Loans to Directors: Proposed Amendment in the Definition in Section 185

Loans to Directors: Upon the enactment of the Companies Act, 2013 (“the Act”), 98 sections were notified with effect from 30th August, 2013. From 30th August, 2013 to 31st March, 2014, one of the most talked about provisions of the Act was “Loans to Director, etc.” [Section 185]. This was evident as the Ministry of Corporate Affairs (“MCA”) had to swiftly come out with clarification to deal with this section in February 2014 itself. The said section prohibited the companies to give loan to its Directors and to any other person in whom director is interested and was more stringent in comparison to the provisions of sections 295 and 296 of the Companies Act, 1956

Loans to Directors

In order to set right the deficiencies and problem areas noticed in the Companies Act 2013 during its operation since August 2013, the Government came out with the Companies Amendment Bill, 2016. This Bill which proposes several amendments to the principal Act is yet to be passed. One important proposal relates to loans to directors. This brief discussion throws more light on this proposal.

Nonetheless, upon notification of the Companies (Meetings of Board and its Powers) Rules, 2014, the companies got some relief as under:

(i) loan advanced by a holding company to its wholly owned subsidiary (WOS) or any guarantee given or security provided by a holding company in respect of any loan made to its WOS; and

(ii) guarantee given or security provided by a holding company in respect of loan made by any bank or financial institution to its subsidiary company were exempted from the requirements of section 185 of the Act.

The MCA, vide notification dated 5th June, 2015, notified that section 185 of the Act shall not apply to private companies:

• (a) in whose share capital no other body corporate has invested any money;
• (b) if the borrowing of such a company banks or financial institutions or any other body corporate is less than twice of its paid up share capital or Rs.50 crore whichever is less; and
• (c) such a company has no default in repayment of such borrowing at the time of making transaction under the said section.

The Companies (Amendment) Bill, 2016 (the Bill) proposes to substitute the entire section 185 of the Act with a new section which will have wider implications.

In this Article, Author intends to deliberate critical analysis of proposed amendments in Section 185 as summarized below

IMPACT OF OMISSION OF THE TERM ‘SAVE AS OTHERWISE PROVIDED IN THIS ACT’

The term “Save as otherwise provided in this Act” means “except to the extent as oppositely provided” or “protected unless said differently”. The Bill proposes to omit the said term from the Section 185 of the Act.

The present provisions of Section 185 of the Act prohibit the company to give loan or to provide guarantee, etc. to certain persons. However, if the same is permitted under Section 186 of the Act, then the requirements laid down under this section need to be followed as section 185 starts with the term ‘‘Save as otherwise provided in this Act”. This is in line with the general rules of Interpretation [i.e. Rule of harmonious construction which means law should be interpreted by taking into consideration all

The omission of the term “Save as otherwise provided in this Act” is also likely to have an impact on the exemption provided under subsection (11) of Section 186 as the said sub-section starts with the term “Nothing contained in this section, ………, shall apply ……….”.

the relevant provisions].

This effectively means that with the proposed amendments, both sections 185 and 186 need to be read separately and hence the requirements laid down in both these sections need to be followed concurrently.

The omission of the term “Save as otherwise provided in this Act” is also likely to have an impact on the exemption provided under sub-section (11) of Section 186 as the said sub-section starts with the term “Nothing contained in this section, ………, shall apply ……….”. This means the other provisions of the Act shall apply i.e. section 185 which proposes that no loan, etc. can be given unless approval of the Shareholders is obtained by way of Special resolution and applicable interest is charged on such a loan advanced. This appears to be more coherent also as to why the approval of the Shareholders should not be sought for matters relating to giving loan, etc. by banking/ insurance/ housing finance companies or companies engaged in providing infrastructural facilities, etc.

As the provisions of section 186, except sub-section (1), are not applicable to banking/ insurance/ housing finance companies or companies engaged in providing infrastructural facilities etc., this exemption places such companies in an advantageous position as compared to the companies engaged in other businesses. As prescribed in Schedule VI of Act, the definition of “companies engaged in providing infrastructural facilities” is very wide and covers a large chunk of projects or activities

It is also to be noted that the removal of the words “Save as otherwise provided in this Act” from section 185 of the Act will have a major bearing on “companies engaged in providing infrastructural facilities” as such companies will also be required to ensure compliances such as seeking approval of the Shareholders, charging interest etc. on loan etc. given to subsidiaries/ other companies. The proposed omission also places all the companies (except private companies which are exempted vide notification dated 5th June, 2015) on equal footing. Further, “companies engaged in providing infrastructural facilities” without any concrete rationale enjoy the liberty of not disclosing the details of loan given, etc. in their financial statements.

