Loan to Directors under Section 185 of Companies Act, 2013

It is said that shareholders are owners of the company. However, in reality it is the Board of Directors who exercise great control. Board of directors only take decisions regarding day to day operations and routine affairs of the company. With control comes risks of misuse of that power. So to prevent directors from using the funds of the company simply at their will, Section 185 of Companies Act, 2013  was introduced to provide rules and regulations for Loans to Directors or related parties of directors by a company. In this article we will discuss Section 185 of Companies Act,2013  in detail.

Section 185 of Companies Act, 2013 : Loan to Directors

Section-185 of Companies Act, 2013 lays down the provisions for giving loans to the directors, security or guarantee to loans taken by directors. The section tells mainly the situations in which loans cannot be given and conditions under which loans can be given but subject to certain conditions. It also states that in which conditions concurrence of shareholders is mandatory by way of a resolution. The section contains 4 subsections that have specific provisions. We will discuss all these one by one.

Who cannot be given the loan : Section-185(1)

According to this section a company is not allowed to provide any type of loan (not even a book debt), security and guarantee to any of the following persons-

• Any director of the company or its holding company.
• Any relative or partner of any of the above director.
• Any firm in which the director or relative is a partner.

So, it is prohibited by law to give any loan. Guarantee, security to these persons mentioned above. Well it’s not that simple; law has got other provisions also in store for us. So, let us proceed further.

Who can be given the loan subject to conditions : Section-185 (2)

Now, the law was very strict in Section-185 (1) above, but in this subsection it loosened itself a bit and allowed certain transactions but subject to conditions. According to this section company can advance loan (including a book debt), security, guarantee in connection to a loan taken by a person in whom the director of the company is interested.

The main two parts of this provision are “person in whom director is interested” and “conditions to be satisfied”. So, let us understand these two parts-

“Person in whom director is interested” includes-

• A private company in which such director is a director or member.
• Anybody corporate in whose general meeting at least 25% of the voting rights are exercised or controlled by one or more directors together.
• Where the managing director, manager or Board of Directors of a body corporate act according to the instructions of Board or any one or more directors of the lending company.

In short if the lending company significantly controls operations or voting rights of the company then it will be allowed subject to conditions.

“Conditions to be satisfied” are-

• Company should pass a special resolution in a general meeting. The explanatory statement to the notice should include full details about such proposed loan, guarantee or security and the purpose for which it is supposed to be utilised.
• The borrowing company can use it only for its principal business activities.

Cases where 185(1) & (2) need not be followed : Section-185 (3)

This section provides about the cases where the provisions of the subsections discussed above will not be applicable. This section lays down the rules where loan, security, guarantee can be given if some conditions are satisfied.

Now, last part of the section is what happens if the provisions of the section are not followed-

Penalties for not following provisions : Section-185 (4)

As we see the law has laid down detailed provisions as to what a company should do and not do. However, if a company still fails to abide by the provisions of Section 185 of Companies Act, 2013 and contravenes any of the provisions then it will subject to penalties.

A Brief Sum up

Looking at provisions of Section-185 of Companies Act, 2013, we can understand intention of the law. The intention of the law is to provide safety to the shareholders’ rights. In most of the permitted cases resolution from members is compulsory. Also law has taken care that business should not be hindered because of very stringent provisions. That is the reason loan to subsidiaries is permitted. If a company wants to provide loans as a facility to its employees, as a uniform policy than that is also permitted. We can see that law takes care of interests of all parties involved. Similarly, companies should also abide by provisions of law and avoid unnecessary penalty and litigations.