Initially, public companies were allowed to grant loans, guarantees and securities subject to Central Government approval and private companies were exempted under Section 295 of the former Companies Act, 1956.
Section 185 of the Companies Act, 2013 imposed a ban on loans to directors, their relatives and partners. The main intention of Section 185 is to ensure that directors who hold a fiduciary position with respect to shareholders do not misappropriate the funds of the company for their own benefits.
Private Companies were facing problems due to stringent provisions of Section 185 while carrying out operations. So, Government exempted private companies from entire Section 185 to ease the compliance requirement vide notification dated 5th June, 2015, subject to following 3 conditions:
1. There should be no investment in the concerned company from any other body corporate;
2. The company should not have any borrowings from banks, financial institutions and other bodies corporate equal to or more than twice its paid-up share capital, OR Rs. 50 crores, whichever is lower; and
3. There should be no subsisting default at the time of making such transaction, and that the company should have the capability to pay off the loan.
Companies (Amendment) Act, 2017.
Government substituted entire Section 185 by way of Companies (Amendment) Act, 2017 to promote ease of doing business. The original Section 185 specified more exhaustive list to which Companies can’t give loans, guarantee and securities. Thus, at par with the global company laws, the provision has been amended to remove the prohibition to an extent and provides for the passing of shareholders’ resolution for granting of loans, guarantees, and securities to entities in which directors are interested.
All the Companies (Except Private Companies which fulfill the criteria of exemption notification dated 5th June, 2015) are prohibited to give loans, guarantees and securities to the following persons and firm:
Any Director of a Company
Any Relative of a Directors
Any Partner of a Directors
Any Directors of a Holding Company
Any firm in which any such director or relative of a Director is a Partner
Companies can give loans, guarantee or securities to the following entities after passing Special Resolution at a duly convened general meeting:
Any private company of which any such director is a director or member;
Any body corporate in which more than 25% of the total voting power exercised or controlled by any such director, or by two or more such directors, together;
Any body corporate, the BoD, MD or manager, whereof is accustomed to act in accordance with the directions or instructions of the BoD, or of any director or directors, of the lending Company.
3) UNRESTRICTED OR EXEMPTED
The Provisions of Section 185 doesn’t apply to the following transactions:
Any loan given to a M.D or W.T.D as a part of the conditions of service extended by the company to all its employees; OR pursuant to any scheme approved by the members by a Special Resolution;
A company which ‘in the ordinary course of its business’ provides loans or gives guarantees or securities for the due repayment of any loan and in respect of such loans an interest is charged at a rate not less than the rate of prevailing yield of one year, three years, five years or ten years Government security closest to the tenor of the loan; or
Any Loan/Guarantee or Security made by a holding company to its wholly-owned subsidiary Company.