Section 185: loans to directors, etc.

Introduction

The current section was substituted by section 61 of the Companies (Amendment) Act, 2017, with effect from 7 May 2018. Loans, guarantees and security for any person in whom a director is interested are allowed only on two conditions. First, the company must pass a special resolution, with full particulars in the explanatory statement. Second, the borrowing company must use the loan for its principal business activities.

A person in whom a director is interested means any of three things. It is a private company of which the director is a director or member. It is a body corporate at whose general meetings the director, or two or more directors together, can exercise or control at least twenty-five per cent of the voting power. It is also a body corporate whose Board, managing director or manager is accustomed to act on the instructions of the lending company's Board or directors.

Key takeaways

Classify the borrower

Subsection (1) prohibits any loan, including a loan represented by a book debt, and any guarantee or security for a loan, to three groups: a director of the company or its holding company; a partner or relative of such a director; and a firm in which such a director or relative is a partner.

This text was substituted by section 61 of the Companies (Amendment) Act, 2017, in force from 7 May 2018. Section 185 itself first came into force on 12 September 2013.

• India Code — consolidated Companies Act, 2013, section 185
• eGazette — Companies (Amendment) Act, 2017 (No. 1 of 2018)
• eGazette — MCA notification S.O. 1833(E), 7 May 2018 (commencement of Act 1 of 2018 provisions)
• eGazette — MCA notification S.O. 2754(E), 12 September 2013 (commencement)

Meet the conditions for connected persons

For a person in whom a director is interested, as defined in the Explanation to subsection (2), the company may lend or give a guarantee or security only on two conditions. It must pass a special resolution in general meeting, with an explanatory statement disclosing full particulars and the purpose. The borrowing company must use the loans for its principal business activities.

Check the exceptions

Subsections (1) and (2) do not apply in four cases. The first is a loan to a managing or whole-time director as part of conditions of service extended to all employees, or under a scheme approved by members by special resolution. The second is a company that lends or guarantees in the ordinary course of business at interest not below the prevailing yield of the Government security closest to the loan's tenor, choosing from one, three, five or ten years.

The third and fourth cases are loans, guarantees or security by a holding company for its wholly owned subsidiary, and guarantees or security by a holding company for a bank or financial institution loan to its subsidiary. In both, the subsidiary must use the loans for its principal business activities.

Understand the penalties

If a loan, guarantee or security is given, provided or used in contravention of the section, three penalties apply. The company faces a fine of five lakh to twenty-five lakh rupees. Every officer in default faces imprisonment of up to six months or a fine of five lakh to twenty-five lakh rupees. The director or other person who received the loan, guarantee or security faces imprisonment of up to six months or a fine of five lakh to twenty-five lakh rupees, or both.

Check class-specific exemptions

The MCA e-book for the Act lists exemption or modification notifications under this section for private companies, Nidhi companies, Government companies and Specified IFSC public and private companies. These can change whether and how section 185 applies. Read the current notification and its conditions before relying on it.

• MCA e-book — Companies Act, 2013 (exceptions, modifications and adaptations)

Practical preparation

Identify the borrower and its relationship with each director; separate prohibited cases from connected-person cases; for connected persons, pass the special resolution with full particulars and confirm how the funds will be used; test each exception in subsection (3); check any exemption notification for your class of company.

Practical checklist

Glossary

Book debt

A loan can include one represented by a book debt; section 185(1) covers such loans.

Person in whom a director is interested

The private companies and bodies corporate listed in the Explanation to section 185(2).

Frequently asked questions