PROPOSED AMENDMENT IN THE DEFINITION IN SECTION 185

The proposed definition ‘to any other person in whom director is interested’ is reproduced hereunder:

• (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.

The Bill proposes to omit the following two aspects from the existing definition ‘to any other person in whom director is interested’:

• i. any director of the lending company, or of a company which is its holding company or any partner or relative of any such director; and
• ii. any firm in which any such director or relative is a partner.

The above aspects at (i) and (ii) are now proposed to be included in sub-section (1) of section 185 of the Act. With the amendments, companies would be prohibited to give loan, etc. only to its directors or directors of their holding company, etc. as mentioned in (i) and (ii) above. Nonetheless, there is a big respite for the companies as they would be permitted to give loan etc. to “any person whom any of the director of the Company is interested” [i.e. to all persons mentioned in (a), (b) and (c) to the proposed definition] subject to the following:

• Approval of the Shareholders through a special resolution ; and
• interest on such loan etc. is charged which shall not be less than the rate of prevailing yield of Government security closed to the tenor of the loan.

Both these requirements of seeking approval of Shareholders and charging of interest are intended for ensuring better corporate governance.

UNIFORMITY IN CHARGING OF INTEREST

Section 185 states that the company which in the ordinary course of its business provides loans or give guarantee etc. for due repayment of loan shall charge interest not less than the bank rate declared by the Reserve Bank of India (‘RBI’) whereas as per Section 186, no loan can be given at rate less than the rate of prevailing yield on one year, three year, five year or ten year government security closed to the tenor of the loan.

The proposed amendment in Section 185 of the Act (i.e. replacing the words “interest is charged at a rate not less than bank rate declared by the RBI” with “interest is charged at a rate not less than the rate of prevailing yield of one year, three year, five year or ten year Government security closes to the tenor of the loan”) brings uniformity with regard to charging of interest on the loan advanced which was desirable.

LOAN TO SUBSIDIARY OTHER THAN WOS

Pursuant to Section 186 read with relevant Rules, a company can give loan to its WOS provided that interest is charged on such loan. However, due to restrictive provisions of section 185 companies are apprehensive to give loan to non WOS, even to a 99.99% subsidiary company, as there were chances of such transaction(s) getting hit by clauses (d) and (e) of the existing definition “to any other person in whom director is interested” of the Act.

The proposed amendment would enable the companies to give loan to its non WOS also. The only requirement would be to seek approval of the Shareholders by giving full justification of such loan, etc. in the Explanatory Statement to the notice of the general meeting and charging the requisite interest on such loan. An ease in giving loan by the Company to its non WOS is definitely needed due to the fact that if the parent would be prohibited to support its non WOS then it is not pragmatic to expect Banks/ Financial Institutions, etc. to fund them

It would be apt, if MCA also prescribes that the details of such loan etc. given in accordance with Section 185 also should be disclosed in the financial statements of the company to bring uniformity in line with requirement of Section 186. Further, listed companies are mandatorily required to seek approval under section 186 through postal ballot as per the provisions of the Act. Similarly, approval of Shareholders under section 185 should also be mandated to be sought through Postal Ballot.

CONCLUSION

“Well begun is half done”–Aristotle Under the existing provisions of the Act, there is a restriction on companies giving loan etc. “to any other person in whom director is interested” as it was felt that in such transactions the funds might be misused by the company.

The Companies (Amendment) Bill, 2016 proposes to remove certain restrictions on loans to directors etc.. At the same time, the Government has ensured that approval of the Shareholders is sought; and interest at the rate prevailing in respect of government securities is charged on such loan transactions. These are indeed laudable amendments. This will also ensure that the loan transactions are on arms length basis and at the same time better corporate governance practices are followed.

Above all, the proposed amendments are in consonance with the tenet of ‘Minimum Government Maximum Governance’ under the current ‘Ease of doing business’ concept.

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