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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