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Section 185 of the Companies Act, 2013

When it comes to giving a loan to the directors, sureties, or security to the directors or entities in which the directors have an interest, we are able to find out a lot of favouritism and bias that permeates everyone. Assume that such a transaction is simple to complete. In that situation, it promotes unfair advantages and unethical behaviour among those who have a fiduciary duty to the organization and all of its stakeholders. In order to prohibit top management in the company from abusing their authority, Section 185 of the Companies Act 2013 (the Act) was added. To achieve the double goals of preventing such transactions and making corporate operations simpler, this Section categorises such transactions as prohibitive, conditional, and exempted.

The objective of this Section
Prior to the implementation of the Companies Act, 1956, which allows directors and public companies to give loans, securities, and guarantees without requesting the prior approval of the Central Government.

The legal provision was replaced by Section 185 after the enactment of the Companies Act, 2013 , which imposed the ban on all kinds of companies from lending loans to the directors. However, the intention of the legislators in this regard was very apparent; as the directors have a fiduciary position and are required to make choices in the company's best interests, this clause will stop the directors from using the company's funds for their own gain. Additionally, the money that the business uses is typically borrowed from financial institutions, which means that the money comes from the general population. As a result, the government must exercise restraint.

Due to the fact that this legal clause imposed a broad ban, the Indian companies´┐Żwhich are led and established by promoters´┐Żopposed it. Therefore, they cannot be prevented from utilizing or having access to the money from their own company. The law's incompatibility with the laws of other nations, where a complete ban is not imposed, was another factor in its criticism.

Section 185: Loans to directors, etc.

Who may a company provide a loan to a director?
As per Section 185 of the Company Act, 2013 deals with loans to the director with some prohibitions, and exemptions relating to the lending loans and providing guarantee and security. The purpose of this Section is to prevent any conflict of interest that may arise due to the provisions of loans, guarantees,s or securities to the director which may result in the misuse of the company's funds for personal gain.

Section 185(1) of the Act prohibits the company from directly or indirectly advancing any loan, guarantee, or security to the following:
  • Any director of the Company
  • Any other person in whom the director of the Company is interested.
  • Any other person in the Company which is its holding company.
  • Any firm in which the director or a relative is a partner.

Conditions for granting a loan
under Section 185 (2) of the Companies Act, 2013 permitsthe companies to provide loans or give any guarantee or provide any security. To avail of this exception, the director seeking financial support must fulfill two requirements:

The Company must obtain the approval of the shareholders through a special resolution passed at a general meeting.

The loans so taken must be utilized by the borrowing of the Company for its principal business activities.

Exceptions to this Section
The things which are mentioned in Section 185(1) and Section 185(2) does not apply when the following conditions are fulfilled which are mentioned in Section 185(3) which are as follows:

When a management or full-time director receives a loan as compensation for services rendered by the firm or its workers, or when a plan is approved by the members through a special resolution..

When a company provides a loan or guarantees or securities in the normal course of business, the interest rate on those loans must not be less than the current rate on a government security with a maturity of one year, three years, five years, or ten years, which is close to the terms of loans.

When the loan is made by a holding company for its subsidiary company or any guarantee provided or security has been given by a holding company in respect of any loan is made to its wholly own subsidiary company.

when a holding company has offered a guarantee or provided security for a loan that a bank or other financial institution made to a subsidiary of its for the purpose of the subsidiary's business activities.

Punishment for non-compliance to this Section
Section 185 (4) of the Company Act, 2013 provides a penalty provision according to which if the loan is advanced or a guarantee or security has been provided in contravention then the following punishment will be provided to the following person

The company which provide a loan to a director shall be punishable with a fine which shall not be less than five lakh rupees but which may extend to twenty rupees as well.

Every officer of a company who is in default shall be punishable by imprisonment for a term that may extend to six months or a fine which shall not be less than five lakh rupees but which may extend up to twenty-five lakh rupees as well.

The director or whom the loan is advanced or guarantee or security is given then he shall be punishable with imprisonment which may extend to six months or with a fine of not less than five lakh rupees but which may extend to twenty-five lakh rupees.

Exceptions to the applicability of Section 185
Section 185 shall not applicable on to the following companies

Private Company
The following are conditions when Section 185 does not apply to private company:

The Private Company in whose share capital no other body corporate has invested money.

If a private firm borrows money from a bank or another financial institution for less than twice its paid-up share capital, fifty crore rupees, or the lower of the amounts.

There has no default in the repayment of such borrowings subsisting at the time of making the transactions.

