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All About Loans to Directors – Section 185- Companies Act, 2013
 muthukumarancs
 | Company Law - Articles
 14 Aug 2018
 47,718 Views
 3 comments

Introduction
Through the Companies (Amendment) Act, 2017(“Amendment Act”), the existing
Section 185 of the Companies Act, 2013 (‘the Act’), which deals with Loan to
directors, etc has been completely substituted with the new provisions w.e.f
7th May,2018.
The substituted Section 185 deals with the restrictions on part of the Companies in
advancing any loan or giving any guarantee or providing any security and to those
whom a Company can provide such loan or guarantee or security subject to
compliances under the Act. Also, section provides relaxation for Individuals and
Entities from the provisions of Sec. 185 subject to certain conditions and Punishment
for those who contravene the same.
This article aims to bring a clear vison on the newly substituted provisions of Sec 185
and the practical issues prevailing thereon.
Rationale Behind Substitution of Section 185
Sec. 185 was completely substituted with the new section through the Amendment
Act, 2017. The Amendment Act was based on suggestions of the Companies Law
Committee, constituted by the Ministry of Corporate Affairs (MCA), in its report dated
1st February 2016, with the aim to strengthen corporate governance and ease
doing business in the country. Recommendations for amendment along with the
reasons were clearly reported in the report.
The Extract of the committee’s report w.r.t Sec. 185 is reproduced below for
reference:
“Loans to Directors, etc.
12.14 The Committee acknowledged that there are difficulties being faced in genuine
transactions due to the complete embargo on providing loans to subsidiaries with
common directors, but at the same time there is no doubt that the route has been
misused in the past for siphoning of funds by controlling shareholders. The
Committee noted that limited relaxation has already been provided to private
companies not having other body corporates invested in them and therefore
any further relaxation should be subject to greater safeguards. The Committee,
therefore, recommended, that it may be considered to allow companies to
advance a loan to any other person in whom director is interested subject to
prior approval of the company by a special resolution. Further, loans extended
to persons, including subsidiaries, falling within the restrictive purview of
Section 185 should be used by the subsidiary for its principal business activity
only, and not for further investment or grant of loan.
12.15 The Committee also felt that there was no rationale as to why the interest rate
prescribed in the proviso (b) to Section 185(1) should not be aligned with the rate
prescribed under Section 186(7). Thus, it recommended that this be aligned,
keeping in mind further changes suggested to the provision, in the succeeding
paragraphs dealing with other issues in Section 186.”
Facts about Section 185 of the Act
a) Sec. 185 brought to force from 12th September, 2013 and Corresponds to
Sec.295, 296 of the Companies Act, 1956.
b) There are no rules prescribed, at present, for Sec. 185 under the Companies Act,
2013.
c) Other sections of the Act relating to Sec. 185 are Sections 177, 179 and 186.
d) This section shall not apply to a Govt. Companies, Private Companies and Nidhi
Companies subject to conditions specified in MCA’s Exemption Notification dated
5th June, 2015 and 13th June 2017.
e) Sec. 61 of the Companies (Amendment) Act, 2017 completely substituted the
existing Sec. 185 with new provisions w.e.f 7th May,2018.
Provisions of Substituted Section 185 (After the Amendment Act, 2017)
Subsection 1 states that a Company (Private & Public whether small, OPC, Start-ups
etc.) shall not directly or indirectly, advance any loan (including loan represented
by a Book debt) OR give any guarantee OR provide any security in connection with
any loan take by:
a) Any director of the company; or
b) Any director of its holding company; or
c) Any partner of any such director; or
d) Relative of any such director;
e) Any firm in which any such director is a partner; or
f) Any firm in which the relative of any such director is a partner;
(Note: The Term “any Such” would mean in reference to the director of the
lending company and/ or in relation to the director of its holding company)
This subsection strictly prohibits providing Loan or Guarantee or Security to the
aforesaid Individuals and firms.
Subsection 2 states that a Company can advance any loan (including Book debt) or
give any guarantee or provide any security in connection with any loan taken by
(a) any private company of which any such director is a director or member;
(b) any body corporate at a general meeting of which not less than 25% of the total
voting power may be exercised or controlled by
a. any such director, or
b. by two or more such directors, together; or
(c) 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
a. Board; or of
b. any director or directors, of the lending company.
However, the above provisions are subject to following conditions that:
a) A special resolution is passed by the Company in general meeting; and
b) The loans are utilised by the borrowing company for its principal business
activities.
Subsection 2 allows companies to provide loan/guarantee/security to other
Companies / body corporates subject to conditions. This was earlier prohibited and
now relaxed.
As per Subsection 3, the following entities and individuals are exempted from
complying with subsection 1 & 2 as explained above, subject to certain conditions:
a) 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 way of special resolution;
b) Company which in the ordinary course of its business provides loans or
gives guarantees or securities for the due repayment of any loan e.g Banking
Companies and Loan NBFCs. (In respect of such loans an interest shall be charged
at a rate not less than the rate of prevailing yield of 1 year, 3 years, 5 years or 10
years Government security closest to the tenor of the loan);
c) any loan made by a holding company to its wholly owned subsidiary company
or any guarantee given or security provided by a holding company in respect of
any loan made to its wholly owned subsidiary company; (in case of WOS complete
relaxation from Sec. 185).
d) any guarantee given or security provided by a holding company in respect
of loan made by any bank or financial institution to its subsidiary company.
(Unlike class ‘C’ (i.e WOS) only Guarantee & Securities provided for loan made
by any bank or financial institution are allowed for subsidiary company).
Provided that the loans made under clauses (c) and (d) are utilized by the subsidiary
company for its principal business activities.
(In order to ensure that the companies do not take advantage of the relief, the
provision ensure that there is no siphoning of funds received by the companies, as
the amount received under this section should be utilised by the borrower for its
principal business activities and not for further investment or grant of loan.)
(Even though ‘principal business activity’ has not been defined under the Act,
generally the activities provided in the main objects of the MOA will qualify as the
principal business activity of that company)
Subsection 4 talks about the punishment, where any loan advanced or a guarantee
or security given or provided or utilized in contravention of the provisions of this
section.

