Loan to directors, etc. – as contained under section 185 of the Companies Act, 2013 is reproduced below:

185. (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) If any loan is advanced or a guarantee or security is given or provided in contravention of the provisions of sub-section (1), the company shall be punishable with fine which shall not be less than five lakh rupees but which may extend to twenty-five lakh rupees, and 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 which shall not be less than five lakh rupees but which may extend to twenty-five lakh rupees, or with both.

This provision is covered by CHAPTER XII on MEETINGS OF BOARD AND ITS POWERS [Sections 173 to 195]

Section 185 is brought to force with effect from September 12, 2013.

For this chapter, the Companies (Meetings of Board and its Powers) Rules, 2014 (‘the Rules’) are notified with effect from April 01, 2014.

Rule 10 of the Rules is relevant.

Corresponding provisions of the Companies Act, 1956:
Section 295

Corresponding provisions of the English Companies Act, 2006:
Sections 197 to 214

Applicability:
This section is applicable to all companies.

What is the difference from the Companies Act, 1956:
For private companies, provisions of section 185 has become applicable, while provision of section 295 was not applicable under 1956 Act. And since the exemptions of erstwhile section 295 are not available, even a private company (which is not a subsidiary of a public company) cannot give loan, guarantee or provide security to its director(s) or “other person in which a director is interested”.

Comments
Section 185 is subject to ‘otherwise’ provided under the Companies Act, 2013. Meaning, if other provisions of the Companies Act, 2013 permits giving of loans, providing security or giving guarantee then the said provision shall prevail and provisions of section 185 shall not come in the way.

Section 185 of the Companies Act, 2013 corresponds to section 295 of the Companies Act 1956. Section 185 prohibits giving of loan to directors and other persons in which director of lending company is interested except, inter alia, where lending is done in ordinary course of business with rate of interest not less than bank rate declared by RBI.

Whether section 186 prevails over section 185?
A view expressed by some that provision of section 186 of the Companies Act, 2013 permits giving of loan, guarantee or security (similar to section 372A of the 1956 Act) shall prevail over section 185. However, this is doubtful.

Let’s consider the argument in favour and against to interpretation that the provision of section 186 overrides section 185.

Those who suggests that section 185 overrides section 186 strongly rely on the premise that section 185 starts with the wordings “save as otherwise provided in this Act” and since section 186 permits giving of loan etc. to any person, which includes directors etc. albeit within limits and subject to several conditions. Thus, according to this argument, loans etc. under section 185 shall be subject to overall limits and compliance of requirements of section 186 of the Act.

[highlight]The other view (also my view) [/highlight]is that such an interpretation suffers from deficiency that such interpretation renders section 185 redundant. And it is well settled principle of law that any interpretation which renders provision redundant or otiose should be avoided. ((In High Court of Gujarat and another vs. Gujarat Kishan Mazdoor Panchayat and others : (2003) 4 SCC 712))

Further, section 186 does not provide “otherwise” or contrary to section 185 for lending etc. to director or any other persons in whom a director is interested. Section 186 only provides for general lending etc. and not for specific lending to director or other person in whom a director is interested.

Section 185 do not apply to loan by holding company to wholly owned subsidiary and guarantee or security for loan to subsidiary
With effect from April 01, 2014, any loan made by a holding company to its wholly owned subsidiary company is exempted from section 185 if loan is utilised by the subsidiary company for its principle business activities.

With effect from April 01, 2014, any guarantee given or security provided by a holding company in respect of [highlight]any loan[/highlight] made to its wholly owned subsidiary company is exempted from section 185 if such loan are utilised by the subsidiary company for its principle business activities.((Rule 10(1) read with proviso, of the Companies (Meetings of Board and its Powers) Rules, 2014 ))

With effect from April 01, 2014, any guarantee given or security provided by a holding company in respect of [highlight]loan made by any bank or financial institution[/highlight] to its subsidiary company is exempted from section 185, if such loan are utilised by the subsidiary company for its principle business activities. ((Rule 10(2) read with proviso, of the Companies (Meetings of Board and its Powers) Rules, 2014 ))

Where approval under section 372A of the Companies Act 1956 is taken for making investment in a subsidiary / joint venture but the actual investment (funds outflow) is to be made after few months – as approval of RBI needs to be obtained. And in the mean time, if section 185 of 2013 Act is brought to force, whether approval under section 372A will hold good or not?

It is relevant to note provisions of section 465(2)(b) of the Companies Act, 2013.

