Adverse Impact of Wrongful Interpretation of Section 185 of New Companies Act 2013 on struggling Indian Economy and Economic Slow-Down

Advocate CS Sanjay Lalit of  Jupiter Legal, Advocates & Legal Consultants, Mumbai

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This Article make the crucial scrutiny of Section 185 of New Companies Act 2013 which relates to  giving  of Corporate Guarantee by larger/bigger companies (often a known flagship or holding or parent  company) for providing loans to its smaller or its subsidiary companies  who may not be well known or have developed a relationship with the Banks/Lenders. The wrongful interpretations of Section 185 resulted de facto prohibition by Banks from taking Corporate Guarantee as a Security for sanctioning loans to its Subsidiary.

Corporate Guarantee is a written affirmation payment made by a known flagship or holding company,   on behalf of  its another business entity who would be normally smaller company.  

Since Section 185 of the New Companies Act 2013 became operative effective September 2013, there is all around ambiguity  in Banking Sector whether the Bank can  stipulate Corporate Guarantee as one of Security or or not. Section 185 is infact replacement of old section 295 of the Companies Act, 1956 which provides for loans to directors.  As per the objective  of the legislation, there is a  control for loans to directors etc. and to any other person in whom the director is interested, which was earlier allowable under Section 295 of the Companies Act, 1956.

But true spirit of every economic legislation/statutory enactment should ever facilitate and improve the efficacy of the Economic Structure of a nation in line with the changing and dynamic requirements of a vibrant Indian Economy. Proviso of new Companies Act should never put speed-breakers or bottlenecks for the growth of trade & commerce.  Because when the Corporate Guarantees are provided to any Bank, the Bank lend monies in the Economic System of the Country and that Loan Funds are usually used in the ordinary course of business  for productive purposes in the overall growth the economy of the country. The eventual  purpose of Section 185 of the New Companies Act, 2013  is to put additional restrictions on Loan to Directors only and not on giving of  Corporate Guarantee  by the Holding Company to its  Subsidiary Company. This new proviso of Section 185 unintentionally hampered the acceptance of Corporate Guarantees as one of Security by Banks. Even under the (old) Section  295 of the Companies Act, 1956, a Corporate Guarantee  by the Holding Company to its  Subsidiary Company  is permissible.

Section 372A of the Companies Act, in regard to Inter-Corporate Loans And Investments, including giving of Corporate Guarantee  1956 which is still in operation, specifically deals with inter-corporate loans, giving of any guarantee including Corporate Guarantee or providing any security to the Banks etc. In view of all these related proviso of Section 372A of the Companies Act, 1956 which is still in operation, holding or parent  company  can provide Corporate Guarantee to Banks for the loan being provided to its subsidiary company or other smaller Group Company.

As on date Section 372A of the Companies Act  1956 permits  giving Corporate Guarantee  by holding or parent  company   to the Bank for the loan being provided to subsidiary company or other smaller Group Company  by any Bank. The statutory provisions of Section 372A of the Companies Act  1956 specifically deals with inter-corporate loans and exempts loans advanced or Corporate Guarantee by holding company to its wholly owned subsidiary.

Conclusion

Based upon the above analysis of Sections 185 and Section 372A of the Companies Act  1956,  even after the effectiveness of Section 185 of the New Companies Act   2013, the Bank can take the Corporate Guarantee from holding or parent  company   to the  Bank for the loan being provided to subsidiary company or other smaller Group Company in accordance with the  existing Section 372A of the Companies Act, 1956, which is operative as of now along with ensuring required compliance with Section 185 the New Companies Act 2013.

Even, as per recent Circular No. 18/2013 dated 19.11.2013 of   the Ministry of Corporate Affairs, a clarification has been issued with regard to applicability of provision of Section 372A of the Companies Act, 1956 on account of number of representations received consequent upon notifying Section 185 of the Companies Act, 2013 dealing with loans to directors which is corresponding to Section 295 of the Companies Act, 1956. It was unequivocally  clarified in the said Circular that Section 372A of the Companies Act, 1956 dealing with inter-corporate loans continue to remain in force till section 186, of the Companies Act, 2013 is  notified.

It should be undoubtedly noted that no law can ever restrict the smooth flow of trade & commerce or creates bottlenecks in the economic growth of any nation. The ultimate objective of any Economic Legislation like New Companies Act 2013 is to facilitate the Economic Growth of any in line with the changing business requirements. But, recently lot of Banks in the country, only on account of narrow and wrong interpretations  of Section 185 of the New Companies Act 2013, stopped taking Corporate Guarantee as a Security  as one of Security from Holding Companies for sanctioning loans to its Subsidiary. Ultimately, this narrow interpretations has created speed breaker or bottlenecks in the flow of loaned funds from Banks to Corporates which can definitely and adversely affect the economic growth of the resources starved nation like India. The Banking Industry should be advised to review the narrow interpretation of Section 185 and start taking Corporate Guarantees  from the respective holding or parent  companies for the credit facilities/loan being provided to subsidiary company or other smaller Group Company in accordance with the  existing Section 372A of the Companies Act, 1956.