In case of Punishment Remarks

Lending Punishable with fine which shall not be less than Rs. 5 lakh but which Only Fine
Company may extend to Rs. 25 lakh

Officer in Punishable with imprisonment for a term which may extend to 6 Fine or
default months or with fine which shall not be less than Rs. 5 lakhbut which imprisonment
 may extend to Rs. 25 lakh.

Recipient Punishable with imprisonment which may extend to 6 monthsor with Fine or
Director/ fine which shall not be less than Rs. 5 lakh but which may extend imprisonment
Entity to Rs. 25 lakh, or with both. or both
Under this subsection, specific offence of contravention in utilization of loan and
punishment for officers in default is introduced vide the Amendment Act.
In Simple words,

Substantial Changes made under Section 185 by the Amendment Act

> New section omitted the words “save as otherwise provided in the Act” to
avoid confusion as to whether the provisions of section 186, which starts with
“without prejudice to the other provisions”, can exclude section 185.
> By this new section, Companies are allowed to grant loans, guarantees and
security to entities in which directors are interested, in certain cases, subject to
prior approval of the shareholders by a special resolution and on the condition that
such loans are used by the borrower for its principal business activities.
> Interest rate prescribed in the proviso (b) to Section 185(3) is aligned with the
rate prescribed under Section 186(7) of the Act. Prior to amendment it was “interest
at a rate not less than the bank rate declared by the Reserve Bank of India”.
> The ambit of the penalties has been widened and as a result, the obligations of
every “officer” of a company (as defined in Section 2(59) of the Act) have been
increased to ensure that all loans, security and guarantees are in compliance with
the provisions of the Act failing which officer of the company who is in default shall
be liable for penal actions and may also attract criminal liability. Also, in the list of
offenses under this section, specific offence of contravention in utilization of loan has
been added.
Exemptions from Section 185

