Section 185 of Companies Act, 2013

Analysis[1] of the provisions of law

Applicable provisions

The provisions of Company law in respect of the following transactions are analysed here in below;

Giving loans to any body corporate (Loans)

Acquisition by way of subscription, purchase or otherwise the debentures of any other body corporate (Investments)

The above transactions have been covered in CA 1956 and CA 2013 under the following sections:

s372A and s295[2] of CA 1956

s186[3] and s185 of CA 2013

Erstwhile position of law - Freedom to private companies due to non-applicability of section 372A and 295 of CA 1956

Section 372A (1) of the Companies Act, 1956 prohibits loans and investment by any company exceeding the limits specified[4] therein unless the procedure[5] prescribed in the said section is followed, subject to the exceptions as laid down in section 372A (8).

The provisions of s372A being not applicable to a private company, vide s372A (8)[6], a private company can give loans or make investments without following the procedure and the conditions mentioned in that section. However, this is subject to compliance of other provisions in Companies Act, 1956 in general and also those specifically governing giving loans or making investments.

The provisions of section 295 of the Companies Act, 1956 governing loans to director, etc. did not apply to a private company. There being no provision in the Companies Act, 1956 specifically concerning giving of loans and making investments by a private company it is a settled position under the Companies Act, 1956 that a private company is free to extend loans and make investments subject only to compliance of general sections like 291 & 292 and 299/303 of the Companies Act, 1956 i.e. without attracting the stipulations in s372A or s295 of the Companies Act, 1956.

Effect of coming into force of section 185 of CA 2013 replacing section 295 of CA 1956

While the provisions of section 295 of the Companies Act, 1956, which stand replaced with section 185 of the Companies Act, 2013 with effect from 12th September 2013[7], were not applicable inter alia to private companies, the later i.e. provisions of s185 of CA 2013 are applicable to all companies.

Thus, the freedom available to private companies due to the non-applicability of section 372A and 295 of Companies Act, 1956 to them is now curtailed to the extent provided in section 185 of the Companies Act, 2013.

According to section 185 (1), a Company cannot give loans[8] to body corporates which qualify under the expression “person in whom the director (i.e. any of its director) is interested”[9]. However, there are exceptions to the general proposition in section 185(1).

The first exception is an implied one, that s185 applies only to loans and not to investments.

The other two exceptions are provided as a proviso to section 185 (1) according to which the sub-section is not applicable to giving of any loan to a managing director or whole-time director[10] and to a company which in the ordinary course of its business provides loans and in respect of such loans an interest is charged[11].

[The phrase at the beginning of section 185; “save as otherwise provided in this Act” has been examined later hereunder.]

Thus, though the freedom that was available to a private company due to the non-applicability of s372A and s295 is restricted due to the replacement of s295 CA1956 by s185 CA 2013, the restrictions has to be read in light of the exceptions to s185. Consequently, in the context of this Article, it can be said that s185 of Companies Act, 2013 does not apply in the following transactions;

Loans to body corporates not covered by section 185[12]

Acquisition by way of subscription, purchase or otherwise the debentures of any other body corporate (Investments) including body corporates which are covered by the expression “person in whom the director is interested”

Loans made by a company to its managing and whole-time director as mentioned above

Loans made by a company in the ordinary course of its business and in respect of which an interest is charged as mentioned above. The phrase “in the ordinary course of business” is explained later hereunder.

Permissible transactions under the present context

Hence under section 185 of CA 2013 read with 372A of CA 1956 the following transactions are permissible;

Loans to body corporates not covered by section 185

Acquisition by way of subscription, purchase or otherwise the debentures of any other body corporate (Investments) including body corporates which are covered by the expression “person in whom the director is interested”

Loans made by a company to body corporates which are covered by the expression “person in whom the director is interested” if such loans are made in the ordinary course of its business and in respect of which an interest is charged as mentioned above

Unsecured transactions

None of transactions mentioned above need to be ‘secured’ by a charge on the assets of the company, as there is no requirement in the Companies Act, 1956 or Companies Act, 2013 which requires such loans or investments to be compulsorily ‘secured’.

