Directors of the company or partner of such Director, or any firm wherein the Director or relative is a partner are the only parties to whom the limitations on loans, advances, including other financial transactions, apply under Section 185 of Companies Act 2013.
There is always a nagging suspicion of nepotism and favoritism bred in everyone when it comes to granting loans, guarantees, or security to Directors or parties in which the Directors are interested. Suppose such a transaction is easily carried out. In that case, it encourages unfair advantages and malpractices among the individuals with a fiduciary duty towards the company and all the parties interested in it. Section 185 of the Companies Act 2013 has been added to prevent higher management in the company from abusing their authority. This Section classifies such transactions as prohibitive, conditional, and exempted to accomplish the dual goals of keeping a check on such transactions and making it easier to conduct business.
This article will assist you in learning about the Companies Act 2013 requirements pertaining to loans to Directors; also, it answers many important questions like why Section 185 of Companies Act 2013 was enacted, the situation before enacting Section 185 in the Companies Act and what is the present situation after enacting Section 185 of the Act, are there any penalties mentioned under the same section, whether any exceptions do exist or not.
Loans to Directors are covered by Section 185 of the 2013 Companies Act. Loan to Director: According to Section 185(1) of the Act, a company may not: directly or indirectly make an advance loan, make an advance loan that is expressed by a book debt, give a guarantee or security in conjunction with any borrowed money
- To its Director
- to its holding company’s Directors
- To Directors’ Relatives
- To the business partner, if the Director is a partner
- To the Partnership Firm in which the company’s Director or holding company is a Partner.
Why was Section 185 of the Companies Act 2013 enacted?
Public firms were allowed to offer loans, guarantees, and securities when the Companies Act of 1956 was in effect as long as they first had approval from the Central Government to do so. The businesses used to engage in a practice of borrowing money and dispersing it through inter-corporate loans to subsidiaries and other affiliated businesses. However, the holding firms used to back off when adhering to the loan agreement’s provisions, placing the subsidiary in the lurch. Section 185 of the Companies Act, 2013 came into force to halt the abuse of the subsidiaries.
Section 185: Before amendment and after the amendment
The original Section 185 forbade the firms from making any loans or providing security or guarantees for loans taken by the company’s Directors or anybody else in whom the Directors have an interest. Only companies or beneficiaries who had obtained such a loan, security, and assurance were subject to fines if found to be in breach.
The Companies (Amendment) Act of 2017 made the following changes to Section 185:
- Restricts the ban on loans, advances, and other financial transactions to the Director of the company or their parent company, any partners of such Directors, any partners of such Directors, or any firms in which such Directors or relatives are partners.
- The passage of a special resolution by the company at a general meeting (approval of a minimum of 75% of the members is necessary) authorises the business to lend money to, guarantee, or provide security for any person or entity in which any of the Directors has an interest. – The borrowing company’s use of loans must only be for its main business purposes.
- The Act’s Section 185(4) penalty measures now apply to an officer who is in breach of the corporation adding to the Company.
Are there any exceptions available to this rule?
Yes, The Act’s Section 185(3) outlines exceptions to the limitations on the company’s ability to provide loans. Exceptions are as follows.
- Companies that provide business loans to Managing Directors or full-time Directors are required to do so in accordance with the following terms: conditions of service provided to all of their workers, or in accordance with a plan approved by special resolution.
- Companies offering loans, guarantees, and securities in the regular course of business charge interest that is at least as high as the current yield on government securities with terms of one year, three years, five years, or ten years.
- A fully owned subsidiary firm receives a loan and guarantees security from the holding company for its main commercial operations.
- A holding company offers it’s subsidiary a guarantee or security for the sake of its main business operations.
What penalties are provided in Section 185 of the Companies Act, 2013?
Section 185(4) throws light upon penalties
- In the case of lending companies
Any violation of Section 185 would result in a punishment of at least ₹5 lakh, with a maximum of ₹25 lakh, being imposed on the lending company.
- In case of any officer in arrears
Any officer who is in arrears will be punished with either a period of imprisonment that may reach six months or a fine that must not be less than ₹5 lakh but may reach upto ₹25 lakh.
- Recipient of loan
The loan receiver will be punished with up to six months in jail, a fine that must be lower than ₹
5 lakh but can reach ₹25 lakh or a combination of the two.
Looking at the terms of Section 185 of the Companies Act of 2013, we may comprehend the law’s aim. The law’s purpose is to protect the interests of shareholders.
Members’ approval is required in most circumstances when it is permitted. Onerous regulations cannot hamper business, and that is the justification for allowing the loan to subsidiaries.
It is also acceptable for an organisation to offer loans to its employees as a regular practice. The rights of all parties participating in the transaction are protected by company law.
Companies must also follow the law’s rules to avoid fines and legal disputes.
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