Companies Act Section 185 — Loans to directors, etc
CHAPTER XII MEETINGS OF BOARD AND ITS POWERS
Commercial / Corporate
Summary
Sub-section (1) prohibits a company from directly or indirectly giving a loan (including a loan recorded as a book debt) to, or giving a guarantee or providing security for a loan taken by, any director of the company or of its holding company, or any partner or relative of such a director. It also prohibits giving a loan, guarantee, or security to any firm in which such a director or relative is a partner.
Sub-section (2) allows a company to give a loan, guarantee, or security in connection with a loan taken by any person in whom a director of the company is interested, but only if two conditions are met. Under clause (a), a special resolution must be passed by the company in a general meeting, and the explanatory statement attached to the meeting notice must disclose full particulars of the loan, guarantee, or security, the purpose for which it will be used by the recipient, and any other relevant facts. Under clause (b), the loans must be used by the borrowing company for its principal business activities.
The Explanation to sub-section (2) defines the expression "any person in whom any of the director of the company is interested" to mean three types of entities: under clause (a), any private company of which such a director is a director or member; under clause (b), any body corporate at whose general meeting not less than twenty-five per cent of the total voting power may be exercised or controlled by such a director, or by two or more such directors together; and under clause (c), any body corporate whose board of directors, managing director, or manager is accustomed to act according to the directions or instructions of the board, or of any director or directors, of the lending company.
Sub-section (3) lists the situations to which sub-sections (1) and (2) do not apply. Under clause (a), the prohibition does not apply to a loan given to a managing or whole-time director either as part of the conditions of service extended by the company to all its employees, or under a scheme approved by the members through a special resolution. Under clause (b), it does not apply to a company that, in its ordinary course of business, provides loans or gives guarantees or securities for repayment of loans, provided that interest is charged at a rate not less than the prevailing yield of a one-year, three-year, five-year, or ten-year Government security closest to the loan's tenor. Under clause (c), it does not apply to a loan made by a holding company to its wholly owned subsidiary, or any guarantee or security given by a holding company for a loan made to its wholly owned subsidiary. Under clause (d), it does not apply to a guarantee or security given by a holding company for a loan made by any bank or financial institution to its subsidiary company. The proviso to this sub-section states that loans made under clauses (c) and (d) must be used by the subsidiary company for its principal business activities.
Sub-section (4) sets out the penalties for contravening this section. Under clause (i), the company is punishable with a fine of not less than five lakh rupees, which may extend to twenty-five lakh rupees. Under clause (ii), every officer of the company who is in default is punishable with imprisonment for up to six months, or with a fine of not less than five lakh rupees but which may extend to twenty-five lakh rupees. Under clause (iii), the director or other person to whom the loan, guarantee, or security was given in connection with a loan taken by him or her is punishable with imprisonment for up to six months, or with a fine of not less than five lakh rupees but which may extend to twenty-five lakh rupees, or with both.
Official Text
(1) No company shall, directly or indirectly, advance any loan, including any loan represented by a book debt to, or give any guarantee or provide any security in connection with any loan taken by,—
(a) any director of company, or of a company which is its holding company or any partner or relative of any such director; or
(b) any firm in which any such director or relative is a partner.
(2) A company may advance any loan including any loan represented by a book debt, or give any guarantee or provide any security in connection with any loan taken by any person in whom any of the director of the company is interested, subject to the condition that—
(a) a special resolution is passed by the company in general meeting: Provided that the explanatory statement to the notice for the relevant general meeting shall disclose the full particulars of the loans given, or guarantee given or security provided and the purpose for which the loan or guarantee or security is proposed to be utilised by the recipient of the loan or guarantee or security and any other relevant fact; and
(b) the loans are utilised by the borrowing company for its principal business activities. Explanation.—For the purposes of this sub-section, the expression “any person in whom any of the director of the company is interested” means—
(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.
(3) Nothing contained in sub-sections
(1) and
(2) shall apply to—
(a) the giving of any loan to a managing or whole-time director—
(i) as a part of the conditions of service extended by the company to all its employees; or
(ii) pursuant to any scheme approved by the members by a special resolution; or
(b) a company which in the ordinary course of its business provides loans or gives guarantees or securities for the due repayment of any loan and in respect of such loans an interest is charged at a rate not less than the rate of prevailing yield of one year, three years, five years or ten years Government security closest to the tenor of the loan; or
(c) any loan made by a holding company to its wholly owned subsidiary company or any guarantee given or security provided by a holding company in respect of any loan made to its wholly owned subsidiary company; or
(d) any guarantee given or security provided by a holding company in respect of loan made by any bank or financial institution to its subsidiary company:
Provided that the loans made under clauses
(c) and
(d) are utilised by the subsidiary company for its principal business activities.
(4) If any loan is advanced or a guarantee or security is given or provided or utilised in contravention of the provisions of this section,—
(i) the company shall be punishable with fine which shall not be less than five lakh rupees but which may extend to twenty-five lakh rupees;
(ii) every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to six months or with fine which shall not be less than five lakh rupees but which may extend to twenty-five lakh rupees; and
(iii) the director or the other person to whom any loan is advanced or guarantee or security is given or provided in connection with any loan taken by him or the other person, shall be punishable with imprisonment which may extend to six months or with fine which shall not be less than five lakh rupees but which may extend to twenty-five lakh rupees, or with both.]