Other Provisions of the Companies Act relating to Sec. 185

While providing the Loan or Investment or Security and guarantee, in addition to
Sec. 185, the Company shall also comply with the following provisions of the Act:
Section 177 (4) (v): Every Audit Committee shall scrutiny of inter-corporate loans and
investments.
Section 179(3) (e): The Board of Directors of a company shall exercise the power to
invest the funds of the company by means of resolutions passed at meetings of the
Board.
Section 180(1)(d): To remit, or give time for the repayment of, any debt due from a
director.
Section 186: Loan and Investment by Company.
Practical Problems / Case Laws for better understanding
Problem: Abc Ltd is a Computer manufacturing company. One of the Directors
Mr. A is setting up an Office for which he will also need to buy Computers. Mr.
A asks the Company to give him 20 Computers for a long credit period.
Whether is there any restriction on this transaction?
Solution: As per Sec. 185 (1) providing loan either directly or indirectly, including
any loan represented by a book debt to any director of company, is prohibited.
Hence, this transaction is prohibited and violation of Sec. 185.
Further, in the case of “Pennwalt India Ltd. v. RoC”, wherein the Hon’ble High
Court of Bombay has held that to ascertain whether a transaction is a loan or
not, surrounding circumstances, relationship and character of the transaction
and the manner in which parties treated the transactions will have to be
considered. Therefore, with reference to each transaction with Directors and other
person in whom the Directors are interested, the nature of transactions has to be
studied, in case they relates to book debts.
Question: Whether a company can lend through intermediary to the persons
who are otherwise related with the lending company?
Answer: Under subsection 1 of Sec. 185 a company shall not advance any loan
either directly or indirectly. Further, in the case of Dr. Fredie Ardeshir Mehta V.
Union of India [1991] 70 Comp. Cas. 210 (Bom.), the term Indirect used in the
Section 295 of CA, 1956 (now Sec.185 of CA, 2013) is interpreted as “When Section
295 refers to indirect loan to director, what it means is that the company shall not
give a loan to a director through the agency of one or more intermediaries.” The
word “indirectly” used in Sec. 295 cannot be read as converting what is not a
loan into a loan. Therefore, the company shall not lend through intermediary to the
persons who are otherwise related with the lending company.
Question: Is the section applicable to a letter of comfort (LoC) given by the
company?
Answer: No, Guarantee has been covered, however, LoC is not covered by sec
185. In case of Guarantee, guarantor undertakes the liability of principal debtor,
whereas In case of letter of Comfort, intention is to give introduction of debtor,
without undertaking the liability of principal debtor. The word guarantee is defined in
the Contracts Act to imply the “undertaking of the liability of a principal debtor
by the guarantor”.However, in case of letter of comfort, the commitment of
comforting party is merely to the extent of introducing the principal debtor, but
there may be a moral obligation, but there is no contractual obligation of the
comforting party, and hence, there is no guarantee. Therefore, LoC is not covered
under the Sec. 185.
Problem: Abc Ltd provided corporate guarantee to Xyz Pvt Ltd ( Mr. A,
shareholder of Abc Ltd is also a director in Xyz Pvt Ltd) on 01.07.2018. Later
on in the view of conditional exemption u.s 185(2), the Abc Ltd obtained
approval of shareholders for the said corporate guarantee on 20.07.2018.
Whether this transaction is violative of Sec. 185? Whether Prior Approval of
shareholders are required for loans to certain entities under Sec. 185 (2)?
Solution: As per the substituted Section 185, Company may provide loan/guarantee
to any person in which director is interested u/s185(2), subject to the condition that
A special resolution is passed. This condition has to be prior approval, because
only after meeting with this condition, company is allowed to give loan/guarantee to
any person as specified under Section 185(2). Hence, this transaction is violative
of Sec. 185 and prior approval of members is mandatory.
Problem: ABC Ltd grants loan to its director Mr. A for Construction of flat /
house pursuant to a Loan Scheme approved by the shareholders by way of
Special Resolution. Whether the same violates Sec. 185? Also, whether the
director is criminally liable?
Solution: Yes, as per Sec. 185 (3), giving of any loan to a managing or whole-
time director alone is exempted from the provisions of Sec. 185 subject to the
condition that it was provided pursuant to scheme approved by the members by a
special resolution. Hence, providing loan to Mr. A who is not WTD or MD is violation
of Sec. 185 and the director is criminally liable.
Problem: Abc Ltd, Lender Company and also Subsidiary of Xyz Pvt Ltd. Abc
Ltd wants to give Loan/Guarantee/ Security to Holding Company. Whether the
same is possible in the following scenario i) Where Directors of Abc Ltd are
also shareholders of Xyz Pvt Ltd. ii) If the holding Company is Public Limited.
Solution: (i) Where Directors of Lender Company are Directors or shareholder of
Holding Company, it will fall under u/s 185(2). Therefore, Subsidiary can give loan
to holding Company by complying with conditions of subsection 2 of
Sec.185 i.e prior approval of the shareholders by a special resolution and such loans
are used by the borrower for its principal business activities.
(ii) If the Holding Company is Public Limited Company, Lender (Subsidiary) can give
loan to such holding Company and such transaction will not fall u/s 185.
Problem: ABC Pvt Ltd and XYZ Pvt Ltd does not have any common director. In
ABC Private Limited, Mr. R is a Director and in XYZ Private Limited, the wife of
Mr. R is a Director. In this scenario whether the provisions of Sec. 185 will
attract?
Solution: In such a situation, the loan can be given by ABC Pvt Ltd to XYZ Pvt Ltd.
The condition mentioned u.s 185(2) is common directorship i.e “private company of
which any such director is a director or member”. It clearly excludes the relative
of director and hence the provisions of Sec. 185 will not attract.
Conclusion
When the section was originally introduced, there were complete prohibition on loan
to its directors and other entities and it was felt that the said changes were much
required for better governance & transparency in the affairs of the Companies
keeping in view the fiduciary character of the directors.
However, the section was quite harsh when it came to implementation, even the
deserving and genuine cases were debarred from raising Loans from the
Companies. Considering the same and for ease of doing business in India, the relief
has been given to certain entities vide the substituted provisions, while at the same
time providing adequate safeguards and additional responsibility on the part of
company and its officers.
DISCLAIMER: The information given in this document has been made on the basis
of the provisions stated in the Companies (Amendment) Act, 2017 and Companies
Act, 2013. It is based on the analysis and interpretation of applicable laws as on
date. The information in this document is for general informational purposes only and
is not a legal advice or a legal opinion. You should seek the advice of legal counsel
of your choice before acting upon any of the information in this document. Under no
circumstances whatsoever, we are not responsible for any loss, claim, liability,
damage(s) resulting from the use, omission or inability to use the information
provided in the document.
Tags: Companies Act, Companies Act 2013

