The Companies Act, 2013 ("2013 Act") was brought in to address the concerns in the existing corporate law regime. However, the 2013 Act saw issues on account of implementation and operational inconvenience, as well as extreme hardships in doing business because of some of the stringent provisions contained therein. In its efforts to facilitate ease of doing business and remove the hardships faced by the stakeholders, the Ministry of Corporate Affairs ("MCA") constituted the Company Law Committee ("CLC") to take a holistic and comprehensive view and suggest changes in the 2013 Act and the rules made thereunder keeping in mind the difficulties and challenges expressed by various stakeholders. The CLC submitted its report on various issues relating to the 2013 Act on February, 1, 2016. Consequently, after taking the recommendations of the CLC into account, the Companies (Amendment) Bill, 2017 ("Bill") was introduced and passed by the Lok Sabha on July 27, 2017 and is currently pending approval of the Rajya Sabha. Many changes have been proposed in the Bill and herein we discuss one such change, i.e. loan to directors, etc.
The provisions with respect to the loan to directors, etc. are provided in Section 185 of the 2013 Act. As per Section 185 of the 2013 Act, the companies are prohibited from advancing any loan (including loan represented by a book debt) or giving any guarantee or providing any security in connection with a loan taken by the directors of such company or any other person in whom the directors are interested.
The Explanation to Section 185 (1) of the 2013 Act provides that the expression 'to any other person in whom the director is interested' means any director of the lending company, or of its holding company, or any relative or partner of such director; any firm in which the director is a partner; any private company where such director is also a director, any body corporate where a director controls more than twenty five percent voting power or where the board of director or management of a body corporate is accustomed to act in accordance to instructions of a director.
The proviso to Section 185 (1) of the 2013 Act provides for certain exemptions and situations under which, loan can be advanced or guarantee can be given or security can be provided. Such exemptions include (a) where such director is a managing director or a whole time director and such proposed loan is either a part of the conditions of service extended by the company to all its employees or pursuant to any scheme approved by members vide special resolution; (b) where the loan is provided by the companies that are in the business of extending loans, provided the interest charged on such loans is not less than bank rate as declared by the Reserve Bank of India; and (c) where loan is provided 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 company.
In terms of the aforesaid provisions, there was a restriction on providing a loan by the companies to other companies having common directors. This created a lot of hardships for companies from availing a loan from its group companies (unless it is a wholly owned subsidiary). In order to remove such a restriction, the MCA issued a notification in July, 2015 wherein exemption from the provisions of Section 185 of the 2013 Act was provided to private companies pursuant to fulfilment of conditions that (a) no member of the company should be a body corporate; (b) the debt equity ratio should be not more than 2:1 and; (c) the company should not have defaulted in any past borrowings. However, such exemption did not gave any operational comfort to the companies, owing to the conditions that came with it. Most companies still found themselves unable to grant loans to their group companies (having common directors). This would often hinder genuine transactions due to complete embargo on providing loans to subsidiaries / group companies with common directors.
In terms of the amendment proposed to Section 185 of the 2013 Act in the Bill, a company has been permitted to advance loans or give guarantees or provide security in connection with the loan taken by any person in whom the director is interested, subject to the condition that (a) prior approval of shareholders by way of a special resolution is obtained; and (b) such loan may only be utilised for the principle business activities of the borrowing company.
The intent of the rigidity of Section 185 of the 2013 Act was to ensure that directors do not surpass their fiduciary duty towards the company for personal benefit. Keeping that in mind, the Bill still restricts the advancement of loan inter alia to (a) the director of a company; (b) the director of the holding company; (c) any partner or relative of such director; and (d) any firm in which any such director or relative is a partner. It appears that the amendment has been proposed with a rationale that where the shareholders of the company themselves approve the deployment of the funds of the company in a specified manner, the law need not create a bar on the same. In conclusion, the amendments in the Bill is a welcome move to encourage business and allowing it to flourish by ensuring that the shackles of a rigid law do not suffocate the course of growth in business.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