Section 465 (1), inter alia, states that the Companies Act, 1956 and the Registration of Companies (Sikkim) Act, 1961 shall stand repealed.
Section 465 (2) Notwithstanding the repeal under sub-section (1) of the repealed enactments,-
(a) anything done or any action taken or purported to have been done or taken,
including any rule, notification, inspection, order or notice made or issued or any
appointment or declaration made or any operation undertaken or any direction given
or any proceeding taken or any penalty, punishment, forfeiture or fine imposed under
the repealed enactments shall, insofar as it is not inconsistent with the provisions of
this Act, be deemed to have been done or taken under the corresponding provisions of
this Act;
(b) subject to the provisions of clause (a), any order, rule, notification, regulation,
appointment, conveyance, mortgage, deed, document or agreement made, fee directed,
resolution passed, direction given, proceeding taken, instrument executed or issued,
or thing done under or in pursuance of any repealed enactment shall, if in force at the
commencement of this Act, continue to be in force, and shall have effect as if made,
directed, passed, given, taken, executed, issued or done under or in pursuance of this
Act;
…..

Section 465 is not yet brought to force. However, section 465 saves actions under repealed enactments only to the extent the same is not contrary to provisions of the Companies Act, 2013.

Circular on section 185 of the Companies Act, 2013 and section 372A of the 1956 Act

MCA has issued a circular dated 14 February, 2014, to clarify applicability of Section 185 of the Companies Act, 2013 and section 372A of the Companies Act, 1956. For copy of circular, click here. Though wordings of the circular are not proper, it conveys the following:

Giving of loan, guarantee or providing security or making investments is governed by section 372A of the Companies Act, 1956. Said provision corresponds to section 186 of the Companies Act 2013.

[pullquote-left]Section 186 is brought to force from April 01, 2014 and the Circular relates to period from September 12, 2103 to April 01, 2014.[/pullquote-left]

Giving of loan, guarantee or providing security by a company to its wholly owned subsidiary is exempt under section 372A(8)(d) of the 1956 Act and will continue to remain exempted until section 186 of 2013 Act is brought to force. However, circular has put a condition that such transaction will be exempt only if loan obtained by wholly owned subsidiary is utilised exclusively for its principal business activities.

Our comment on the circular: There is nothing new in this clarification. Rather extra condition specified in the circular about utilisation of money by wholly owned subsidiary lacks legal support as same or similar condition is not present in Section 372A of the Companies Act 1956.

Normally, lending by a holding company to its wholly owned subsidiary cannot be treated as lending to its director or other person in which directors of lending company are interested. However, in the circumstances stated in explanation (e) to sub-section (1) of section 185 of 2013 Act, a director of holding company is deemed to be interested where lending is done by holding company to its wholly owned subsidiary company. In our understanding, MCA might have intended to clarify that even in such a situation (where explanation (e) of section 185(1) is attracted), transaction would not hit by prohibition of section 185 of 2013 Act if loan obtained by wholly owned subsidiary is utilised exclusively for its principal business activities.

Penalty:
1. The company shall be punishable with fine which shall not be less than five lakh rupees but which may extend to twenty-five lakh rupees.
2. The director or the other person [highlight]to whom any loan is advanced or guarantee or security is given or provided[/highlight] 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 which shall not be less than five lakh rupees but which may extend to twenty-five lakh rupees, or with both.

Nature of offence:
Since officers of company may be punished with imprisonment, it is necessary to decide nature of offence.
And offence is punishable with imprisonment for a term not exceeding two years, it is treated as summons case under section 2(w) of the Code of Criminal Procedure Code, 1973. In summons case, no charge needs to be framed only the particulars of the offence needs to be conveyed to the accused. And the complainant may, with the permission of the court, withdraw the complaint against the accused. Accused gets only one opportunity to cross-examine the prosecution witness.

As violation of the section 185 is not covered under sub-section (6) of section 212, it is non-cognizable offence as provided in section 439.
Court to take cognizance of offence of section 185 only upon complaint filed by either:
a) shareholders of the company; or
b) the Registrar of Companies; or
c) a person authorised by the Central Government.

And offence shall be triable only by a special court, as provided under clause (a) of sub-section (1) of section 436. Special Court (is equivalent of Sessions Court) may try, in the same trial, offence under the Companies Act 2013 as well as other offence triable under the Code Of Criminal Procedure, 1973.

Adjudication:
Under Section 454, the officer appointed by the Central Government, not below the rank of Registrar of Companies, may adjudicate and impose monetary penalty for violation of this section, where it decides that no prosecution be launched. However, before imposing penalty, an opportunity of hearing shall be given to the Company and its officers. For violation of section 185, the company is punishable with fine only. And hence adjudication proceedings under section 454 becomes applicable.

Compounding:
It may be noted that under section 441, where offence is punishable with fine only, the same may be compounded by the National Company Law Tribunal or where the fine does not exceed Rs.5,00,000/- by the Regional Director or any other officer authorised by the Central Government.
Only company may apply for compounding for violation of section 185. Since directors and officers of company who is in default are punishable with fine or imprisonment or both, they cannot avail compounding mechanism to settle the contravention.