However, in this context and from the point of view of the borrower, the provisions of s58A of the Companies Act, 1956 read with Companies (Acceptance of Deposit) Rules, 1975 must be highlighted, according to which any amount received by one company from another company is exempted from the definition of “Deposits”[13]. Debentures are exempted[14] when they are secured or optionally[15] convertible. However, a debenture issued by a company and subscribed by another company can be categorised under “any amount received by one company from another company” and hence exempted[16]. So, even if it is an unsecured debenture, it will not fall outside the exceptions provided in the definition of “Deposits”[17]. Further the definition of ‘Debenture’ as per s2(30) CA 2013 (already in force) says that “debenture” includes debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not.

Charging of Interest

Until s186 CA 2013 is duly notified, the transactions in point 4.1.1 above can be undertaken without charging any interest[18]. The transactions in point 4.1.2 above can be undertaken subject to the terms of its issue and compliance of specific provisions[19] applicable to issue of debentures in addition to general compliance of other applicable provisions of Companies Act.

Future effect when s186 will be notified

Now coming to Section 186 (2) of CA 2013, which shall on its notification replace section 372A of the CA 1956; it covers loans and investments corollary to section 372A. It is applicable to all companies and hence on it notification the provisions of section 186 need to be complied with by private companies also.

Even after the notification of section 186, those loans which do not fall under the exceptions mentioned in section 185 will continue to attract the general prohibition of section 185. Thus, the permissible transactions that can be undertaken by a private company as mentioned in para 4 above will remain same with the addition that the procedural requirements and conditions in s186 must be fulfilled. Detailed discussion regarding the requirements of s186 is outside the scope of this Article.

The phrase “Save as otherwise provided in this Act” in section 185(1) of CA 2013 (saving clause)

This phrase should ideally be interpreted to refer to any other provision in the Act. The word “Save”[20] means “Except” or “Unless”.

Section 186(3) lays down that “Where the giving of any loan or guarantee or providing any security or the acquisition under sub-section (2) exceeds the limits specified in that sub-section, prior approval by means of a special resolution passed at a general meeting shall be necessary.” Thus, it is applicable where loans or investments exceed the limit mentioned in s186(2). In case the limit is not exceeded there is no requirement of passing the special resolution. However, s186 does not mention anything regarding the recipient of the loans, etc. So, it cannot be inferred from the phrase “Save as otherwise provided in this Act” in s185 that the prohibition under section 185 can be overcome by complying with s186. Further as on date the draft rules framed under s186 (12) also do not indicate that the restrictions in s185 can be overcome under s186. Even if by any construction it is concluded that the saving clause refer to s186, it will render the s185 wholly redundant as then under no scenario the restriction laid in s185 would be applicable thereby defeating the intention of the legislature.

The phrase also does not refer to the proviso in S185, as even without the saving clause the proviso remains an exception to s185 (1).

In the circumstances either harmonious construction need to be adhered or the words need to be rejected as excess and useless. Here we have resorted to harmonious construction and hence the saving clause is not to be understood as surplusage as it may refers to other provisions in the Act which may be applicable to loans to Directors, etc. eg. i) s186 w.r.t. the requirement as to special resolution, rate of interest, etc. that needs to be complied (in the present scenario when s186 is not a rule of law, its compliance is out of question); ii) Loans to Directors, etc. by a Banking Company[21]; iii) s188 (not notified) & s192 of CA 2013 (in force). A harmonious construction of the provisions of law need to be adhered to so that proper effect can be given to both s185 and s186.

Meaning of “ordinary course of business” in proviso to section 185(1)

“Ordinary course of business” – As precedents by Indian Courts are scarce, extracts from judgements in English jurisdiction have been taken to clarify the ambit of the phrase.

Whether a particular transaction was within the ordinary course of business was a question of fact and law that had to be determined by a two stage test; the first part being to ascertain whether an objective observer, knowing the company and its memorandum of association, would view the transaction as being in the ordinary course of its business, if so, it then had to be considered whether the document that created showed that the parties had not intended the transaction to be so regarded. [2005] 1 B.C.L.C. 623

What constituted the ordinary course of business having regard to business practices in the commercial world in general in relation to the ordinary operational activities of businesses as going concerns;

that the past practices of the particular company and its dealings with the particular creditor were also relevant considerations; [1998] 2 W.L.R. 441

The Lender need not be banking company in order to be able to lend in the ordinary course of its business as the proviso (b) to Companies Act, 2013 uses the word “a Company” not a banking company. Any company can give loan in the ordinary course of its and what is ordinary course will depend upon the facts and circumstances of each payment.

