Guest Post: Guarantee Against Loan from Banks and Financial Institutions

[The following post is
contributed by Abhishek Bansal and Stuti Bansal, Corporate
Professionals, Advisors & Advocates. The authors can be reached at abhishek@indiacp.com and stuti@indiacp.com respectively]
Recently, India
saw the enactment of the Companies Act, 2013 (“Act”), replacing the Companies
Act, 1956, which governed the incorporation, functioning, transactions and
other activities of the companies in India. Witnessing uproar from corporate
India, much discussion was seen in the arena of loans and guarantees,
e-commerce business, and corporate social responsibility amongst others. This post,
while examining the provisions of section 185 of the new Act, throws light
specifically on guarantees against loans from banks and financial institutions.
Some background
The provisions of
section 185 of the Act, as earlier notified, for the most part, barred granting
of any loans, giving of guarantee or providing of any security to the directors
or any other person in whom the director is interested; otherwise than for
given exemptions. In contrast to the counterpart provisions under the Act of
1956, the section withdrew exemptions with respect to such transactions among
private limited companies and transactions between holding and subsidiary
companies and also the provision for obtaining approval of the Central
Government.
Many corporates filed
representations before the Ministry of Corporate Affairs (“Ministry”) requiring
clarification on the intent of Section 185 and for making the provisions
industry friendly, although the Ministry seemed clear on its intent, citing
that it had taken stringent view having regard to the flow of funds from the
company to its directors or other person in whom the director is interested. The Companies (Meetings of Board and its
Powers) Rules, 2014, legislated under the section, provide for the following exemptions:
– Transactions amongst
holding and wholly owned subsidiary company with regard to:
– 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 and
– Transactions amongst
holding and subsidiary company
– 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; wherein such loans
are utilized by the subsidiary Company for its principal business activities.
Section 185: A brief discussion
The provisions of
Section 185 of Chapter XII of the Act of 2013, which corresponds to Section 295
of the Companies Act, 1956 provides that:
– No company
shall, directly or indirectly, advance any loanincluding 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.
– Exemptions under the
section relate to:-
– the giving of any loan
to a managing or whole-time director if it is given 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; or
– 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.
– Here,
the expression “to any other person in
whom director is interested
” means—
            – 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 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; and
           
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.
It may
be said in terms of Section 185 of the Act that even a promoter company cannot
give loan or guarantee against the loan taken by such company, where the
directors of such company and its promoter company are common or if there is
any other person in such company in whom the director(s) of the promoter
company is/are interested. The only exception is given in favour of the holding
company which can give guarantee in respect of the loan made by any Bank or
Financial Institution only and not from any other entity
and the loan
amount is utilized by the subsidiary for its business activities. In other
words, the said exemption would be available if any only if the loan is made by
a bank of financial institution and not by any other body corporate or
individual. Thus, understanding the meaning of a ‘bank and financial
institution’ becomes crucial here.
Meaning
of “Bank”
A “Banking
Company” is defined under the Companies Act, 2013, as a Banking Company as defined in clause (c) of Section 5 of Banking
Regulation Act 1949
.
Section
5(c) of Banking Regulation Act, 1949 defines ‘Banking Company’ as any company which transacts the business of
banking in India
.
Further,
in terms of Section 7(1) of the Banking Regulation Act, 1949, no company other
than a banking company shall use a part of its name or in connection with its
business any of the words “bank”, “banker” or
“banking” and no company shall carry on the business of banking in
India unless it uses a part of its name at least one of such words.
Meaning
of “Financial Institution”
As per
the Companies Act, 2013, “financial institution” includes a scheduled bank
and any other financial institution defined or notified under the RBI
Act, 1934 (2 of 1934). A list of scheduled banks has been provided under Schedule
II of the RBI Act, 1934.
Further,
“Financial Institution” has been defined under section 45I (c) of RBI Act, 1934
as any non- banking institution.
Non-Banking Institution” means a
company, corporation or cooperative society under section 45I(e) of RBI
Act, 1934
. “Corporation” under Section 45I(b) of RBI Act means, a corporation incorporated by an Act of
any legislature
.
Thus,
it may be said that where the promoter company of a company is not a holding
company of such company, it cannot give guarantee for the loan taken by such
company. However, if the promoter company of a company is a holding company of
such company, it may give guarantee for the loan taken from a bank and even a
foreign bank provided such foreign bank falls under schedule II of the RBI Act,
1934. However, this must not be the intention of law, since the loan from any
of the foreign banks is coming through the regulated channel. For such cases, representations
may be filed before the Ministry of Corporate Affairs seeking clarification.
It is
interesting to note that, and also worthwhile to keep a note that, in the event
of default/ non-compliance, not only the provider of guarantee but also such
company (borrower) who is taking loan is liable for penal provisions under
sub-section (2) of Section 185 of the Act.


Abhishek Bansal & Stuti Bansal

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

Add comment

Subscribe to Blog via Email

Enter your email address to subscribe to this blog and receive notifications of new posts by email.

Recent Posts

Topics

Recent Comments

Archives

web analytics