Companies (Amendment) Act, 2017: Loans to Directors

[Utsav Mitra is a 3rd year, B.A. LLB Hons student at The National Law Institute University, Bhopal]

The granting of loans to, and security and guarantees provided on behalf of, directors and other interested parties of the directors is governed by section 185 of the Companies Act, 2013. However, this is a widely criticised section, being too prohibitive in nature as compared to the corresponding section 295 of the erstwhile Companies Act, 1956. Under section 295, companies could grant loans to, or provide security and guarantees on behalf of, directors or entities they are interested in. This was considered to be a partly restrictive section as the only requirement for the granting of such loans, or providing securities and guarantees, was the prior approval of the Central Government of India. This section also contained certain exceptions to the abovementioned criteria, which included the loans being granted, security or guarantee provided by private companies that were not the subsidiary of public companies, and banking companies whose principal business involved the granting of loans. Another important exception included the loans granted by a holding company on behalf of its subsidiary company, and also security and guarantees provided by a holding company on behalf of its subsidiary company, and not just wholly owned subsidiaries.

However, with the coming into force of Section 185 of the Companies Act, 2013, the status of loan to directors underwent a drastic change. Section 185 imposed an almost ‘blanket prohibition’ on both public and private companies by completely removing the option to obtain Central Government’s approval as proposed under section 295 of the 1956 Act. The intent behind the drafting of section 185 of the 2013 Act was to prevent the misappropriation of funds by directors who hold a fiduciary relationship with the company. While it could be argued that such strong measures were necessary to deter malpractices related to the availing of loans by directors or their interested parties, this resulted in the section being very stringent, and not in line with the rest of the 2013 Act, which relaxes norms and seeks to improve the ease of doing business in India. Moreover, the words “Save as otherwise provided in this Act’’, in the beginning of section 185 created an ambiguity. This would mean that if any other section of the Companies Act, 2013 allows the giving of loan to the person covered in this section 185, then it will be permitted. Thus, this defeated the purpose of section 185 in itself.

Hence, it was not surprising that this section drew widespread criticism, especially from the private sector. Allegations were also made that such harsh prohibitions on the granting of loans, and providing guarantees and securities, were not in consonance with company law in other jurisdictions, where such intra-corporate loans are permitted. It was at this juncture that, on April 1, 2014, an exemption to the granting of loans and providing securities and guarantees was allowed by way of the Companies (Meetings of Board and its Powers) Rules, 2014. Thereafter, by way of a notification dated June 5, 2015, the Ministry of Corporate Affairs (MCA) exempted private companies from section 185 subject to three conditions. First, there should be no investment in the concerned company from any other body corporate; secondly, the company should not have any borrowings from banks, financial institutions and other body corporates equal to or more than twice its paid up share capital, or rupees 50 crores, whichever is lower; and finally, that there should be no subsisting default at the time of making such transaction, and that the company should have the capability to pay off the loan. While this notification did provide a temporary relief of sorts for private companies, the three conditions which were required to be met in this notification provided for quite a high threshold. Although an exemption was indeed carved out for private companies, this notification does not really relax the norms.

It is in light of this situation that the Companies (Amendment) Act, 2017 seeks to make section 185 less stringent in nature, by proposing that certain transactions be completely prohibited, while others be subject to a special resolution passed at a general meeting, and that the loan be used for the principal business activity by the subsidiary company (as was already the condition previously). Transactions involving loans, guarantees and securities provided to a director of a company or the director of its holding company, or any partner or relative of such director, and any firm in which the director or his relative is a partner, is prohibited. However, under the proposed amendment, transactions with a private company in which a director of the company providing loans, guarantee or security is also a director or member is allowed subject to a special resolution at the general meeting. Another check and balance mechanism which the section provides is that full disclosures relating to the amount of loan, purposes of the loan, and other relevant details must be placed before the shareholders.

Thus, this amendment seeks to grant the final say to the shareholders, and is drafted with the intention that the law should not restrict the granting of loans where the shareholders themselves approve of the same. However, approval from shareholders will not be required where a loan or guarantee is given or where a security has been provided by a company to its wholly owned subsidiary company, joint venture company, or acquisition is made by a holding company, by way of subscription, purchase or otherwise of, the securities of its wholly owned subsidiary company. This will clearly increase the investing power of the company, and help with the ease of doing business. The limit to the loan amount permitted is that no loan should exceed 60% of the company’s paid up share capital, free reserves, and securities premium account, or 100%of its free reserves and securities premium account, whichever is more. If it does exceed the aforesaid amount, a special resolution will be required for the same.

Moreover, under the existing 2013 Act, 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. The Amendment proposes to provide for the interest to be at least at the rate of the prevailing yield of one, three, five, or ten years government security closest to the tenor of the loan, taking into consideration section 186 of the 2013 Act. Finally, to prevent any further ambiguity from arising, the amendment proposes to delete already mentioned non-obstante clause in section 185, with the words ‘Save as otherwise provided in this Act’.  

Thus, the 2017 Amendment is partly prohibitive and partly restrictive by nature. It seeks to arrive at a middle ground, between both section 295 of the erstwhile 1956 Act, and section 185 of the 2013 Act. The amendment also strikes a fair balance by granting the final say to shareholders, and also mandates that full disclosures must be made to them before a loan is sanctioned. This amendment relaxes the norms to a certain extent, and will be beneficial especially to the private sector. Moreover, it is also in line with the ease of doing business in India, being somewhat more liberal in nature.

– Utsav Mitra

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