Issues

A Company intends to give interest free unsecured loan to other private companies in India;

Issue No. 1.1 a)Whether or not the Company can enter into the proposed transaction and if yes, b) what are the relevant compliances required to be done by i) the Lender and ii) the Borrower Companies under the Companies Act, 2013 and the Companies Act, 1956?

Issue No. 1.2 What all are the restrictions/limits on a) the Lender and b) the Borrower Companies in executing the proposed transactions?

Issue No. 1.3 What all are the transactions the Company can enter into without attracting the provisions of section 185 of the Companies Act, 2013?

Reply to Issues 1.1 (a) and 1.3:

The Company can give unsecured loans to other private companies in India provided the transactions do not attract the provisions of section 185 of the Companies Act, 2013.

As opined in para 4, para 5 and para 6 of Section A herein above, under section 185 of CA 2013 read with 372A of CA 1956 the following transactions are permissible;

Interest free unsecured loans to another private body corporates not covered under Explanation to section 185 (1)

Acquisition by way of subscription, purchase or otherwise the zero coupon unsecured debentures of another private company (Investments) including private companies which are covered by the expression “person in whom the director is interested” i.e. explanation to s185(1)

Unsecured loans made by a company to a private company which are covered by the expression “person in whom the director is interested” only if such loans are made in the ordinary course of its business and in respect of which an interest is charged as mentioned above

Reply to Issues 1.1 (b) (i) and 1.2 (a): Compliances, restrictions and limits – Lenders

The Board can exercise the power to make loans or to invest the funds of the Company only by means of a resolution (simple majority) passed at a meeting of the Board.[22]

The Board may delegate its power to a committee on such conditions as the Board may prescribe.[23]

Every such resolution delegating the power shall specify the total amount up to which the funds may be invested, and the nature of the investments which may be made, by the delegate, the total amount up to which loans may be made by the delegate, the purposes for which the loans may be made, and the maximum amount of loans which may be made for each such purpose in individual cases.[24]

An interested director shall disclose his concern or interest at a meeting of the Board of Directors of the Company.[25]

No Special resolution is required where the loan or investment exceeds 60% of the paid-up capital or free reserves of the Company or 100% of its free reserves[26]

No register is required to be maintained by the Company[27] except u/s 303 CA 1956[28] in case of loans made under point (c) above.

Advances made by a company fall outside the purview of s185 of CA 2013[29]

The Board shall be subject to the provisions contained in this behalf in in the memorandum or articles of the company, or in any regulations not inconsistent therewith and duly made thereunder, including regulations made by the company in general meeting.[30]

The company in general meeting can impose restrictions and conditions on the exercise by the Board of any of the powers as mentioned above.[31]

Loans can be interest free or rate of interest can be less than the prevailing bank rate[32] Provided, private company to whom loan is made does not fall within the explanation to s185(1) of CA 2013[33]

If they fall within the explanation to s185 of CA 2013, loan can be given only in the ordinary course of business and interest charged at the bank rate declared by RBI[34]. In order to check whether the transaction is in the course of ordinary business of the lender, the objects of the company as mentioned in it Memorandum, established business practices in commercial world and past treatment should be taken into account.

Reply to Issues 1.1 (b) (ii) and 1.2 (b):Compliances, restrictions and limits – Borrowers

The Board of Directors of a company shall exercise the powers to borrow money, where the money to be borrowed, together with the money already borrowed by the company will exceed aggregate of its paid-up share capital and free reserves, apart from temporary loans obtained from the company’s bankers in the ordinary course of business, only with the consent of the company by a special resolution.[35]

The Board can exercise the power to borrow or issue debentures only by means of a resolution (simple majority) passed at a meeting of the Board.[36]

The Board may delegate its power to borrow otherwise than on debentures to a committee on such conditions as the Board may prescribe.[37]

Every such resolution delegating the power shall specify shall specify the total amount outstanding at any one time up to which moneys may be borrowed by the delegate.[38]

An interested director shall disclose his concern or interest at a meeting of the Board of Directors of the Company.[39]

In case of borrowing by way of issue of debentures, the provisions of s117 CA 1956[40] need to be complied and consequently debenture redemption reserve must be created by the borrower.

