India: Loans To Directors – Companies Act Of 1956 Vs. Companies Act Of 2013

LOAN TO DIRECTORS U/S 295

Under the Companies Act, 1956 the provisions relating to Loan to directors by a Company were governed by Section 295 of the Companies Act, 1956. Section 295 of the Companies Act, 1956 had a wide scope and for the purposes of Section 295 of the Companies Act, 1956, there was no distinction between the loan and deposit. The provisions of the said section were applicable even if the monies advanced to the directors are shown as deposits or described as deposits as in both the cases the relationship created is one of the creditor and the debtor.

Furthermore, the Government of India had issued guidelines providing stringent norms for loans or corporate guarantee or furnishing security under Section 295 of the Companies Act, 1956 to the directors of the companies or their relations. Such conditions inter alia provided that the rate of interest proposed on the loan must not be less than 4 percent above the prevailing bank rate as the standard rate made public under Section 49 of the Reserve Bank of India Act, 1934 and the quantum of loan with the other loans taken, if any, should not exceed 25 times the gross salary drawn in the preceding 6 months prior to the making of the application. Also, no guaranteed commission was allowed to anyone in respect of the proposals.

Further, an application is required to be accompanied by the declaration that the Company has not defaulted in making repayments to the investors as and when their deposit becomes due for the payment and the statutory auditors or the Company Secretary in Practice shall certify that the proposal is on conformity with the provisions of Section 372A of the Companies Act, 1956 and the Company has not defaulted in the repayment of any fixed deposits accepted by the Company under Section 58A of the Companies Act, 1956 or part thereof or interest thereon or payment of dividend, redemption and repayment of debenture and timely payment of interest thereon, redemption of preference shares, and regularity of company in filing all forms and returns as per the provisions of the Companies Act, 1956. Also, in case there is any term loan subsisting on the Company, a no objection certificate or prior approval is required from such lender.

LOAN TO DIRECTORS U/S 185

After being assented by both the houses, certain provisions of the Companies Act, 2013 were brought in force and Ministry of Corporate Affairs vide its circular dated 12.09.2013 enforced 98 sections of the Companies Act, 2013 which also contained the Section 185 of the Companies Act, 2013 which deals with the provisions of Loan to Directors henceforth. Section 185 of the Companies Act, 2013 reads as follows:

185. Loan to Directors etc.

(1) Save as otherwise provided in this Act, no company shall, directly or indirectly, advance any loan, including any loan represented by a book debt, to any of its directors or to any other person in whom the director is interested or give any guarantee or provide any security in connection with any loan taken by him or such other person:

Provided that nothing contained in this subsection shall apply to—

(a) the giving of any loan to a managing or wholetime director—

(i) as a part of the conditions of service extended by the company to all its employees; or

(ii) pursuant to any scheme approved by the members by a special resolution; or

(b) 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 loans an interest is charged at a rate not less than the bank rate declared by the Reserve Bank of India.

Explanation.—For the purposes of this section, the expression "to any other person in whom director is interested" means—

(a) any director of the lending company, or of a company which is 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;

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

(d) any body corporate at a general meeting of which not less than twenty five per cent. of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together; or

(e) any body corporate, the Board of directors, managing director or manager, whereof is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company.

(2) If any loan is advanced or a guarantee or security is given or provided in contravention of the provisions of sub-section (1), the company shall be punishable with fine which shall not be less than five lakh rupees but which may extend to twenty-five lakh rupees, and the director or the other person to whom any loan is advanced or guarantee or security is given or provided in connection with any loan taken by him or the other person, shall be punishable with imprisonment 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, or with both.

With the Section 185 coming into force from 12.09.2013, the position for the loan to directors has been changed. Section 185 of Companies Act, 2013 can be understood by dividing its provisions as follows:

RESTRICTIONS

No Company shall directly or indirectly advance any loan, including any loan represented by a book debt, to any of its Directors or to any other person in whom the Director is interested, or give any guarantee or provide any security in connection with loan taken by Director or such other person.

Thus, a Company (hereinafter referred to as 'Lending Company') cannot advance a loan to:

  • Any Director;
  • Any Director of Holding company of the Lending company;
  • Any Partner or Relative of any such Directors mentioned above;
  • Any Firm in which any such Director or Relative is partner;
  • Any Private Company of which any such Director is a Director or Member of Lending Company;
  • Any Body Corporate (i.e. Company or LLP) at a general meeting of which not less than 25% of total voting power may be exercised individually or jointly by any such Director/(s) of Lending company;
  • Any Body Corporate, the Board of Directors of which is controlled by the any Director(s) of Lending Company.

EXEMPTIONS

The aforesaid restrictions are not applicable to:

  • Giving any loan to the Managing or Whole-time Director in following manner:–

(i) as a part of the conditions of service extended by the company to all its employees;

(ii) pursuant to any scheme approved by members vide special resolution.

  • A Company which provides loans in the ordinary course of its business and interest in respect of such loans is charged at a rate not less than Bank rate declared by RBI.

PENALTIES

On Lending Company

In case of contravention of this section, the Lending Company shall be punishable with a minimum fine of Rs.5 lacs but which may extend to Rs.25 lacs;

On Recipient Director/ Entity

In case of contravention of this section, the recipient Director or other entity shall be punishable with imprisonment which may extend to six months or with a minimum fine of Rs.5 lacs but which may extend to Rs.25 lacs, or with both.

CONCLUSION

With the new regime in place with respect to loans to directors, it can be concluded that no company can offer loan to its directors except in case 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, or such company is in the business of extending loans. The provisions of Section 185 of the Companies Act, 2013 does not provide any exemption to a private company as provided in the provisions of Section 295 earlier. However, the company whose primary business is that of lending, is exempted from the provisions of Section 185 of the Companies Act, 2013. The said change is anticipated to bring the better governance & transparency in the affairs of the Companies in the light of the applicable laws keeping in view the fiduciary character of the directors of the Company.

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.

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