As an investor or company director in India, you need to be aware of the provisions under Section 186 of the Companies Act, 2013 regarding loans, guarantees, and investments. Section 186 lays down the general conditions for providing loans, guarantees, security, and making investments by a company. Non-compliance with Section 186 can attract penal provisions. It is imperative for you to understand the applicability, limits, and conditions prescribed under Section 186 before providing loans, issuing guarantees, making investments or providing securities on behalf of your company. This article aims to provide you with an in-depth insight into Section 186 and how to ensure compliance.
What Does Section 186 of the Companies Act 2013 Pertain To?
Section 186 of the Companies Act 2013 pertains to the loans, investments, guarantees and securities provided by companies. Under this section, companies can give loans,
guarantees or make investments in other companies subject to the limits and
conditions prescribed.
What Does This Section Govern?
This section governs the following:
Loans and advances to other companies or bodies corporate
Guarantees given or securities provided in connection with loans to other companies
Investments in shares, debentures or other securities of other companies
Limits up to which a company can provide loans or guarantees
Conditions subject to which a company can provide loans or guarantees
Applicability
Section 186 applies to all companies, whether public or private. However, it does not apply to:
Loans, guarantees or securities provided by a banking company in the ordinary course of business
Investments made by an insurance or housing finance company in the ordinary course of business
Loans or advances made by a company to its employees
Limits and Conditions
Under this section, a company can give loans, guarantees or make investments up to 60% of its paid-up capital, free reserves and securities premium account or 100% of its free reserves and securities premium account, whichever is more.
The company must pass a special resolution to provide loans, guarantees or make investments exceeding the prescribed limits. Certain additional disclosures are also required in the financial statements of the company.
This section aims to protect the interests of shareholders and creditors by regulating the loans, investments and guarantees made by companies. By adhering to the limits and conditions prescribed under this section, companies can undertake such transactions in a fair and transparent manner.
Conditions to Be Fulfilled for Making Loans, Guarantees and Investments
To make loans, guarantees and investments under Section 186 of the Companies Act, 2013, certain conditions must be fulfilled.
First, approval of the Board of Directors is required by means of a resolution at a board meeting. The resolution must specify the details of the loans, guarantees or investments proposed along with the purpose, nature of the transaction and the maximum amount of investment.
Second, loans, guarantees and investments can only be made for legitimate business purposes. The funds cannot be used for speculative purposes. Some examples of legitimate purposes include providing working capital to subsidiaries or affiliates, funding capital expenditures, and acquiring assets for business use.
Third, loans, guarantees and investments together cannot exceed 60% of the company’s paid-up capital, free reserves and securities premium account or 100% of free reserves and securities premium account, whichever is more. However, approval of shareholders by special resolution can allow exceeding these limits.
Furthermore, investments can only be made in entities where the company has control or significant influence. This means the investee company should be a subsidiary, joint venture or associate of the company as per applicable accounting standards. Exceptions are allowed for investments in compliance with government policy or for infrastructure projects.
With the necessary compliance and approvals, companies can utilize surplus funds for strategic investments and to support group companies and affiliates. However, care must be taken to not violate any conditions prescribed under Section 186 to avoid penalties and legal issues. Following the rules and limits set out in the Act, companies have the flexibility to make prudent investment decisions aligned with their business objectives.
Limits on Loans, Guarantees and Investments
Section 186 of the Companies Act, 2013 prescribes the limits up to which a company can make loans, investments and issue guarantees. This section aims to ensure that the company's money is used prudently and not diverted for non-business purposes.
Limits on Loans and Investments
A company can give loans, provide guarantees and make investments up to 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. This limit can be exceeded by passing a special resolution in a general meeting. The loans and investments made should be utilized by the recipient for its principal business activities.
Any loan or investment made to a subsidiary, associate company or any other person in excess of the prescribed limit should be approved by the shareholders through a special resolution. The company should disclose the details of such loans, guarantees and investments in the financial statements and also file necessary returns with the Registrar of Companies.
Exemptions
The following classes of loans, investments and guarantees are exempt from the limits prescribed under Section 186:
Loans and investments made by an NBFC in its ordinary course of business.
Loans and investments made by a company engaged in the business of financing of companies or of providing infrastructural facilities.
