Section 185 Of Companies Act, 2013 - Loans To Directors

Section 185 of the Companies Act 2013 is an essential regulation that governs the financial and loan transactions between companies and their directors or related parties. It establishes the regulations and limitations for lending money to the directors. All companies registered in India must comply with the terms and conditions set out in this section before providing any security, guarantee, or loan to their directors. 

Furthermore, Section 185 imposes penalties on the defaulting corporation, its officers, and its directors for violating its terms.

In this guide, we will cover all aspects related to Section 185 of the Companies Act, including loans permitted under Section 185, exemptions, applicability, penalties for non-compliance, and more. 

What Is Section 185 Of The Companies Act 2013

Section 185 of the Companies Act states that a company cannot:

• Advance any loan, either directly or indirectly.
• An advance loan, which includes a loan represented by a book debt. 
• Provide a guarantee or security for a loan taken.

By a director, a director of its holding company, a relative or a partner of any director, or any firm in which a director is either a partner or a relative. 

In a nutshell, Section 185 of the Companies Act 2013 forbids companies from granting loans to directors, partners, or their relatives. 

Note: For NRI directors in Indian companies, the provision under Section 185 of the Companies Act remains the same. 

Loan Permissible To Directors Of The Company

Section 185(2) of the Companies Act permits the company to extend loans to any entity, a person in whom any of the directors are interested, provided the following conditions are fulfilled. In simpler terms, the companies can advance loans, including loans reflected in book debt, and provide security or a guarantee in connection with any loan taken by any person in whom a company director is interested. 

The conditions that must be fulfilled for the companies to extend a loan or provide any security or guarantee to the person in whom the company director is interested are as follows. 

1. The company is required to pass a specific resolution in a general meeting. 

2. The loan granted to the borrowing company must strictly be used for its principal business activities. 

3. The general meeting explanatory statement in which the resolution for extending the loan is passed must disclose. 

• Complete particulars of the loan, security, or the guarantee provided.
• The purpose for which the security, loan, or guarantee is proposed to be used. 

For the aforementioned purpose, any person in whom any of the directors of the company is interested must include the following persons: 

• Any private limited company in which such a director is either a director or a member. Meaning they are involved in the management or the ownership. 
• Any company where the director (alone or with other directors) holds 25% or more of the voting power, giving them significant influence.
• Any company whose Board of Directors acts based on the directions or the instructions of the lending company's directors. 

Exemption Under Section 185 of the Companies Act, 2013

Section 185 of the Companies Act 2013 also provides an exception to the restrictions prohibiting a company from granting a loan to its directors. The company is permitted to give a guarantee, provide security, or advance loans to: 

• A loan can be extended to a managing or whole-time director if it is part of employment benefits or approved by the company's shareholders through a special resolution. 
• A company can advance loans, securities, or guarantees in the normal course of business, but the interest charged must not be lower than the government's security rate for a similar loan period. 
• The holding company can extend a loan, security, or guarantee to its wholly owned subsidiary; however, the loan must be utilized for principal business purposes. 
• A holding company can provide a guarantee or security for loans taken by its subsidiaries from financial institutions or banks, provided that the loan funds are used for the subsidiaries' principal business activities. 

Penalty For Non-Compliance With Provisions Of Section 185. 

If any provision of the Act is not complied with, Section 185(4) of the Companies Act requires that a penalty be imposed. If any company extends a loan in violation of Section 185, the company will be imposed a fine of nothing less than Rs 5 lakh, which may extend to Rs 25 lakh. 

The director, or any other person related to the director to whom the security, guarantee, or any loan is extended, shall be subject to imprisonment for a period of six months, a fine of up to Rs 5 lakh, which may extend to Rs 25 lakh, or both. 

Key Checklist For Section 185 Of The Company Act

The following are the key points to remember under Section 185 of the Companies Act when extending loans, providing securities, or granting guarantees.

• A company cannot advance loans or grant securities or guarantees to its directors, officers, or relatives. 
• A company, furthermore, cannot extend a loan to any firm where a director is a partner or relative.
• A loan can be provided to a person in whom the director is interested. However, this can occur only after shareholder approval through a special resolution, and the loan must be used for business purposes. 
• The company must first check whether the borrowing party falls within the category of "person in whom a director is interested" as defined by law. 
• The loan can be extended to a managing or whole-time director if the following considerations under the Companies Act are satisfied. 
• A company that extends loans and provides securities or guarantees for the due repayment of any loan in its ordinary course of business can advance a loan.
• Under the Act, the holding company may grant loans or provide support to its subsidiary if the subsidiary meets the conditions stated in Section 185(3) of the Companies Act, 2013. 

The Bottom Line 

For companies to maintain strong corporate governance, accountability, transparency, and compliance with Section 185 of the Companies Act 2013 is essential. By adhering to the provisions in this section, the companies can safeguard their financial resources, build a strong foundation of trust with their stakeholders, and protect shareholders' interests. Non-compliance with the provision will subject the defaulting party to severe penalties and punishment. 

As an NRI, if you are planning to register a company in India and seeking professional guidance, Savetaxs is the name to trust. Our expertise will consult NRIs with the best business strategies, regulatory requirements for the same, documentation management, handle DSC/DIN filings, filing incorporation documents, FEMA and RBI compliance consultation, and more. 

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