First of all we need to understand that the Companies Act 1956 had much liberalised structure for providing loans to directors. Companies used to borrow funds and pass them to subsidiaries as intercorporate loans, but there was visible compliances issues when it comes to compliance with the terms of loan agreement.
Section 185 of the Companies Act have specific terms and conditions for providing loans to directors. It lays down certain restrictions with regard to granting of loans to directors. This is done to have better monitoring on their working.
Before the Amendment Act 2017, the provisions were like, the companies were prohibited from advancing any loan and/or giving guarantee or security for loans taken by Directors or any other persons in whom the director is interested. The act provides for penalties for non compliance to companies or any recipient to whom such a loan, security or guarantee is provided.
After the Amendment Act 2017, there are limits on the prohibition on loans, advances, etc to directors of the company or its holding company or any partner of such director or nay partner of such director or any firm in which such director or relative is a partner.
Amended section allows the company to give a loan or guarantee or provide security in connection with any loan to any person/ entity in whom any of the Directors are interested, subject to the following conditions:-
–Special Resolution by the company in a General Meeting (At least 75% of the members approval is required).
– funds should be utilised by the borrowing company solely for its principal business activities.
Penal provisions are amended to include the officer in default of the company, which can be Director, Manager of Key Managerial person or any person in accordance with whose directions Board of Directors are accustomed to act.
Special provisions with regard to loans given to directors are provided in the section. Loans to Managing Director or Whole time director may be given only if the following conditions are met with
– Where it is part of the Policy of Service of the company to grant loans to all employees.
– Pursuant to any scheme which is duly approved by the members by way of a Special Resolution
Company can provide loans , guarantee or security to its wholly owned subsidiary and it should be used for its principal activity of business only.
Loans also can be given to other companies in the ordinary course of business, if the rate of interest charged on such loans is not lesser than the rate prescribed by the RBI at that time.
Banks and financial institutions can provide loans to subsidiary companies, if the loan is guaranteed by the holding company or security is provided by the holding company. And also it is to be note that the amount is used for the principal business of the subsidiary.
Penalty Provisions
In any case where Section 185 is not complied with:-
– The Lending Company will be punishable with a fine not less than Rs. 5 lakh which can be extended to Rs 25 lakh (maximum).
– Any officer in default will be punishable with imprisonment for a term which may extend to 6 months or fine which shall not be less than Rs.5 lakh but which may extend to Rs.25 lakh.
– The recipient of the loan will be punishable with imprisonment which may extend to 6 months or with fine which shall not be less than Rs.5 lakhs but which may extend to Rs.25 lakhs or with both.