Exploring Loans to Directors: A Concise Overview

Introduction

In this article, we dive into the importance of loans to directors, examining all the aspects that shape these transactions. The article speaks about how a Company can provide loan to its Directors fulfilling all the requirements of law in true letter and spirit.

Enabling Provisions:

Companies Act 2013 Section- 185: ?Loan to Directors Section – 188: Related Party Transactions

A. Can a Company give Loan to its Directors?

A Company cannot directly or indirectly advance any loan (not even as book debt i.e. receivables), neither can it give any guarantee/security to –

a. any directors of Company, or its holding company or any partner or relative of such Directors; or b. any firm in which such director is a relative or partner.

Important Definitions:?

2(46) Holding Company, in relation to one or more other companies, means a company of which such companies are subsidiary companies.

2(87)?Subsidiary company or subsidiary in relation to any other?company?(that is to say the?holding company), means a?company?in which the?holding company—

(i) controls the composition of the?Board of Directors; or

(ii) exercises or controls more than one-half of the total voting power either at its own or together with one or more of its subsidiary companies:

Provided that all the companies incorporated under Indian companies’ act shall not have more than 2 layers of subsidiaries except Banking co., insurance co., government co. non-banking financial co. but this shall not stop Indian co. from acquiring foreign co. having more than 2 layers of subsidiaries.

Explanation— For the purposes of this clause:—

(a) a?company?shall be deemed to be a?subsidiary company?of the?holding company?even if the?control?referred to in sub-clause (i) or sub-clause (ii) is of another?subsidiary company?of the?holding company;

(b) the composition of a company’s?Board of Directors?shall be deemed to be controlled by another?company?if that other?company?by exercise of some power exercisable by it at its discretion can appoint or remove all or a majority of the Directors;

(c) the expression “company” includes any body corporate;

(d) “layer” in relation to a?holding company?means its subsidiary or subsidiaries;

However, the company can advance loan including book debt, give guarantee/security to any person in whom any of the Director of the Company is Interested,

The expression “any person in whom any of the director of the company is interested” means—:

• Any private company in which such director is director or member.
• Body corporate in which director is holding 25% or more voting power either singly or jointly.
• Body corporate in whose board of directors, MD or Manager are accustomed to act as per the directions given by the director of lending company.

B. Exceptions:

• Loan can be given to MD and WTD if such amount is provided to other employees as a part of consideration for service rendered or through a scheme approved by members.
• If the Loan is provided in ordinary course of business at interest rate not less than that decided by government as per tenure.
• Loan given by Holding Company to its Wholly owned subsidiary.
• Guarantee or security provided in respect of loan given by financial institution to its subsidiary provided loan is utilized for principle business activity.

C. Penalty for Non-Compliance:

I. Company – fine not less than INR 5,00,000 which may extend to INR 25,00,000.

II. Officer in default – imprisonment upto 6 months or fine 5,00,000 which may extend to 25,00,000.

III. Director – imprisonment upto 6 months or fine from 5,00,000 which may extend to 25,00,000 or both.

D. Is the restriction of lending loan applicable to all the Companies?

No, there are few relaxations given to certain companies. Section 185 is not applicable to the following:

• Private company-in whose share capital no other body corporate has invested any money;if the borrowings of such a company from banks or financial institutions or any body corporate is less than twice of its paid up share capital or fifty crore rupees, whichever is lower; andsuch a company has no default in repayment of such borrowings subsisting at the time of making transactions under this section.
• Nidhi company
• Government company- if they take approval of ministry or central government/ state government as may be applicable.
• Specified IFSC Public company.

E. Is a loan from a director considered as a Related Party Transaction (RPT)?

A Director or a Key Managerial Personal is considered as a related party in terms of Section 2(76) of the Act and hence any transaction with the director or KMP shall be regarded as a related party transaction.

However, only those transactions are considered as related party transactions that are enumerated in Section 188(1) of the Act. The transactions specified in Section 188 are primarily in the nature of sale and purchase of goods, properties, and services.?Since the borrowing of money is not covered under Section 188 of the Act, the acceptance of a loan from the director shall not be considered as RPT.

F. Upper Limit:?

There is no upper limit provided in law upto which Loan can be given to a director. Any sum of amount can be given to the directors as Loan the only condition stated is that it requires the approval of members in the form of Special Resolution.

Conclusion:

Loans to directors are complex transactions that carry significant legal implications for companies and their stakeholders. This provision was inserted in the Act with the intention to disclose the transactions which can lead to diversion of funds. These transactions usually create a doubt in the minds of stakeholders, Therefore, to uphold the integrity of transactions and to ensure that these transactions are legally correct that is where this provision comes into picture.

If you are looking for compliance support, we can help you with the same.?SimplyCorp?is a solution that offers comprehensive and end-end management of Corporate Governance & Secretarial Compliances covering all stages of entity life cycle. If want to know more on the compliance requirements and outsource the same to us, please write to our Product Head?– Vaishali Vohra at the mail ?[email protected] ?or to Vanaja, Lead- Corporate Compliances? at [email protected] .