Loans to Directors - Applicability of section 185 of Companies Act 2013

The companies Act 2013 section 185 prohibits a company from giving loans to its directors and providing guarantees or securities on their behalf. This restricts the company’s ability to fund a wholly owned subsidiary if the two companies share a common director. Recently a circular issued by the MCA to explain the scope & restrictions as contained in the Section 185. Basically the wordings of the Section 185 contains "any other person in whom the director is interested in". Thus mutual directors also comes under its ambit. This restricts the holding companies not to give loans, securities and guarantee for their subsidiaries by virtue of common directors.

Unlike the previous Act of 1956 , in which the private companies were allowed to lend money to its directors or entities of interest and provide guarantees and security for loans availed by them without central government approval. This is the Section 295 of the Companies Act, 1956. With the new enactment the equivalent of Section 295 is Section 185 under Companies Act, 2013. More stringent words and restrictive intention are put.

Now there is a bit of debate out there that whether it applies to a situations of a holding – subsidiary relationship. If there is common director on the Board of the holding company as a Director, then the section 185 is invoked. Thus the loans given or guarantee given by the holding company or security taken by the holding company in favor of the subsidiary need Union Government approval.

Similarly where a Special Purpose Vehicle (SPV) created then there will also be applicability of section 185. It is a very common business practice that in order to be able to avail bank funding and loans at the level of project company and special purpose vehicles, holding companies generally have to provide for guarantees and securities. Now since exemptions are not there in Section 185 of the Companies Act, it will become extremely difficult for the banking industry to be able to function and for Indian corporate to avail loans for genuine business purposes.

The issue have been partially settled . To resolve this concern, the Ministry of Corporate Affairs has now clarified that Section 372A of the old Companies Act will continue to apply till such time Section 186 is notified. But in its clarification, the Ministry has allowed holding companies to give only guarantees and securities on behalf of wholly owned subsidiaries but not provide them with loans. The Section 372A of the repealed Act specifically allows holding companies to provide loans, give guarantee or security to its wholly owned subsidiary. Its equivalent is Section 186 under the new Companies Act that allows a holding company to give loans of a specified amount and provide guarantees and securities on behalf of its subsidiary without a special resolution.

So with confusion there need a clear-cut solution .