Amendment to Section 185 of the Companies Act, 2013 – A Step towards Business Growth

[Mr. Arjun Gopalakrishnan]

The author is a Legal Manager at ICICI Bank Limited

Introduction

Section 185 of the Companies Act, 2013 imposes restrictions on a company in relation to advancement of loans to the directors or any other person in whom the director is interested and providing guarantees/securities in connection with the loans taken by the director or such other person. Subsequent to the Companies Amendment Act, 2017[1] and the Ministry of Corporate Affairs (“MCA”) notification dated May 7, 2018[2], Section 185 of the Companies Act, 2013 (“Original S.185”) stands amended (“Amended S.185”). The amendment is intended to relax the restrictions that were originally imposed by the section, consequentially promoting operational convenience.

Analysis of the Amendment

In order to address the issues in Original S. 185 and to make the section less stringent, the entire section has been substituted by Amended S. 185. The below- mentioned are the important amendments that have been made to Original S.185:

1. Deletion of the non-obstante clause:

The text of Original S.185 started with “Save as otherwise provided in this Act” which meant that if there were other provisions in the Companies Act, 2013 that allowed lending, as covered under Original S.185, then such specific provision would prevail over the prohibition under Original S.185. This resulted in a lack of clarity as to whether the specific provision of Section 186 of the Companies Act, 2013 which starts with “Without prejudice to the other provisions” would exclude the prohibition imposed by Original S.185. To bring an end to the ambiguity, the words “Save as otherwise provided in this Act” have been omitted in the Amended S.185.

2. Partly prohibitive and partly restrictive nature of Amended S.185:

The restrictions that were placed by Original S.185 have been substantially relaxed vide the amendment. In a scenario where none of the exemptions to Original S.185 are applicable, the section places a blanket prohibition on a company (the “Lending Company“)[3] from providing a loan to or providing security/guarantee in relation to a loan (such loan, guarantee, or security will hereinafter be referred to as the “Assistance”) taken by, a director of the Lending Company or any other person the director is interested in.

The expression “any other person the director is interested in” has been defined as:

(a) any director of the Lending Company, or of its holding company, or any partner or relative of any such director; or

(b) any firm in which such director or relative is a partner; or

(c) any private company of which any such director is a director or member; or

(d) any body corporate at a general meeting of which 25% or more of the voting power is exercised or controlled by any such director(s); or

(e) any body corporate, of which the board, managing director or manager is accustomed to act with the directions or instructions of the board, or any of the director(s) of the Lending Company.

The following exemptions are available under Original S.185:

(i) The provisions of Original S. 185 do not apply to private companies that fulfil all of the following conditions: (a) no other body corporate has invested in the share capital of such private company, (b) the borrowings of such private company from banks and financial institutions or any body corporate is less than twice its share capital or 50 crores, whichever is lower, and (c) such private company has no default in the repayment of such borrowings subsisting at the time.

(ii) The prohibition under Original S.185 will not apply if the Lending Company is providing Assistance to or in relation to a loan advanced to its wholly owned subsidiary (“WoS”) subject to the Assistance being in relation to an activity that forms a part of the principal business activities of the WoS.

(iii)The prohibition under Original S.185 will not apply if the Lending Company is providing Assistance to its subsidiary which is not its WoS, in the form of security or guarantee for a loan provided to the subsidiary, subject to the Assistance being in relation to an activity that forms part of the principal business activities of the subsidiary.

(iv) The prohibition under Original S.185 will not apply if the Lending Company is providing Assistance to its managing or whole-time director in the form of a loan, as a part of the conditions of service extended by the Lending Company to all its employees, or pursuant to any scheme approved by the members of the Lending Company by a special resolution.

(v) The prohibition under Original S.185 will not apply if the Lending Company is one which in the ordinary course of its business provides Assistance, provided an interest is charged in respect of such loans, at a rate not less than the bank rate declared by the Reserve Bank of India (“Ordinary Course of Business Exemption”).

Pursuant to the amendment, the definition of “any person in whom any of the directors of the company is interested in” has been modified and in a case where none of the exemptions apply, the prohibition under Amended S.185 would become applicable in the below-mentioned manner:

(i) A blanket prohibition under Amended S.185 will apply in relation to an Assistance provided by the Lending Company, to, or in relation to a loan taken by:

(a) any director of the Lending Company, or of its holding company, or any partner or relative of any such director

(b) any firm in which any such director or relative is a partner

(ii) In relation to an Assistance provided to, or in relation to a loan taken by “any person in whom any of the directors of the company is interested in”, the Lending Company is now permitted to do the same subject to the passing of a special resolution in a general meeting with the explanatory statement to the notice of the general meeting clearly disclosing the full particulars of the Assistance provided and the purpose for which the same would be utilized by the Beneficiary. It is pertinent to note that the special resolution should be passed prior to providing the Assistance[4] and the Assistance must be used only for the principal business activities of the borrowing company.

The expression “any person in whom any of the directors of the company is interested” has been defined as:

(a) any private company of which any director of the Lending Company is a director or member; or

(b) any body corporate at a general meeting of which 25% or more of the voting power is exercised or controlled by any director(s) of the Lending Company; or

(c) any body corporate, of which the board, managing director or manager is accustomed to act with the directions or instructions of the board, or any of the directors of the Lending Company.

The rationale behind this amendment seems to be that when the shareholders themselves are approving the disposition of funds, the law need not create a bar on the same. It is pertinent to note that with respect to the exemptions applicable to Amended S.185, status quo has been maintained. However, in relation to the Ordinary Course of Business Exemption, the rate of interest will now be 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.

3. Extension of penal provisions:

The Amended S.185 has extended the penal provisions to officers of the company who are in default. Such an officer shall be punishable with imprisonment for a term which may extend to six months or with fine which shall not be less than five lakh rupees but which may extend to twenty-five lakh rupees. For the purpose of this section, an officer of the company would include any director, manager or key managerial personnel or any person in accordance with whose directions or instructions the Board of Directors or any one or more of the directors is or are accustomed to act.[5]

Conclusion

The prohibitions that were imposed by Original S. 185 created insurmountable challenges to the business operations of certain groups, especially those investees who were largely dependent on investors. Ever since these challenges became prominent, the MCA has been taking steps to bring relief to the affected concerns. The amendment made to S.185 vide the Companies Amendment Act, 2017 is another major step towards the same. The amendment, while bringing about legislative clarity to Original S.185, is also a welcome move to encourage business in India by ensuring that the manacles of a stringent law do not suffocate the course of growth in business.

[1] The Companies Amendment Act, 2017, http://www.mca.gov.in/Ministry/pdf/CAAct2017_05012018.pdf.

[2] Ministry of Corporate Affairs, Notification, S.O. 1833(E) (Notified on 07/05/2018), http://www.mca.gov.in/Ministry/pdf/CompaniesAmendmentNoti_07052018.pdf.

[3] The term “Lending Company” denotes the company providing the Assistance, and not the lender that provides the loan which is supported by the Assistance.

[4] Companies Law Committee, Report of the Companies Law Committee, (February 1, 2016), http://www.mca.gov.in/Ministry/pdf/Report_Companies_Law_Committee_01022016.pdf.

[5] The Companies Act, 2013, Section 2(59).