Section 185 & how ill-drafted, ill-implemented provisions cause serious consequences

The manner in which
the Companies Act, 2013, is being implemented is causing ongoing grief to
numerous companies. As the financial year comes to a close, several violations
with potentially serious consequences are being noticed by auditors and others.
The deservedly much maligned Section 185 is one example that is focus of this
post (several earlier posts have also discussed many issues). Section 185 makes
an almost absolute and comprehensive prohibition, with few exceptions, of loans
to persons in which directors have interest. While widely held listed companies
too suffer from the broad provisions, it hits even more harshly closely held
companies who tend to have regular transactions in the group almost as running
current accounts.

To give a specific situation,
Section 185 prohibits giving of loans to companies within the same group even
if the borrower private limited company has one common director. For most
closely held groups, this would practically mean all companies in the group. It
is routine for companies to have running current accounts with group companies
to manage liquidity without charging interest. Section 185 prohibits this
almost totally.

This was not so
under the Companies Act, 1956 and the few instances where there were
restrictions, internal approvals usually resolved the issue. Section 185,
however, has no method to permit it by approval of the board or shareholders or
even Central Government. Granting of such loans is a violation that attracts
fine/imprisonment.

Looking at the provision
even more closely reveals the inherent complexities that arise when a law is in
transition, which gets worsened when the provisions are implemented ambiguously
on one hand and then “clarified” to create fresh creases. While bringing
Section 185 into effect, the Central Government issued a circular
stating that “corresponding” provisions were “repealed”. This created an
ambiguity as to which provisions are repealed.

Then the Central
Government compounds matter further by further “clarifying”,
taking into account representations made regarding Section 185, that Section
372A
will remain in force till Section
186
is notified. It may be recollected that, arguably, Section 185 and
Section 372A operate in different fields for different purposes. And while
linking Section 372A with Section 186 does make sense, giving the clarification
in context of section 185 creates further confusion. Yet another “clarification”
regarding Section 185/372A in light of guarantees to subsidiary companies
creates more confusion.

The result is that companies
are queuing up at offices of auditors and legal advisors to reassure that the
audit reports will not be splashed with red and penal consequences are, if
possible, avoided. Resolving such issues is not easy in many cases and at times
create complications of income-tax, which can be costly. Needless but
considerable energy is being wasted on issues as to legal standing of a
notification/circular, powers of clarification, meaning in law of terms used,
etc. 

Considering the elections, one wonders whether
there will be any resolution of this in the near horizon.

About the author

CA Jayant Thakur

2 comments

  • Reaction (rooted in common sense):

    While ‘ill- drafting’ is the root cause, ‘ill-implementation’ (or authority’s inherent inability to implement or enforce itself) is the necessarily unavoidable / inevitable effect /consequence. To put it with a different stroke, ‘ill- drafted’ implicitly means many things; loopholes, lacunae, incomprehensibility, complexity, so on. More often than not, going by wisdom mostly gathered only in hindsight, one is invariably left wildly wondering, musing, perplexed, -are not all or most of such deficiencies, not merely in drafting , being the initial stage, so also in all the subsequent stages of bureaucratic /legislative procedure in place – to the end of final enactment /nod or assent, mainly attributable to an oversight, deliberately or unwittingly so. It goes without having to add, – any such deficiency has the necessary potential to serve as a source of provocation for the vested interests, to try and avoid enforcement to the extent possible.
    Perhaps, legal pundits, having the unique privilege of firsthand / field experience, may be better equipped to firstly edit, then elaborate or dilate, the foregoing sporadic reflections!

  • sec 185 is simply monstrous devoid of application of mind with simple one goal to crush the corporate body and all the professionals getting work to haaandle them. Message is clear -do not work under a pvt ltd co but closure has many implications in terms of stamp duty on its properties ,their valuations ,carry forward of losses/depreciaion/other statutory allowances, permissions in the backward areas for continuation of sales tax/excise benefits. The section did not apply earlier to private ltd co;su/s 295 under the old Act which needs to be ressstored to enable pvt ltd co;s to continue in peace . There can be restrictions in terms of closely held co;s that they can deal with only co;s wherein they are entrenched with their own folks only and not the outsiders as the intent is to protect outsiders/public under the garb of a shareholderor otherwise
    thx
    keshav garg FCA

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