Loan To Directors

Impact of Companies Act 2013 on "loan to directors"

Introduction

1. The Companies Act, 2013 ('CA, 2013' for short) has brought about a number of amendments to the corporate law in India be it the provisions relating to class action suits, participation in board meetings through video conferencing, requirement to have at least one woman director or other major provisions. But, the provision that has been talked about the most is section 185, titled as 'Loan to directors, etc.' [corresponding to section 295 of the Companies Act, 1956 ('CA, 1956' for short)]. Needless to say, section 185 is one of the 98 sections which have already been notified for implementation vide MCA notification, dated 12th September, 2013. In view of the stringent penal provisions and the confusion which has been going on in respect of this provision, it is very important to clearly understand the intricate points of this section.

Section 185 of the Companies Act, 2013 versus section 295 of the Companies Act, 1956

2. At the outset, it has to be understood that both, section 295 of the CA, 1956 and section 185 of the CA, 2013 contains the provisions which are applicable in the case of a loan, security, and guarantee by a company to certain specified persons. Thus, for a better understanding & analysis of both these sections, let us examine them side-by-side:

Section 295 of the CA, 1956: Loans to Directors, etc.

Section 185 of the CA,  2013: Loan to directors, etc.

"(1) Save as otherwise provided in sub-section (2), no company (hereinafter in this section referred to as "the lending company") without obtaining the previous approval of the Central Government in that behalf shall, directly or indirectly, make any loan to, or give any guarantee or provide any security in connection with a loan made by any other person to, or to any other person by,— (a) any director of the lending company or of a company which is its holding company or any partner or relative of any such director ; (b) any firm in which any such director or relative is a partner ; (c) any private company of which any such director is a director or member ; (d) any body corporate at a general meeting of which not less than twenty-five per cent of the total voting power may be exercised or controlled by any such director, or by two or more such directors together ; or (e) any body corporate, the Board of directors, managing director, or manager whereof is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company. (2) Sub-section (1) shall not apply to— (a) any loan made, guarantee given or security provided — (i) by a private company unless it is a subsidiary of a public company, or (ii) by a banking company ; (b) any loan made by a holding company to its subsidiary company; (c) any guarantee given or security provided by a holding company in respect of any loan made to its subsidiary company."

"(1) Save as otherwise provided in this Act, no company shall, directly or indirectly, advance any loan, including any loan represented by a book debt, to any of its directors or to any other person in whom the director is interested or give any guarantee or provide any security in connection with any loan taken by him or such other person: Provided that nothing contained in this sub-section shall apply to— (a) the giving of any loan to a managing or whole-time director— (i) as a part of the conditions of service extended by the company to all its employees; or (ii) pursuant to any scheme approved by the members by a special resolution; or (b) a company which in the ordinary course of its business provides loans or gives guarantees or securities for the due repayment of any loan and in respect of such loans an interest is charged at a rate not less than the bank rate declared by the Reserve Bank of India. Explanation.—For the purposes of this section, the expression "to any other person in whom director is interested" means— (a) any director of the lending company, or of a company which is its holding company or any partner or relative of any such director; (b) any firm in which any such director or relative is a partner; (c) any private company of which any such director is a director or member; (d) any body corporate at a general meeting of which not less than twenty five per cent of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together; or (e) any body corporate, the Board of directors, managing director or manager, whereof is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company."

2.1 Persons covered - A careful reading of the language used in both the aforesaid sections makes it clear that the list of persons covered u/s 185 of the CA, 2013 is similar to the list of persons covered u/s 295 of the CA, 1956. The list of these persons is as follows:

		any director of the lending company, or of a company which is its holding company or any partner or relative of any such director;
		any firm in which any such director or relative is a partner;
		any private company of which any such director is a director or a member;
		any body corporate at a general meeting of which not less than twenty five per cent of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together; or
		any body corporate, the Board of directors, managing director or manager, whereof is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors of the lending company.

