When legislators enacted the Companies Act, they allowed public companies to grant loans, guarantees, and securities, provided these companies obtained prior approval from the Government. However, companies often borrowed funds and passed them to subsidiaries and other associate companies through inter-corporate loans. This practice led to compliance issues, particularly when the holding company failed to honor loan agreements, leaving subsidiaries in financial distress. To prevent such exploitation, Section 185 of Companies Act 2013 was introduced.
Section 185 of the Companies Act 2013 initially prohibited companies from advancing loans or providing security or guarantees for loans taken by the Company’s directors or individuals connected to the directors. The original provision was strict, with penalties applied only to companies or recipients violating these regulations.
The Companies (Amendment) Act of 2017 modified Section 185 to provide more flexibility while safeguarding subsidiaries and the company’s financial health.
1. Applicable to Directors and Interested Parties: Section 185 now applies to the directors of the company or its holding company, any partner of such a director, or any firm in which the director or their relative is a partner.
2. Loan to Interested Parties: The company may lend money to any person or firm in which a director has an interest, provided it meets certain conditions.
3. Penalties: If a company, its directors, or any officer acts in violation of these provisions, they are subject to penalties under Section 185(4) of the Act. This includes penalties for the company, the directors, and any officer in default.
Section 185(1) specifies that a company is prohibited from directly or indirectly:
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It may be provided if it is part of the company’s service policy to extend such loans to all employees.
Loans must be by any scheme approved by the members through a special resolution.
The holding company may offer security or a guarantee for any loan that a bank or financial institution grants to its subsidiary, ensuring the subsidiary uses the loan for its principal business activities.
When a holding company provides a loan, guarantee, or security to a wholly-owned subsidiary, and the subsidiary uses it exclusively for its commercial activities.
The private company may grant loans if it operates in the ordinary course of business and charges an interest rate not less than the prevailing rate set by the Reserve Bank of India (RBI).
Non-compliance with Section 185’s provisions results in severe penalties:
Section 185 of the Companies Act 2013, prevents directors or persons in whom the directors have an interest from misusing company funds. The amendments made in 2017 provided a balance between maintaining corporate governance and allowing companies some flexibility in their financial dealings.
Once companies understand the provisions of Section 185, they can ensure compliance while avoiding hefty penalties.
The primary objective of Section 185 is to prevent companies from misusing their funds by advancing loans, guarantee given, or security offer to directors or entities in which directors have an interest, thereby protecting subsidiaries and the company’s financial health.
Generally, a company cannot provide loans to its directors. However, there are specific exemptions where loans can be granted, such as loans to managing directors or whole-time directors if it is part of the company’s service policy.
Penalties for violation include a fine for the company ranging from ₹5 lakh to ₹25 lakh, imprisonment for officers in default for up to six months, and fines for the director or interested party ranging from ₹5 lakh to ₹25 lakh, or both.
Yes, loans, guarantee or security is provided by a holding company to its wholly-owned subsidiary are exempt if the loan is used exclusively for the subsidiary’s principal business activities.
The Companies (Amendment) Act, 2017, introduced more flexibility by allowing companies to lend money to entities in which directors are interested, subject to conditions such as passing a special resolution and ensuring the loan is used for the borrowing entity’s principal business activities.
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