Section 185 of the Companies Act, 2013, is a major step towards separation of the substantive portions of law from the procedural ones. The main motive of this enactment is to ensure fewer regulatory approvals by promoting self-governance of corporations. It came into effect on September 12, 2013, replacing Section 295 of the Companies Act, 1956. Being aware of the impact that it has on the corporate scenario, this write-up attempts to answer all the FAQs that surround the section.
What is the legislative intent behind the enactment of the section?
Though the main intention of the legislature behind this enactment isn’t specifically mentioned in the explanation to the section, we do get the idea that the real reason behind enacting Section 185 is the need to meet the wants of Section 295 of the Act of 1956. The Section 185 aims to ensure that the directors do not misuse their power to benefit themselves by facilitating provision of loans/securities from the companies they are associated with or interested in. In other words, this section intends to avoid a conflict of interest between companies and its directors and can be termed as a “conflict of interest provision.”
What does Section 185 of the Companies Act, 2013, say exactly?
According to Section 185(1), “save as otherwise provided in this Act, no company shall, directly or indirectly, advance any loan, including any loan represented by a book debt, to any of its directors or to any other person in whom the director is interested or give any guarantee or provide any security in connection with any loan taken by him or such other person.”
The following are exempted from the applicability of this Section:
(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 bank rate declared by the Reserve Bank of India.”
The expression “save as otherwise provided in this Act” is to be construed harmoniously. Applying the rule of Harmonious Construction here, it may be explained that loans to directors or others in whom the director is interested is restricted by virtue of Section 185 and Section 186 is not an enabling provision in such cases.
The Explanation attached to the section provides for a clear understanding of the expression, “to any other person in whom the director is interested.” This expression means and includes:
- any director of the lending company or of a company which is its holding company or any partner or relative of any such director;
- any firm in which any such director or relative is a partner;
- any private company of which any such director is a director or member;
- any body corporate at a general meeting of which not less than twenty-five percent of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together; or
- 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, of any director or directors, of the lending company.
Thus, a lending company cannot advance a loan to the aforementioned entities.
Section 185 of the Companies Act, 2013 v. Section 295 of the Companies Act, 1956
The two sections, though similar in their subject matter, differ entirely in major aspects. For example, if the provision of any loan or guarantee falls within the framework of Section 185 of the 2013 Act, there is no way that it could be ratified through government approval. This is in contrast to the provisions of Section 295 of the old Act. Again, Section 185 applies to every company as opposed to Section 295 which did not apply to a private company unless it happened to be a subsidiary of a public company. Unlike in Section 185 of the Companies Act, 2013, no distinction was made between loan and deposit in Section 295 of the old Act. Furthermore, Section 185 has given the term “loan,” an amplified connotation in order to include book debts due from a director. Suppose, if any amount is due from a director by way of rent payable against accommodation taken by him from the company or against the value of goods credited to him by the company, the said due would amount to a “loan” and the outstanding amount will have to be paid off by the director to ensure that it does not come within the purview of this Section. Section 295, however, does not include such pseudo loans (book debts) in its definition of “loan.”
What is the punishment for violation of the provisions of this Section?
If any loan is advanced or a guarantee or security is given in contravention of the provisions of sub-section (1) of this Section, the lending company shall be punishable with a minimum fine of Rs 5 lacs which may extend to Rs 25 lacs and the recipient director or other person shall be punishable with imprisonment which may extend to 6 months or with a minimum fine of Rs 5 lacs which may extend to Rs 25 lacs, or both.