Whether loan to director of the company be given?

Chartered Accountants and Companies Act consultants provide guidance to ensure compliance with Section 185 of the Companies Act, 2013, which regulates loans, guarantees, and securities to directors. This is for informational purposes only and does not constitute legal or professional advice.

Introduction

Section 185 of the Companies Act, 2013:

Section 185 of the Companies Act, 2013, governs the provision of loans, guarantees, and securities by companies to their directors or persons in whom the directors are interested. This section aims to prevent misuse of company funds and ensure transparency and accountability in corporate governance.

Prohibited Transactions

Under Section 185, companies are restricted from directly or indirectly:

• Advancing loans to directors or to any other person in whom the director is interested.
• Providing guarantees for loans taken by directors or persons in whom they are interested.
• Offering securities in connection with loans for directors or their related parties.

Persons in Whom Directors Are Interested

This includes:

1. Any director of the lending company, its holding company, or any partner or relative of such a director.
2. Any firm in which such a director or relative is a partner.
3. Any private company in which such a director is a director or member.
4. Any body corporate where at least 25% of the voting power is held by such a director or two or more directors of the lending company.
5. Any body corporate where the board of directors is accustomed to act per the instructions of the director(s) of the lending company.

Exceptions to Prohibited Transactions

Certain exceptions allow companies to extend loans, guarantees, or securities under specific conditions:

1. Loans to Managing or Whole-Time Directors
   1. If the loans are part of the director’s service conditions, or
   1. If they are under a scheme approved by the shareholders through a special resolution.
2. Transactions with Wholly Owned Subsidiaries
   1. Companies can provide loans, guarantees, or securities to their wholly owned subsidiaries without restriction.
3. Loans for Principal Business Activities
   1. Loans provided to entities for their principal business activities at interest rates not lower than the prevailing Reserve Bank of India (RBI) rates.

Compliance Requirements under the Companies Act

To ensure compliance with Section 185, companies must:

1. Conduct Board Meetings: Resolutions approving loans or guarantees must be passed at the board level.
2. Obtain Shareholders’ Approval: In certain cases, a special resolution is mandatory to proceed.
3. Ensure Proper Documentation: Maintain detailed records of transactions, including agreements and resolutions.
4. Adhere to Interest Rate Norms: Loans must be at or above RBI’s prescribed rates.
5. Disclosures in Financial Statements: Transactions under Section 185 must be disclosed in the company’s annual financial statements.

Penalty Provisions

Non-compliance with Section 185 attracts stringent penalties:

1. For the Lending Company: A fine ranging from ₹5,00,000 to ₹25,00,000.
2. For Officers in Default:
   1. Fine ranging from ₹5,00,000 to ₹25,00,000.
   1. Imprisonment for up to six months.
3. For the Borrowing Entity: A fine ranging from ₹5,00,000 to ₹25,00,000.

Powers of the Ministry of Corporate Affairs (MCA)

The Ministry of Corporate Affairs (MCA) has significant oversight and enforcement powers under Section 185. It can:

1. Conduct inspections and inquiries to ensure compliance.
2. Levy penalties for violations.
3. Initiate legal proceedings against defaulting entities and individuals.
4. Issue clarifications and notifications to address ambiguities in the law.

Case Study: XYZ Ltd.

Background: XYZ Ltd., a private company, extended a loan of ₹1 crore to a partnership firm where one of its directors was a partner, without obtaining the necessary approvals.

Violation: The transaction violated Section 185 as the director was a person in whom the company’s director was interested.

Action Taken: Upon inspection by MCA, the company can be  fined ₹25,00,000, and the director responsible may be  fined ₹5,00,000 and may be sentenced to three months’ imprisonment.

Lessons Learned:

• Companies must strictly adhere to Section 185 provisions.
• Proper approvals and documentation are crucial to avoid legal repercussions.

Conclusion

Section 185 of the Companies Act emphasizes preventing directors from misusing their position to access company resources for personal gain. Chartered Accountants and Companies Act consultants play a crucial role in ensuring compliance by guiding companies in obtaining necessary approvals and maintaining transparency in transactions involving directors or their related parties. Their expertise helps businesses adhere to these provisions effectively, avoiding substantial penalties and fostering trust and integrity in corporate governance.This is for informational purposes only and does not constitute legal or professional advice.