Loans to Directors by a Private Limited Company

The article seeks to answer the question of whether Private Limited Company can lend funds or give loans to its director. This article discusses the objective of enactment of section 185 of Companies Act, 2013 on the companies and reaction of the companies to the legal provision. It also highlights that the amendments that were made to this legal provision in order to give relaxation to the companies.
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Introduction

This article seeks to answer the question of whether Private Limited Company can lend funds or give loans to directors. This article discusses the objective of enactment of section 185 of Companies Act, 2013 on the companies and reaction of the companies to the legal provision. It also highlights that the amendments that were made to this legal provision in order to give relaxation to the companies. This article seeks to answer the above question by discussing in detail the legal provisions under section 185 of Companies Act, 2013 along with the intention and reasoning of the legislators behind the formulation of the legal provision.

Enactment of Section 185 of Companies Act, 2013

Before the enactment of Companies Act, 2013 the Companies Act of 1956 was in force which allowed the companies to give loans, securities and guarantees to its directors or promoters, the public companies for giving these loans had to seek approval from the Central Government. However, the 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 imposed a blanket ban on all kinds of companies from lending loans to its directors, their relatives and the partners. Thus, a prohibition was imposed on all the companies rather than a restriction being imposed.[1] However, the intent of the legislators in this respect was very clear, the directors hold a fiduciary position and are expected to make decisions in the benefit of the company, this provision will prevent the directors from misappropriating the funds of the company for their personal benefits. Also, the funds being used in the company are usually borrowed from financial institutions, which means that the companies are using funds of the general public. Thus, the government needs to keep a check.

Since a blanket ban was imposed by this legal provision, it was opposed by the companies in India, since the companies in India are driven and set up by the promoters. Thus they cannot be barred from using or accessing the funds from their own business. Another reason for its opposition was that the law is not in consonance with the laws of other countries as in other countries a blanket ban is not imposed, only a restriction is imposed or else the lending is permitted, unlike India. The argument that was being made on behalf of companies was that if the shareholders who have made the investment of their funds agree for utilisation of funds in a particular way, then the law should not create a bar on the same.[2]

Exemptions

Since the legal provision was being opposed by private as well as the 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 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. Thus private companies were given an exemption through the notification only if the following three conditions are satisfied. [3]

  1. There should be no investment in the concerned company from any other body corporate;
  2. 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
  3. There should be no subsisting default at the time of making such transaction, and that the company should have the capability to pay off the loan.”[4]

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 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 Companies Act, 2013 and the amount of said loan should be in limits as laid down under section 186 of Companies Act, 2013.

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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. So, this provision can be divided into three categories. 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-

  1. Director of the Company
  2. Directors of the holding company
  3. Any partner of a director
  4. Any relative of director
  5. Firm in which the director is a partner[5]

The next category includes those who can be given a loan by the company, but certain restrictions are imposed. Prior to the enactment of 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 loan 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 utilised by the borrowing company only for carrying out the principal business activities. At the same time, the amount of loan must comply with the limitation imposed by section 186 of Companies Act, 2013.

The third category lays down all the cases in which section 185 of Companies Act, 2013 will not apply at all, and the companies can lend loan in an unrestricted manner.

  1. When the members have approved a scheme by passing a special resolution, and the loan is being extended to Managing Director or a whole-time director, in pursuance of the said scheme.
  2. When the amount of loan is being extended by a holding company to a subsidiary company owned by it wholly. —rephrase
  3. 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. [6]

Objective

The main intent of the legislature in imposing restrictions on grant of loans to directors by companies was to ensure that the directors do not fail to perform their fiduciary duties towards the company. It cannot be denied that the directors are in a fiduciary relationship with the company and they have to perform functions on behalf of a company in a manner that is in general benefit of company. Thus, if these directors are allowed to take loans from company easily without any restrictions then it may allow the directors to work for their personal benefit rather than focussing on benefit of company.

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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 fine, the minimum amount of 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 in 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 penalised with a fine ranging between Rs. 5,00,000 till Rs. 25,00,000 or/and with imprisonment extending to a maximum period of 6 months. [7]

Conclusion

The Companies Law, 2013 placed a blanket ban on all companies from lending any loans, securities or guarantees to the company’s directors, with the intention of preventing the directors from using funds for their personal benefit. But this blanket ban was opposed by all the companies, both private and public because it created problems in the conduct of business easily. Then further amendments were made which allowed the private companies to extend loans and thereby be exempted from the application of section 185 of Companies Act, 2013. Thus, at present private limited companies can grant loans to its director on fulfilment of conditions as specified above in the article. The government had made this change to ensure ease of doing business for private companies.

Bibliography


[1] Avtar Singh, Company Law (17th ed. Eastern Book Company, 2018).

[2] DhavalGusani, Loans to Director under Section 185, Taxguru Complete tax solutions (26 August 2018), https://taxguru.in/company-law/loans-director-section-185.html.

[3] Dr. G.K. Kapoor; Dr. Sanjay Dhamija, Company Law-A Comprehensive Text Book on Companies Act 2013 178 (22nd ed. Taxmann, 2019).

[4]Muthukumaran, All About Loans to Directors – Section 185- Companies Act, 2013, Taxguru Complete tax solutions (14 August 2018), https://taxguru.in/company-law/loans-directors-section-185-companies-act-2013.html.

[5] B.K. Goyal, Company Law 109 (13th ed. Singhal Law Publications, 2018).

[6] DhavalGusani, Loans to Director under Section 185, Taxguru Complete tax solutions (26 August 2018), https://taxguru.in/company-law/loans-director-section-185.html.

[7] Muthukumaran, All About Loans to Directors – Section 185- Companies Act, 2013, Taxguru Complete tax solutions (14 August 2018), https://taxguru.in/company-law/loans-directors-section-185-companies-act-2013.html.

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