Loan to Director

The purpose behind Section 185 of the Companies Act,2013 is to ensure that directors of the company do not surpass their fiduciary duty towards the company for their benefit

Section 185 deals with prohibitions, relaxations, and exemptions concerning advance loans, providing security or guarantee to the directors of a company or any other person in whom directors are interested. 

Section 185 of the Companies Act is divided into three clauses:

1. Prohibitive clause
2. Restrictive clause 
3. Unrestrictive clause

PROHIBITIVE CLAUSE: [Section 185(1)]

A company (subject to exemptions stated in below mention) shall not be permitted, directly or indirectly, to advance any loan, including any loan represented by a book debt or any guarantee or provide any security in respect of any loan taken by:

1. Any director of the company
2. Director of the holding company
3. Partner of such director
4. Relative of such Director 
5.  Firm in which any such director is a partner
6.  Firm in which any such relative of the director is a partner.

Analysis of Section 185(1) of the Companies Act, 2013

Company: It includes every company i.e Private Company, Public Company, Section 8 Company, Nidhi Company, Government Company

An indirect loan means that the corporation shall not give a loan through the mode of one or more intermediaries.

Relative: 

As per section 2(77) of the Companies Act,2013 "relative", concerning any person, means anyone related to another

(i) If they are members of a HUF

(ii) If they are husband and wife

(iii) one person is related to the other in the following manner

• Father (“Father” includes step-father)
• Mother (“Mother” includes the step-mother)
• Son (“Son” includes the step-son)
• Son’s wife
• Daughter
• Daughter’s husband
• Brother (“Brother” includes the step-brother)
• Sister (“Sister” includes the step-sister)

Illustrations: Does Section 185 allow Loan/Guarantee/Security to

Q. ABC Ltd - Subjected Company which provides Loan/Guarantee/Security

     XYZ Ltd -Holding Company of ABC Ltd

1. Firm in which the director is a partner-NO

AB & Co. [where Mr.  A (Director of ABC LTD) is a partner] 

1. Firm in which the director of the holding company is a partner- NO

CD & Co. [where Mr. C (Director of XYZ LTD) is a partner]

1. Firm in which the holding company’s director partner is a partner-YES

            BZ & Co. [where Mr. B (partner of Mr. C) is a partner]

RESTRICTIVE CLAUSE [Section 185(2)]

Company is permitted Subject to the specified conditions to advance any loan including any loan represented by a book debt or give any guarantee or provide any security in respect of any loan taken by any person in whom any of the directors of the company is interested.

1. Specified Conditions:
2. A Special Resolution is passed at the General Meeting of the Company.

However, the explanatory statement annexed to the notice shall disclose;

•  The full particulars of the loans or guarantee or security 
•  The purpose for which the loan or guarantee or security is proposed to be

        utilized by the recipient 

•  any other relevant fact 

1. The loans are utilized for their principal business activities.
2. Any person in whom any of the directors of the company is interested.

           (a)  Any private company of which any such director is a director or member;

(b) Anybody corporate at a general meeting of which not less than 25 % of the total voting power may be exercised or controlled by any such director or by two or more such directors collectively; or

(c) Anybody corporate, the Board of directors, managing director or manager, who is accustomed to act following the directions or instructions of the Board, or any director or directors, of the lending company.

Illustrations: Computation of Total voting power

Q. Mr. A holds 50% of ABC Ltd. 

ABC Ltd holds 60% of DEF Ltd.

DEF Ltd holds 20% of GHI Ltd.

The total voting power of Mr. A

1. In ABC Ltd.-50%
2. In DEF Ltd.-30% (50%*60%)
3. In GHI Ltd.-6% (50%*60% *20%)

Hence, ABC Ltd and DEF Ltd. will be the persons in whom the director of the company is interested and GHI Ltd. will not be considered as the persons in whom the director is interested

UNRESTRICTIVE CLAUSE [Section 185(3)]

In the following cases, prohibitions u/s 185[1] and Restrictions u/s 185[2] shall not apply [till Section 186] to

1. The loan is given to is Managing Director (MD)/ whole-time director (WTD)

• As conditions of service extended to all employees of the company
• According to a scheme approved by members by passing Special Resolution

1. Company in the ordinary course of its business

• Loans/guarantees/securities for the due repayment of any loan
• Interest charged not less than the prevailing yield of Government security of 1 year, 3 years, 5 years, or 10 years.

1. Loans/guarantees/securities are provided by a holding company to its wholly owned subsidiary company (WOS) and loans are utilized by the subsidiary company for its principal business activities.
2. Guarantee or security provided by the holding company to its subsidiary company for principal business activities

[Principal Business Activities means those activities which are mentioned under the main objects of MOA of the company]

Exemptions from applicability section 185 of the companies Act, 2013

1. Government company:

Section 185 shall not apply to Government companies subject to the following conditions:

1. Obtains approval from the ministry administratively in charge of the company/ State Government before making any Loan/Guarantee/Security.
2. has not defaulted in filing financial statements and annual returns with the ROC

[Notification No. G.S.R. 463(E), dated 5 th June 2015 as amended by Notification No. G.S.R. 582 (E), dated 13 th June 2017.]

1. Private Company:

Section 185 shall not apply to Private companies subject to the following condition:

1. No investment has been done by any body corporate in private Company
2. Borrowing from banks/ financial institutions/ body corporate is less than lower of

• Twice of paid-up capital or      
• Fifty crore rupees           

1. Company has no default in repayment of borrowings subsisting at the time of transaction  
2. It has not committed a default in filing its financial statements or Annual Return with the Registrar.  

[Notification No. G.S.R 464(E), dated 5th June 2015 as amended by Notification No. G.S.R 583(E), dated 13th June 2017.  

1. Nidhi Company:     

Section 185 shall not apply to the Nidhi company subject to the following conditions:

1. While granting the loan to the director or his relative in their capacity as members
2.  Such transaction is disclosed in the annual accounts of the company

[Notification no. G.S.R. 465(E), dated 5th June 2015]  

Penal Provision: [Section 185(4)]

If a loan/guarantee/security is provided in contravention of the provisions of section 185 of the companies Act, 2013

1. Company:

The company shall be a punishable minimum fine of Rs. 5,00,000 and a maximum fine of Rs. 25,00,000 

1. Officer in default:

Every defaulting officer shall be punishable with imprisonment up to six months or with a minimum fine of Rs.5,00,000 and a maximum fine of Rs.25,00,000

1. Director or the person to whom the Loan/Guarantee/Security is provided:

Shall be punishable with imprisonment up to six months or with a minimum fine of Rs. 5,00,000 and a maximum fine of Rs. 25,00,000 or with both.

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