The Companies Amendment Bill, 2017: Proposed Changes to Section 185

[Guest post by Amitabh Robin Singh, who is a corporate lawyer practising in
Mumbai]
With the Companies
Amendment Bill, 2017
(“Amendment“)
being passed by the Lok Sabha and sent to the Rajya Sabha, it would be pertinent
to discuss one of the major changes proposed by the Amendment. The Amendment
proposes to completely replace Section 185 of the Companies Act, 2013 (“2013 Act“) which governs loans granted to, and security and
guarantees provided on behalf of, directors and other parties in whom the
directors are interested.
This provision is particularly important for companies which
are part of corporate groups, which may either grant inter-corporate loans to
support associated companies, or guarantee payment obligations of, or provide
assets as security to assist, associated companies in raising finance.
At this point, it would be interesting to note the manner in
which this provision has been flowing through various regimes under both the
Companies Act, 1956 (“1956
Act”
) and the 2013 Act.
Section 295 of the 1956 Act was the corresponding provision
to Section 185 of the 2013 Act. Under the 1956 Act, companies could grant loans
to, or provide loans or security on behalf of directors or entities they are
interested in,[1] but
only if the prior approval of the Central Government was obtained.
However, there were wholesale exemptions from the provisions
mentioned above. Two such exemptions were for loans granted, security or
guarantee provided by private companies (not being a subsidiary of a public
company) and by banking companies. Further exemptions were provided for a loan
made by a holding company to its subsidiary, and security and guarantees
provided by a holding company on behalf of its subsidiary company. It may be
noted that these exemptions were for subsidiaries and not merely wholly owned
subsidiaries.
Section 185 of the 2013
Act, which was brought into force on 12 September 2013, was more restrictive than
Section 295 of the 1956 Act. It omitted the exemption which was granted to
private companies under the 1956 Act and even removed the option of obtaining
government approval to undertake such transactions, which resulted in an almost
blanket prohibition. However, an exemption for granting loans and providing guarantees
and security on behalf of wholly owned subsidiaries was inserted by way of the Companies
(Meetings of Board and its Powers) Rules, 2014
which came into force on 1
April 2014. It may be noted, however, that these rules granted exemptions only for
a “wholly owned subsidiary
and not to a “subsidiary“. The
only exemption granted to a “subsidiary
(not being wholly owned) at that point in time was for providing guarantees or
security for a loan granted by a bank
or financial institution
. These exemptions for subsidiaries were
subject to the condition that such loans made under the exemptions were utilised
for the subsidiary’s principal business activities. However, the 2013 Act did
add two separate new exemptions: one for loans granted to a managing or
whole-time director (subject to certain conditions) and to a “a company which in the ordinary course of
its business provides
loans
or gives guarantees or securities for the due repayment of any loan.
The two exemptions relating to subsidiaries discussed above
that were provided through rules were subsequently incorporated (with mutatis mutandis changes) into the 2013
Act by way of the Companies Amendment Act, 2015 which amended Section 185 to
that effect.
Next came a notification
issued by the Ministry of Corporate Affairs dated 5 June 2015 which exempted
private companies from certain provisions of the 2013 Act. While an exemption
was provided from the provisions of Section 185, it was subject to fulfilment
of three conditions. First, the relevant company should not have had investment
from any other body corporate; second, the company should not have had borrowings
from banks, financial institutions and other bodies corporate equal to or more
than twice its paid-up share capital or rupees 50 crores (whichever among the
two is lower); and third, there should be no subsisting default in servicing
such borrowings on the date of making transactions under Section 185. While
this exemption was welcomed for facilitating the ease of inter-group financing,
in many cases, the conditions required to be satisfied proved to be stumbling
blocks.
Now, the Amendment proposes to bifurcate the regulatory
framework into two categories: the first contemplating certain transactions
which are prohibited and another consisting of transactions which may be
permitted, subject to approval of the shareholders by way of a special
resolution passed at a general meeting. The first, i.e., prohibited basket
consists of loans, guarantees or security provided to a director of the company
or a director of its holding company or any partner or relative of such
director, and any firm in which any such director or his relative is a partner.
The second basket (which mandates passing a special resolution) contemplates transactions
with entities in whom the director is interested.[2]
These include transactions with a
private company in which a director of the company providing loans, guarantee
or security is also a director or member, which should be a relief for many
companies. A further condition on the second basket is that the explanatory
statement for the relevant general meeting is required to make detailed
disclosures regarding the proposed transaction. Also, the requirement for the
loan to be utilised for the borrowing company’s
principal business activities has been retained. Both
baskets have similar exemptions as were available under the existing position
of the 2013 Act. One difference in the exemptions is in the provision relating
to the “ordinary course of business
where under the existing position of the 2013 Act such exemption could be
availed of if the interest charged on the loans granted was at least equal to
the bank rate declared by the Reserve Bank of India. Now this provision has
been amended to provide for the interest to be at least at
the
rate of prevailing yield of one year, three year, five year or ten year Government
security closest to the tenor of the loan. This change brings Section 185 in
line with Section 186 of the 2013 Act which governs loans, investments,
guarantees and security provided by companies.
Hence, as it can be seen, the provisions regulating providing
of loans, guarantees or security or assisting in availing of such loans,
guarantees or security to associated entities have moved from being somewhat
regulated under the 1956 Act, to almost straitjacketed under the 2013 Act (in
its initial form) and now are proposed to be liberalized to a certain extent
under the Amendment.
Amitabh Robin Singh

[1] This
definition has remained constant between the 1956 Act and the 2013 Act (prior
to the Amendment) and is as follows:

(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.
Now the
amendment proposes to retain only clause (c), (d) and (e) above, as discussed
further below.

[2] The definition of
entities in whom the director is interested is proposed to be reduced to:

(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 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

(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 Board, or of any director
or directors, of the lending company.

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.

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