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Name: Muthukumaran
Qualification: CS
Company: P MUTHUKUMARAN AND ASSOCIATES
Location: Chennai, Tamil Nadu, IN
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3 Comments
1. S Raghavendar says:
Very nice article & analysis. Thank you
Reply

January 12, 2019 at 7:51 am

2. kashiraman says:
Abc Ltd, Lender Company and also Subsidiary of Xyz Pvt Ltd. Abc Ltd wants to give
Loan/Guarantee/ Security to Holding Company. Whether the same is possible in the following
scenario . ii) If the holding Company is Public Limited.
don’t you feel that under such circumstances there is violation of 185(1)(a)
Reply

August 14, 2018 at 5:29 pm

1. muthukumarancs says:
Sir, 185(1) (a) covers only any director of its holding company or any partner or relative of any
such director. Only Individuals are covered u. s 185(1) whereas the company is covered under
185(2).
Reply

August 18, 2018 at 3:18 pm

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 Loans to Director under Section 185
 Dhaval123
 | Company Law - Articles
 26 Aug 2018
 8,139 Views
 2 comments

Since the enactment of the Companies Act 2013, Section 185 of Companies Act,
2013 was seen as unacceptable by companies across India because it was not in
consonance with company laws in other countries where such transactions are either
permitted or restricted but not prohibited. The other reason for resistance is that
majority of Indian businesses are promoter driven and they are barred to access
funds of their own business.
Earlier, public companies were permitted to grant loans, guarantees and securities
subject to Central Government approval and private companies were exempted
under Section 295 of the erstwhile Companies Act, 1956.
Section 185 of the Companies Act, 2013 imposed blanket ban on loans to
directors, their relatives and partners. The main intention of the Section 185 is to
ensure that directors who hold a fiduciary position with respect to shareholders do
not misappropriate the funds of the company for their own benefits.
Why Companies opposed the Section 185 of Companies Act, 2013?
The argument of promoters is that where the shareholders being the ultimate owners
themselves approve the utilization of the funds of the company in the specified
manner, the law should not create a bar or restrictions on the same.
Why Companies debarred?
In India, majority of companies are enjoying credit facilities from banks and financial
institutions. Thus, they are using public money in an indirect way. So, it’s very much
important to check and balance the acts of promoters that they don’t misappropriate
the funds of the shareholders and banks for their own benefits.
JOURNEY OF RELIEF SINCE ENACTMENT OF COMPANIES ACT, 2013
A diverse section of stakeholders including professionals opposed the Section 185
since its enactment and notification and various representations have been made to
Government for some relaxation at least to the Private Companies.
A journey of relief started with the exemption notification dated 5th June, 2015
exempting Private Companies from Section 185 and thereafter Companies
(Amendment) Act, 2017 which allowed to give loans, guarantee and securities to
other Companies and Body Corporates after passing Special Resolution.
Exemption from Section 185 to Private Companies vide Notification dated 5th
June, 2015
Private Companies were facing problems due to stringent provisions of Section 185
while carrying out operations. So, Government exempted private companies from
entire Section 185 to ease the compliance requirement vide notification dated 5th
June, 2015, subject to following 3 conditions:
 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.

