their partners. Thus, a prohibition was imposed on all the companies rather than a restriction being imposed.
The intent of the legislators is 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 funds of the company for their personal benefit. Also, the funds being used in the company are usually borrowed from financial institutions, which means that the companies are using the funds of the general public. Thus, this section also protects the interest of investors
Since the legal provision was being opposed by private as well as public companies, the government had to give some relaxation to the companies in that respect. Relief was given to the private companies by giving them exemption from the application of section 185 of the companies act, 2013 through a notification issued on 5th June 2015.
Private 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, and other body corporate equal to or 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 completely exempted from the application of section 185 of the Companies Act, 2013.
However, to be able to grant a loan to directors the private companies have to pass a board resolution as per section 186 of the Companies Act, 2013 and the amount of said loan should be in limits as laid down under section 186 of the Companies Act, 2013.
Companies (Amendment) Act, 2017
This amendment to the Companies Act, 2013 was made in order to ensure ease of doing business.
Through this amendment, the legal provision of section 185 was substituted by a legal provision, which removed the prohibition to an extent and placed certain restrictions. The first kind of category pertains to prohibited forms of loans to the directors. The company (except the private companies which have been exempted through a notification issued on 5th June 2015) cannot give loans, guarantees and securities to-
- Director of the Company
- Directors of the holding company
- Any partner of a director
- Any relative of a director
- Firm in which the director is a partner
The second one includes those who can be given a loan by a private company, 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 such director controls more than 25% of the voting power, and any corporate body in which the director 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 passing of a special resolution by the shareholders of the company and on the satisfaction of the condition that the funds will be utilized by the borrowing company only for carrying out the principal business 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 Managing Director or a whole-time director, in pursuance of the said scheme.
- When the amount of loan is being extended by a holding company to a subsidiary company owned by it wholly. —rephrase
- A company which ‘in the ordinary course of its business’ includes the providing of loans or 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 the law as per the legal penal provisions. Such a company can be punished with payment of a fine, the minimum amount of the fine shall be Rs. 5,00,000 extending to a maximum fine of Rs. 25,00,000. The individual officers of the company can also be punished individually, with an imprisonment of a term extending to 6 months or with a fine of between Rs. 5,00,000 and Rs. 25,00,000, if they are found to be the defaulters. The director who is receiving the loan in contravention of law can also be penalized with a fine ranging between Rs. 5,00,000 to Rs. 25,00,000 or/and with imprisonment extending to a maximum period of 6 months.
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, it is advisable for companies to seek professional advice and ensure compliance with the provisions of the Companies Act 2013 while granting loans to their directors or their relatives.
FAQs on Loan to Directors