Government Company
Section 185 does not apply to the Government Company which obtain the approval of the Ministry of Department or the Central government which is administratively in charge of the Company or as the case may be, the State Government making any loan or proving any security or guarantee under the section.

Nidhi Company
Section 185 will not be applicable in the case of Nidhi Companies when the loan is given to the director or the relative in the capacity of whom a member and such transactions must be disclosed in the annual account.

Case laws related to Section 185
The following cases related to Section 185 of the Company Act, 2013 are as follows:

Eastern Condiments Pvt Ltd v. ROC, Kerala (2020)
Facts
In this case, the court ordered the company to a fine for granting the loan to the director after passing a special resolution leniently. In this case, the compounding application was filed before the registrar which was transferred to the tribunal for violating the provision of Section 185 of the act by providing a loan to the director in the ordinary business. It was further been stated that the board of directors has approved the loan to another company not amounting to less than 40 lakhs.

Issue:
  • Whether a Special resolution is a need for providing a loan to the director and it should be leniently or strict?
Judgment
The court held that the legislature has taken a lenient view in granting loans to directors after passing a special resolution. Therefore the court ordered me to pay a fine of 5 lakhs. That to deterrent for not repeating the same in the future.

Sardar Raghbir Singh Ahluwalia v. People's Insurance Co. Ltd (1965)
Facts
In the following case, the appellant was employed as the manager of the People's Insurance Company Limited. The company was ordered to be wound up and during the winding-up process, the official liquidator applied under Section 185 against the appellant that he had some amount of money in his possession that belonged to the company and should be handed over to the liquidator.

Issue:
  • Whether Section 185 of the Company Act applicable or not?
Whether the application was barred by the limitation?
Judgment
The court held that the application under Section 185 of the Company Act lies after the winding up has been made and therefore it can have no reference at any point in time prior to winding up. It was also been held that the appellant was an officer the of company at the time when the money was handed over to him therefore Section 185 would be applicable to him. The court has also affirmed that the application against the applicant was not barred by the limitation.

Gaya Sugar Mills Ltd v. Nand Kishore Bajoria and Another (1954)

Facts
In this case, the official liquidator of Gaya Sugar Mills Limited filed an application under Section 185 seeking a sum of Rs 14,77,000 from Nand Kishore Bajoria and Mahadeolal Jhunjhunwala. The company has raised its capital for an ambitious business expansion scheme under Section 153 of the Company Act, 2013 but due to unforeseen circumstances, the scheme could not be implemented. The company found financial difficulty and it eventually wound up. The two respondents were styled as preference trustees who have been given the shares of Ryam Sugar Mill. These shares were sold by them which were in their possession.

Issue:
  • Whether a High Court has jurisdiction to requite the two respondents to pay the sum to the official liquidator under Section 185 of the Company Act?
Judgment
The Supreme Court set aside the order of the lower court and held that no right could be vested in the preference of the shareholder or the so-called trustees on the basis of the document which only contains the proposal and which was never completed or became operative. The court has ordered the respondents to return the amount to Gaya Mills Limited.

Conclusion
The Company Act, of 2013, outlawed all businesses from providing directors with loans, securities, or guarantees in an effort to stop them from utilizing company money for their own gain. Since it made conducting business more difficult, every company, whether public or private, opposed this broad restriction. Then, additional changes were made that enabled private firms to offer loans and, as a result, were exempt from Section 185 of the 2013 Companies Act's application. It is also appropriate for a company to routinely provide loans to its employees. Company law safeguards the rights of all parties involved in the transaction.

Frequently Asked Questions (FAQs)
What activities are prohibited under this Section?
No corporation may extend loans to its "directors" or "other persons in whom directors are interested" directly or "indirectly."

No company can represent a loan by a book of debt to the above-mentioned person.

Can a director of a private firm receive a loan?
A Private Limited Corporation may, with the approval of a special resolution in the meeting and provided that this facility is provided to all of its employees, grant a loan to a management or full-time director of the company.

What does Section 185 intend to achieve?
The purpose of Section 185 of the act is to regulate and restrict the granting of loans and making of investments by the companies to their directors or entities in which the directors have a significant interest. It aims to prevent potential conflicts of interest and ensures that company funds should not be misused.

References:
  • https://ca2013.com/185-loan-to-directors-etc/
  • https://taxguru.in/company-law/Section-185-companies-act.htm
  • https://vakilsearch.com/blog/loan-to-directors-according-to-Section-185-of-company-act-2013/
  • https://www.legalwindow.in/Section-185-of-companies-act-2013/
  • https://blog.ipleaders.in/can-private-company-grant-loan-director/
  • https://www.icsi.edu/media/webmodules/publications/FinalCLStudy.pdf

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