The Board shall be subject to the provisions contained in that behalf in the memorandum or articles of the company, or in any regulations not inconsistent therewith and duly made thereunder, including regulations made by the company in general meeting.[41]

The company in general meeting can impose restrictions and conditions on the exercise by the Board of any of the powers as mentioned above.[42]

The Borrower must not fall within the explanation to s185(1) of CA 2013[43] in order to borrow interest free loans

If the Borrower falls within the explanation to s185 of CA 2013, it should take loan only if the lender lends in the ordinary course of business and interest charged at the bank rate declared by RBI[44]

[1] [The scope of discussion in this paper excludes;

giving any guarantee or providing any security in connection with a loan;

loans to persons other than body corporates;

investment other than investment by way of subscription, purchase or otherwise the debentures of any other body corporate.

Hence references to security or guarantee given in connection with a loan, loans to directors, firms, investment in other securities, etc. found in the sections of Companies Act, 2013/1956 analysed below have been consciously avoided to limit the scope in the context of the Article. Further, for this analysis only transactions between private companies have been considered.]

[2] Currently stand Replaced by s185 of CA 2013

[3] s186 of CA 2013 is yet to be notified

[4] sixty per cent of its paid-up share capital and free reserves, or one hundred per cent of its free reserves, whichever is more

[5] i) Prior authorisation by way of Special resolution, See First Proviso to Section 372A; ii) Certain disclosures in the notice of the general meeting in which the special resolution is proposed, See Third Proviso prescribes; iii) unanimous resolution of the Board in a meeting and prior approval of Public Financial Institution. Prior approval of PFI is not required where the limit of 60% has not been exceeded unless there is a default, see Section 372A(2) read with proviso; iv) Loans will attract rate of interest, see s372A(3)

[6] Nothing in section 372A applies to a private company unless it is subsidiary of a public company, see 372A(8)(a)(iii)

[7] Notification dated 12th September 2013 w.r.t. File No. 1/15/2013-CL.V

[8] It must be noted that it applies to loans and not to investment by way of subscription purchase or otherwise the debenture of any other body corporate

[9] Explanation to S185(1).—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.

[10] s185(1) proviso (a) (i) & (ii)

[11] s185(1) proviso (b); interest is charged at a rate not less than the bank rate declared by the

Reserve Bank of India

[12] Explanation to S185(1), cited above, fn7

[13] Clause 2(b)(iv) of Companies Acceptance of Deposit Rules, 1975

[14] ibid, Clause 2(b)(x)

[15] Under the draft rules only compulsorily convertible debentures within 5 years are excluded, also s 2(31) defining “Deposits” under CA 2013 is yet to notified

[16] Clause 2(b)(iv) of Companies Acceptance of Deposit Rules, 1975

[17] ibid, Clause 2(b)

[18] s186(7) lays down that “No loan shall be given under this section at a rate of interest lower than the prevailing yield of one year, three year, five year or ten year Government Security closest to the tenor of the loan.”

[19]sS117 of CA 1956; s71 after its notification read with rules, draft rules do not prescribe interest; debenture redemption reserve is required to be maintained by the issuer under s117 CA1956 as well as s71 CA2013.

[20] A Dictionary of Modern Legal Usage by Bryan A. Garner (1987) states that “save”; is an archaism when used for “except”.

[21] The saving clause in s295 CA 1956 expressly referred to s295(2) which excluded private companies and banking companies. Under s185 CA 2013, private companies are not excluded but banking companies remain excluded by virtue of other provisions in CA 2013, eg. s1(4) & s67(3).

[22] s292 of CA 1956

[23] ibid

[24] s292, CA 1956

[25] s299, CA 1956

[26] s372A(8), CA 1956

[27] ibid

[28] Register of Director

[29] Advances made by companies for purchase of goods material or services fall outside the scope of s185 and are covered by s188 of CA 2013/s297 of CA 1956

[30] s291, CA 1956

[31] s292(5), CA 1956

[32] ibid

[33] S185(1) CA 2013 read with Explanation

[34] S185(1) CA 2013 proviso (b)

[35] S180 (1)(c) CA 2013

[36] s292 of CA 1956

[37] ibid

[38] s292, CA 1956

[39] s299, CA 1956

[40] s71 CA 2013 is yet to be notified

[41] s291, CA 1956

[42] s292(5), CA 1956

[43] S185(1) CA 2013 read with Explanation

[44] S185(1) CA 2013 proviso (b)