Investment made in shares allotted in pursuance of clause (a) of sub-section (1) of section 62.
To conclude, Section 186 aims to ensure transparency and accountability in a company's financial dealings. While it provides certain exemptions, companies should exercise due caution and prudence while providing loans, guarantees or making investments, especially those exceeding the prescribed limits. Compliance with Section 186 is mandatory to avoid penalties and legal consequences.
Key Exemptions Under Section 186
Under Section 186 of the Companies Act, 2013, certain classes of companies are prohibited from providing loans, guarantees and making investments beyond prescribed limits. However, there are certain exemptions provided under this Section to enable companies to carry on their day to day business operations smoothly.
Loans and Advances to Employees
Companies are allowed to provide loans and advances to their employees for education, medical, house building or other purposes in the ordinary course of business. Such loans and advances should not attract the provisions of Section 186.
Loans, Guarantees and Investments in the Ordinary Course of Business
Loans, guarantees and investments made by companies in the ordinary course of their business are exempt from the limits prescribed under Section 186. For example, a finance company providing loans as part of its business operations or a manufacturing company purchasing raw materials for its production activities.
Investment in Subsidiaries and Associate Companies
Investments made by companies in their wholly owned subsidiaries or associate companies, whether in India or abroad, are excluded from the scope of Section 186. This enables companies to invest in their group companies freely to expand their business.
Investment in Government Securities
Investments made by companies in government securities, bonds or debentures are exempt under Section 186. Companies can invest freely in risk-free government securities to earn fixed returns.
Inter-corporate Deposits
Inter-corporate deposits between companies are excluded from the purview of Section 186. Companies can borrow and lend funds between group companies through inter-corporate deposits for their short-term funding requirements.
By availing these key exemptions, companies can carry on their normal business activities without attracting penal provisions under Section 186 of the Companies Act, 2013. Companies should ensure the loans, guarantees and investments made under these exemptions are utilized for bonafide business purposes.
Penalties for Non-Compliance
Non-compliance with Section 186 can attract penalties for the company and its officers in default. As per Section 186(13), if a company contravenes the provisions of this section, the company shall be punishable with fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees and every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to two years and with fine which shall not be less than twenty-five thousand rupees but which may extend to one lakh rupees.
Imprisonment and Monetary Fines
The non-compliance of the provisions of Section 186 thus invites both imprisonment and monetary penalties. The imprisonment is up to a maximum term of two years while the fines are minimum ₹25,000, which can go up to ₹5 lakhs for the company and up to ₹1 lakh for the officers in default. These are deterrent punishments to ensure that companies follow the rules regarding loans, investments, guarantees and security.
Compoundable Offense
An offense punishable under Section 186(13) is compoundable under Section 441 of the Companies Act, 2013. Compounding allows the company or its officers to settle the offense by paying a penalty. The maximum amount for compounding such offenses is ₹5 lakhs. However, compounding is allowed only once for any offense under the Companies Act.
Other Consequences
Apart from the penalties specified in the Act, non-compliance with Section 186 can lead to other legal consequences as well. It can attract scrutiny from regulatory authorities like SEBI, impacting the company’s compliance rating. It may also lead to civil or criminal actions from shareholders or lenders. Hence, it is advisable for companies to strictly follow the provisions of Section 186 to avoid penal action as well as reputational and financial damage.
Conclusion
You now have a clear understanding of Section 186 and its implications for companies in India. It governs the nature and manner of investments, loans, guarantees, and securities that companies can provide to other entities. Compliance with this section is critical to avoid penalties and legal trouble. However, its provisions also allow companies to pursue strategic investments and fund growth opportunities.
With some prudent decision making and advice from legal experts, companies can take advantage of the flexibility Section 186 offers while also meeting its compliance requirements. Monitoring the limits and restrictions, proper documentation, and transparency in decision making are key. Section 186 may seem complicated, but breaking it down step by step reveals its rationale and simplicity. Following the spirit and letter of the law will allow companies to prosper while building stakeholder trust through good governance.
In the end, Section 186 exists to promote responsible and ethical corporate behavior. Embracing it will lead to sustainable success and a bright future for companies and the Indian economy as a whole. Keep your company on the right side of the law, and the opportunities will be endless.
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