TABLE OF ILLUSTRATIONS TO ANALYSE AS TO WHETHER A PERSON IS COVERED U/S 295 OF THE CA, 1956/185 OF THE CA, 2013

Particulars	Whether covered u/s  295 of the CA, 1956?	Whether  covered  u/s 185 of the CA, 2013?	Remarks
Illustration 1
ABC Limited proposes togive a loan to Mr. Rajneesh who is a director of its subsidiary company,PQR Limited.	×	×	Under both these sections the director of the lending company or its holding company is covered and not the director of the subsidiary company of the lending company.
Illustration 2
ABC Limited proposes to give a loan to M/s XYZ & Associates, a partnership firm in which Mr. Rajneesh (who is a director of its subsidiary company PQR Limited) is a partner.	×	×	Under both these sections only those firms are covered in which any director of the lending company is a partner.It doesn't include those firms in which a director of the subsidiary company is a partner.
Illustration 3
Mr. Rajneesh is a director of ABC Limited and also DEF Limited. ABC Limited proposes to give a loan to DEF Limited.	×	×	Both these sections would apply if the director of the lending company is also a director or member of the 'Private Company'.
Illustration 4
Mr. Rajneesh is a director of ABC Limited and also a member of DEF Limited. ABC Limited proposes to give a loan to DEF Limited.	×	×	Both these sections apply if the director of the lending company is also a director or member of the 'Private Company'.
Illustration 5
Mr. Rajneesh is a director of ABC Private Limited and also a member of DEF Limited. ABC Limited proposes to give a loan to DEF Limited.	×	×	Both these sections apply if the director of the lending company is also a director or member of the 'Private Company'. Moreover, section 295 of the CA, 1956 doesn't apply to the giving of a loan by a Private company, unless it is a subsidiary of a Public company.
Illustration 6
Mr. Rajneesh is a member of ABC Limited and also a member of DEF Private Limited. ABC Limited proposes to give a loan to DEF Private Limited.	×	×	Both these sections apply if the 'director of the lending company' is also a director or member of the 'Private Company'. Merely being a member of the lending company doesn't attract these sections, even though the recipient company is a Private company.
Illustration 7
Mr. Rajneesh is a member of ABC Limited and also a director of DEF Private Limited. ABC Limited proposes to give a loan to DEF Private Limited.	×	×	Both these sections apply if the 'director of the lending company' is also a director or member of the 'Private Company'. Merely being a member of the lending company doesn't attract these sections, even though the recipient company is a Private company.

2.2 Legal requirements:

		Section 295 of the CA, 1956 provides that for giving a loan, guarantee, security to any of the persons mentioned therein, the company has to obtain prior approval of the Central Government.
		Unlike section 295 of the CA, 1956, section 185 of the CA, 2013 prohibits the giving a loan, guarantee, security by a company to any of the persons mentioned therein. Moreover, under section 185 of the CA, 2013, there is no provision of obtaining prior Central Government's approval.

However, the important thing to mention is that section 185 starts with "Save as otherwise provided in this Act", meaning thereby that if something is otherwise provided in the CA, 2013, then that section will prevail over the prohibition contained u/s 185 of the CA, 2013. In this regard we would like to mention that these exemptions are contained under the proviso to section 185(1) itself which have been discussed further in this article.

2.3 Exemptions:

Both the aforesaid sections, i.e., section 295 of the CA, 1956 & section 185 of the CA, 2013 specify certain transactions which are not covered within their purview. Let us analyze these exemptions in the following comparative table:

Exemptions provided u/s 295 of the CA, 1956:-	Exemptions provided u/s 185 of the CA, 2013:-
Any loan made, guarantee given or security provided by a private company which is not a subsidiary of a public company	NA
Any loan made, guarantee given or security provided by a banking company	Loan, security, guarantee given by a company which in the ordinary course of its business provides loans or gives guarantees or securities for due repayment of any loan and in respect of such loans an interest is charged at a rate not less than the bank rate declared by the RBI.
Any loan made by a holding company to its subsidiary company	NA
Any guarantee given or security provided by a holding company in respect of any loan made to its subsidiary company	NA
NA	Loan given to a MD or WTD: as a part of the conditions of service extended by the company to all its employees; or pursuant to any scheme approved by the members by a SR;

2.4 Penal provisions - Any non-compliance with any of the aforesaid provisions under any of these sections, viz., section 295 of the CA, 1956 and section 185 of the CA, 2013 attracts penal provisions which have been specified therein, a tabular comparison of which is as under:

Penal provisions contained u/s 295 of the CA, 1956:—	Penal provisions contained u/s 185 of the  CA, 2013:—
Every person who is knowingly a party to any contravention, in particular any person to whom the loan is made or who has taken the loan in respect of which the guarantee is given or the security is provided: Fine up to Rs. 50,000/-; OR Imprisonment up to 6 months	On the Company: Fine-minimum Rs. 5 lakhs, maximum Rs. 25 lakhs Director or the other person to whom any loan is advanced or guarantee or security: Imprisonment up to 6 months; OR Fine-minimum Rs. 5 lakhs, maximum Rs. 25 lakhs OR Both

Conclusion

3. In view of the stringent prohibitions contained under the CA, 2013 coupled with the hefty penalty amounts provided, it is essential to clearly understand the provisions of the CA, 2013. The giving of 'loans to directors' or to put it clearly, the prohibition on the giving of 'loans to directors' is one such important concept which must be comprehended clearly in order to save the penalties.

■■ 

--

CA SANJAY DEWAN

B.COM (H),FCA

FCMA,LCS,MIMA