The Companies Act, 2013 has laid down specific provisions relating to the flow of funds through any company. Directors act as agents of the company and they are responsible for running the entire company. They receive remuneration against their duties which becomes taxable in their hands. However, to ensure that the funds of the companies are not provided to directors disguised as loans, the Companies Act have laid down the provisions relating to the treatment of loans to directors of the companies. Here are the detailed provisions in this regard.
Section 185: Loans to Directors of the Company
Section 185 of Companies Act, 2013 governs the provisions relating to loans to directors by the companies. As per these provisions, a company shall not advance any loan (including by way of book debt) or give any guarantee or provide any security, whether directly or indirectly, in connection with any loan taken by the following:
- Any director of a company or
- Any director of the holding company or
- Any partner or relative of such director or
- Any firm in which such a director or relative is a partner.
When the Loans to Directors are Permissible?
The companies are allowed to provide any loans (including by way of book debt) or give any guarantee or provide any security in connection with any loan taken by any person in whom any of the directors of the company is interested if the following conditions are satisfied:
- It is approved by passing a special resolution in the general meeting of the company. The explanatory statement to the notice for the relevant general meeting should disclose the full particulars of the loans given, guarantee given or security provided and the purpose for which the loan, guarantee or security is proposed to be utilized by the borrower.
- The loans are utilized for the principal business activities by the borrowing company
For the above purpose, any person in whom any of the directors of the company is interested’ shall include the following persons:
- Any private company in which such a director is either a director or member or
- Anybody corporate in which at least 25% of the total voting power may be controlled or exercised by such director or two or more such directors together or
- Anybody corporate whose board of directors, managing director or manager is accustomed to act in accordance with the directions or instructions of the board or of any of the directors of the lending company.
Non-Applicability of Above Provisions
The above provisions shall not be applicable in the following cases:
- Giving any loan to a managing director or whole-time director either –
- As part of the condition of service that is extended to all its employees or
- Pursuant to any scheme approved by the members by passing a special resolution
- Loan given by any company that provides loans, guarantees or securities in its ordinary course of business and further, interest is charged on such loans at rates not less than the prevailing yield of 1 year, 3-year, 5 year or 10-year government security closest to the tenor of the loan.
- Loan given by a holding company to its wholly owned subsidiary company or any guarantee given or security provided by a holding company in respect of any loan made to its wholly owned subsidiary companies.
- Any guarantee given or security provided by a holding company in relation to any loan made by any bank or financial institution to its subsidiary company.
In the case of points 3 and 4 above, the loans shall be utilized by the subsidiary companies for their principal business activities.
Penalty in Case of Non-Compliance
The company law has placed stringent penal provisions in case of non-adherence. Accordingly, if a loan, advance, guarantee or security is provided in contravention of the above provisions, then the following penal consequences can take place:
- The company shall be liable to a fine which shall not be less than Rs. 5 lakhs but may extend to Rs. 25 lakhs,
- Every officer of the company who is in default shall be liable to imprisonment for a term that may extend to 6 months or with a fine that shall not be less than Rs. 5 lakhs but which may extend to Rs. 25 lakhs and
- The director or any other person to whom the loan, advance, guarantee or security is provided in connection with any loan taken by him or by any other person shall be liable to imprisonment for a term that may extend to 6 months or with a fine that shall not be less than Rs. 5 lakhs but may extend to Rs. 25 lakhs or with both.
Following are the detailed provisions relating to when can companies extend loans to directors. In case you need any assistance in relation to company matters, feel free to contact the ASC Group.