Explore the intricacies of Section 186 in the Companies Act, 2013. From loan limits to board approvals, we break down key aspects to help you navigate the requirements under the provision with ease.
Overview
When it comes to running a company in India, understanding the legal framework is paramount. One crucial aspect of this framework is Section 186 of the Companies Act, 2013. This article deals with loans, investments, and guarantees that a company can make and the stringent rules governing them.
In this comprehensive guide, we’ll unravel the complexities of Section 186, ensuring you have a clear grasp of its provisions and implications.
Section 186: What You Need to Know?
Section 186 of the Companies Act, 2013, serves as a safeguard to ensure that companies make loans and investments prudently and transparently. It primarily focuses on two major aspects: loans and investments through layers of investment companies. Let’s break it down step by step.
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Loans, Guarantees, and Investments:
The first key provision of Section 186 prohibits a company from:
- Giving loans to any person or body corporate.
- Providing guarantees or securities for loans to others.
- Acquiring securities of any other body corporate exceeding certain limits.
Understanding Loan Limits:
Here’s the catch – a company cannot provide loans, guarantees, or securities exceeding 60% of its paid-up share capital, free reserves, and securities premium account or 100% of its free reserves and securities premium account, whichever is higher.
Legal Requirements:
To ensure compliance with Section 186, several requirements must be met:
Requirement No. 1: Board Approval
The company must obtain approval from the board via a unanimous resolution at a board meeting with all directors’ consent.
Requirement No. 2: Special Resolution
When the aggregate of loans, investments, guarantees, or securities exceeds the limit mentioned in Section 186(2), a special resolution by the members is necessary.
Requirement No. 3: PFI Approval
If the company has taken a term loan from a public financial institution (PFI), it must obtain prior approval from that PFI.
Requirement No. 4: Interest Rate
The interest rate on loans should be higher than the prevailing yield of Government Securities for a similar period.
Requirement No. 5: No Subsisting Defaults
A company that has defaulted on repayments of deposits or interest cannot engage in loans, guarantees, investments, or securities until the default is resolved.
Requirement No. 6: Disclosures
The company must disclose all loans, investments, guarantees, and securities, along with their intended purposes, in its financial statements to the members.
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Non-Applicability of Section 186:
Section 186 doesn’t apply in certain cases, such as:
- Government companies involved in defense production
- Companies that obtain approval from relevant government ministries
- Acquisitions of shares through right shares
- Companies primarily engaged in securities acquisition (investment companies)
- Banking, insurance, housing finance, and infrastructure finance companies
Restrictions on Layers of Investment:
Section 186 also imposes restrictions on the number of layers of investment companies through which a company can make investments.
Register of Loans and Investments:
To maintain transparency, every company must keep a register containing all the particulars of loans, investments, guarantees, and securities. This register must be accessible for inspection by members.
Penalties for Contravention:
Failure to comply with Section 186 can lead to penalties:
- Companies can face fines ranging from a minimum of Rs. 25,000 to a maximum of Rs. 5,00,000.
- Officials in default could be imprisoned for up to 2 years and fined between Rs. 25,000 and Rs. 1,00,000.
Illustration: An Example of How Section 186 of the Companies Act Operates
Now that we’ve covered the basics, let’s look at some practical scenarios to better understand how Section 186 works.
Scenario 1: ABC Ltd’s Loan to XYZ Pvt. Ltd
Imagine ABC Ltd wants to provide a loan of Rs. 70,00,000 to XYZ Pvt. Ltd. To comply with Section 186, ABC Ltd must:
- Ensure board approval through a unanimous resolution.
- Seek members’ approval through a special resolution if this loan would exceed the prescribed limits.
- Ensure that interest rate on the loan is higher than the prevailing Government Securities yield.
- Disclose loan in its financial statements.
Scenario 2: A Government Company’s Investment
Suppose a government company involved in defense production wants to invest Rs. 90,00,000 in another company. Since it’s a government company in defense production, Section 186 may not apply to this scenario. However, approval from the relevant ministry is still required.
Scenario 3: A Banking Company’s Routine Lending Activities
A banking company like XYZ Bank provides loans as part of its regular business activities. In such cases, Section 186 doesn’t pose any restrictions. The bank can provide loans without the need for specific approvals under Section 186.
Conclusion: How to Comply with Section 186?
Section 186 of the Companies Act, 2013, plays a pivotal role in ensuring financial prudence and transparency in India’s corporate sector. Companies must navigate its provisions carefully to avoid penalties and legal complications.
To summarize, always remember to:
- Obtain board and member approvals as required
- Seek PFI approval when applicable
- Set appropriate interest rates
- Resolve any defaults before engaging in new financial activities
- Disclose all financial transactions in your company’s statements
By adhering to these guidelines, businesses can operate within the bounds of the law, promoting trust among stakeholders. Understanding Section 186 is not just a legal necessity; it’s a crucial step towards building a robust and compliant corporate landscape in India.
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