As corporate laws in India continue to evolve, staying up-to-date with the latest amendments and provisions introduced can seem like an uphill battle. Section 185 of the Companies Act 2013 is one such provision that has undergone changes in recent times and continues to create confusion. To help demystify this section for you, this article aims to provide an in-depth yet easy to understand overview of Section 185. We will explore what constitutes a loan, guarantee, and security under this section, examine the exceptions and exemptions to the general prohibitions, analyze implications of non-compliance, and provide clarification on the latest changes introduced. By the end, you will have gained clarity on the scope and applicability of Section 185 to enable full compliance by your company. So let's dive in and discover all you need to know about this provision.
What Is Section 185 of the Companies Act 2013?
Section 185 of the Companies Act 2013 prohibits companies from providing financial assistance to entities in which directors are interested. This section aims to prevent the misuse of company funds for the benefit of directors and their related entities.
What Constitutes Financial Assistance?
Financial assistance refers to assistance provided by way of:
Loan, guarantee, or security
Buying or subscribing for shares
Indemnity related to the purchase of shares
Any such assistance provided to the following will be considered a violation of Section 185:
Director of the company or director of the holding company
Partner or relative of the director
Firm in which the director or his relative is a partner
Private company in which the director is a member or director
Exceptions to Section 185
However, the following forms of financial assistance are exempt from the restrictions imposed by Section 185:
Assistance provided in the ordinary course of business: This includes loans, guarantees or securities provided as part of the ordinary business of a company. For example, a loan provided by a financing company to a director in the ordinary course of its business will be exempt.
Assistance approved by special resolution: Financial assistance approved by the company through a special resolution and in accordance with the provisions of Section 186 will not attract Section 185. This enables companies to provide assistance for genuine business purposes with shareholder approval.
Assistance for medical or personal emergencies: Financial assistance provided to directors for medical or personal emergencies is exempt from the restrictions of Section 185. However, such assistance should be reasonable and within prescribed limits.
In summary, Section 185 aims to curb misuse of company funds for the benefit of its directors and related parties. However, reasonable assistance in the ordinary course of business or for emergencies is allowed subject to certain conditions. Companies should exercise caution while interpreting the applicability of the exemptions to avoid violating the provisions of the Act.
Loans to Directors: The Complete Lowdown
As a director, it is important to understand the rules around taking loans from your company. Section 185 of the Companies Act 2013 lays down the law in this regard.
Under this section, a company is prohibited from providing loans, guarantees, or security to its directors, their spouses, or private companies in which a director holds 20% of more voting power. However, there are certain exemptions to this rule:
Loan given to a managing or whole-time director as a part of the conditions of service extended by the company to all its employees. This is allowed subject to the approval of the company in a general meeting.
Loan given to a director pursuant to a scheme approved by the central government.
Loan given to a private company in which a director is a director or member holding not more than 20% of the paid-up share capital.
The ordinary course of business of a company whose principal business is the lending of money or the giving of guarantees or securities for the due repayment of any loan.
If a loan is given in contravention of section 185, the company as well as the director can face penalties. The director can be punished with imprisonment up to 6 months and/or a fine between Rs 500,000 to Rs 5 million. The company can receive a fine between Rs 25 lakh to Rs 50 lakh.
In summary, section 185 aims to prevent misuse of a company’s funds and protect its shareholders and creditors. By understanding the rules and exemptions around providing loans to directors, you can avoid costly violations and ensure good governance.
Important Exceptions Under Section 185
Section 185 of the Companies Act, 2013 prohibits a company from advancing 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 giving any guarantee or providing any security in connection with any loan taken by him or such other person. However, there are certain exceptions provided under this section which allow companies to advance loans or give guarantees to directors and persons in whom directors are interested:
Loans to Managing Director and Whole-time Director
A company may advance a loan to a managing director or whole-time director as per the conditions of service extended by the company to all its employees or pursuant to any scheme approved by the members by a special resolution. The loan should be utilized by the director for meeting the expenses of the company.