Hence, any Private Company fulfilling above conditions are completely out of
purview of Section 185. However, before granting any loan to Directors or any other
person in whom directors are interested, Company has to pass Board Resolution as
per Section 186 and the said loan must be within the limit specified in Section 186 of
the Companies Act, 2013.
Companies (Amendment) Act, 2017.
Government substituted entire Section 185 by way of Companies (Amendment) Act,
2017 to promote ease of doing business. The original Section 185 specified more
exhaustive list to which Companies can’t give loans, guarantee and securities. Thus,
at par with the global company laws, the provision has been amended to remove the
prohibition to an extent and provides for the passing of shareholders’ resolution for
granting of loans, guarantees, and securities to entities in which directors are
interested.
For better understanding of the section, I classified 3 categories i.e Prohibited,
Restricted and Unrestricted for giving loans, guarantees and securities.
1) PROHIBITED
All the Companies (Except Private Companies which fulfill the criteria of exemption
notification dated 5th June, 2015) are prohibited to give loans, guarantees and
securities to the following persons and firm:

1. Any Director of a Company

2. Any Relative of a Directors
3. Any Partner of a Directors
4. Any Directors of a Holding Company
5. Any firm in which any such director or relative of a Director is a Partner

2) RESTRICTED
Companies can give loans, guarantee or securities to the following entities after
passing Special Resolution at a duly convened general meeting:

1. Any private company of which any such director is a director or member;

2. Any body corporate in which more than 25% of the total voting power exercised or
controlled by any such director, or by two or more such directors, together;
3. Any body corporate, the BoD, MD or manager, whereof is accustomed to act in
accordance with the directions or instructions of the BoD, or of any director or
directors, of the lending Company.

Earlier, Companies were prohibited to give loans, guarantee or securities to above

mentioned entities but after enactment of Companies (Amendment) Act, 2017,
Companies may grant loans, guarantees and securities to above entities, subject to
approval of the shareholders by passing a special resolution and on the condition
that such loans are utilized by the borrower for its principal business activities.
It is noted that the loan, guarantee and security provided under this section must be
within the limit of Section 186 of the Companies Act, 2013.
3) UNRESTRICTED OR EXEMPTED
The Provisions of Section 185 doesn’t apply to the following transactions:

1. Any loan given to a M.D or W.T.D 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 Special Resolution;
2. 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 rate of prevailing yield of one
year, three years, five years or ten years Government security closest to the tenor of
the loan; or
3. Any Loan/Guarantee or Security made by a holding company to its wholly owned
subsidiary Company.

PENAL PROVISIONS
If any loan is advanced or a guarantee or security is given or provided or utilized in
contravention of the provisions of this section,—

1. The company shall be punishable with fine between Rs. 5,00,000/- to Rs. 25,00,000/-
2. Every officer of the company who is in default shall be punishable with imprisonment
for a term which may extend to six months or with fine between Rs. 5,00,000/- to Rs.
25,00,000/- and
3. The director or the other person to whom any loan is advanced or guarantee or
security is given or provided in connection with any loan taken by him or the other
person, shall be punishable with imprisonment which may extend to six months or
with fine between Rs. 5,00,000/- to Rs. 25,00,000/- or with both.

Companies (Amendment) Act, 2017 seeks to make section 185 less stringent in
nature, by proposing that certain transactions be completely prohibited, while others
be subject to a special resolution. Another check and balance mechanism in which
the section provides that full disclosures relating to the amount of loan, purposes of
the loan, and other relevant details must be placed before the shareholders for their
informed consent. Thus, the Amendment Act of 2017 is partly prohibitive and partly
restrictive by nature. It strikes balance between both section 295 of the erstwhile
1956 Act and section 185 of the 2013 Act.
Tags: Companies Act, Companies Act 2013

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Author Bio
 Name: Dhaval Gusani

Qualification: CS

Company: DVG & Associates

Location: Mumbai, Maharashtra, IN

Member Since: 02 Feb 2018 | Total Posts: 42

CS Dhaval Gusani is a founder of DVG & Associates, Company Secretaries and Corporate Law
Professionals. He is a Commerce Graduate and an Associate Member of the Institute of
Company Secretaries of India (ICSI). He has cumulative experience of more than 3 years with
Listed Company, Chartered Acco View Full Profile

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2 Comments
1. Nalin Ganatra says:
As per Companies Amendment Act, 2017, entire Section 185 replaced by new section, therefore
question arise as to exemption which was available to private companies under the olde section
185, also continues to apply to new section 185 also?

Reply
 August 28, 2018 at 12:21 pm

1. Dhaval123 says:
Only Section 185 was replaced by Companies Amendment Act, 2017. Still, Exemption
Notification dated 5th June, 2015 still hold good because no corresponding notification or
circular regarding this was issued. This is the personal opinion of me and many other
professionals.

Reply

August 28, 2018 at 3:50 pm

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