Loan in Ordinary Course of Business
A company engaged in business of providing infrastructural facilities may provide loans to its directors in the ordinary course of its business and at an interest rate not lower than the prevailing yield of one year, three years, five years or ten years Government security closest to the tenor of the loan.
Subsidiary Company
A holding company may provide a loan to its subsidiary company or give a guarantee on behalf of its subsidiary company if the loan or guarantee is utilized by the subsidiary company for its principal business activities.
Loan for Medical Expenditure
A company may advance a loan to its director for meeting the medical expenses of themselves, their spouse, child or dependent. The loan should be paid back in accordance with the repayment schedule.
Participation by Director in Employee Welfare Scheme
A director may receive a loan under an employee welfare scheme or be provided a guarantee under an employee welfare scheme if other employees are also provided loans or guarantees under such scheme.
To conclude, while Section 185 puts a general prohibition on loans to directors, there are reasonable exceptions provided to enable companies to advance loans to directors in genuine cases. Companies should ensure any such loans meet the conditions prescribed under the relevant exceptions to comply with the Act.
Penalties for Non-Compliance
Section 185 of the Companies Act, 2013 deals with loans to directors and other interested parties. Non-compliance with this section can attract significant penalties for the company and its officers in default.
Penalties for the Company
A company that contravenes Section 185 may face penalties up to ₹5 lakh. The company can also be subjected to higher fines and even imprisonment of officers for repeat offenses.
Penalties for Officers in Default
Officers of the company, including directors, may face penalties up to ₹5 lakh and/or imprisonment up to 6 months. As with the company, higher penalties and longer imprisonment may apply for repeat offenses. Officers can also be prohibited from holding directorship positions for up to 5 years.
Other Consequences
Non-compliance with Section 185 can damage the company’s reputation and shareholder trust. It may lead to legal challenges and compromise the validity of the loan agreements. The company risks losing the loan amount if the agreements are deemed void, and it has to take action to recover the funds.
To avoid penalties and legal issues, companies must establish proper procedures to evaluate and approve loans to directors and interested parties. All loan agreements should be made at arm’s length and in the ordinary course of business. Complete and accurate records of the evaluation and approval process should be maintained. Annual filings must report all relevant loans as required by the Companies Act.
Taking adequate precautions and following due process can help companies steer clear of the significant consequences of non-compliance with Section 185. With transparent policies and record-keeping in place, companies can demonstrate their commitment to strong corporate governance if questions arise regarding loans to directors and other interested parties.
FAQs on Section 185 of Companies Act 2013
Section 185 of the Companies Act, 2013 deals with loans to directors and other interested parties. This section aims to prevent misuse of a company's funds by placing restrictions on loans, investments and guarantees given to directors and entities in which directors are interested.
What does Section 185 prohibit?
Section 185 prohibits a company from advancing 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.
What are the exceptions to Section 185?
There are certain exceptions where a company may provide loans or guarantees to its directors:
If a special resolution is passed by the company in general meeting.
If the loan is given to a managing or whole-time director as a part of the conditions of service extended by the company to all its employees.
If the loan is given to a subsidiary company or holding company. However, the company has to disclose details in its financial statement.
If the loan is given to a private company of which the director is a director or member.
What are the penalties for contravention of Section 185?
If a company contravenes the provisions of section 185, the company shall be punishable with fine which shall not be less than ₹5 lakh but which may extend to ₹25 lakh. 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 ₹5 lakh but which may extend to ₹25 lakh, or with both.
Conclusion
As a company director, it is critical you have a strong understanding of the legal requirements around related party transactions. Section 185 of the Companies Act 2013 sets clear guidelines on what is and is not allowed regarding loans, investments, and guarantees to directors and entities they have an interest in. Ensure any such transactions your company enters into are compliant, with proper approvals and disclosures. While the rules aim to prevent misuse of company funds and protect stakeholder interests, following them diligently will give you and your fellow directors peace of mind in knowing your governance standards meet the highest integrity. Stay up to date with any changes to Section 185 and keep records to demonstrate your compliance. Understanding and following the law is one of the hallmarks of good corporate governance.
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