Section 185 of Companies Act 2013 deals with prohibitions, relaxations and exemptions on the part of companies towards lending of loans, providing security & guarantee to the directors of such a company or any other person in whom directors are interested. It also deals with the penalty in case of contravention of the provisions of the section takes place.

Purpose of section 185 of companies act 2013

When Companies Act 1956 was in force, public companies used to grant loans, guarantees and securities on a prior permission of Central Government. Companies were used to borrow funds and pass them to the subsidiaries. However, in case of any issue, subsidiaries were left on their own to tackle it.

That’s when Section 185 of the Companies Act was formed putting certain restrictions for granting loans.

• It explains the provisions under company law related to direct or indirect loans or advances to the directors by the company.
• Section 185 of Companies Act 2013 also explains the penalty for contravention of Provisions of Section 185 of Companies Act, 2013.

PROVISIONS OF SECTION 185(1):

It states that, no Company shall, directly or indirectly, advance any loan (including book debt) or give any guarantee or provide any security in connection with any loan taken by:

Prohibits providing of loan or guarantee or security to the below mentioned individuals and firms-

• Any Director of the Company or
• Any Relative of such Director or
• Any Partner of such Director or
• Any Director of its Holding Company or
• Any Relative of the Director of its Holding Company or
• Any Partner of the Director of its Holding Company or
• Any Firm in which any of the above mentioned Director is a Partner or
• Any Firm in which Relative of the above mentioned Director is a Partner

PROVISIONS OF SECTION 185(2):

It states that a Company can advance any loan (including book debt) or give any guarantee or provide any security in connection with any loan taken by any person in whom any of Director of the Company is interested subject to the conditions:

“Any person in whom any of Director of the Company is interested” means following list of persons:

• any private company of which any such director is a director or member
• 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
• 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.

And subject to conditions are:

• Pass Special Resolution in General Meeting and
• Loan must be utilised by the borrowing Company for its Principal business activities

Exemption provisions (Section 185) (3):

This section provides exceptions to the restriction on the company for granting loans. A company can give a guarantee or advance loans or security to:

• The whole – time director or managing director as a part of the conditions of service extended by the company to all of its employees or pursuant to any scheme approved by the members of the company by a special resolution.
• A loan given by a holding company to its wholly owned subsidiary company or any guarantee provided by a holding company in respect of any loan made to its wholly owned subsidiary company. 
• A company that provides loans or gives securities or guarantees for the repayment of any loan in the ordinary course of its business. The interest on such loans advanced is charged at a rate for not less than the rate of prevailing yield of one year, three years, five years or ten years closest to the tenor of the loan.
• Any security or a guarantee is given by a holding company in respect of a loan made by any financial institution or bank to its subsidiary company. The subsidiary company must utilize these loans for principal business activities.

Penalty provisons (Section 185) (4):

• The lending company will be punished with the fine of less than Rs. 5 Lakhs; this may extend to Rs. 25 Lakhs.
• Every officer who would be in default shall be liable to be punished with imprisonment which may extend to six months or with fine which shall not be less than Rs. 5 Lakhs, but may also extend to Rs. 25 Lakhs.
• A person or any person related to the director to whom any loan is advanced or any security is given will be liable to be punished with the imprisonment for six months or with fine which shall not be less than Rs. 5 Lakhs, but may also extend to Rs. 25 Lakhs or with both.

Checklist for Section 185:

The points to be remembered under Section 185 of the Companies Act while advancing loans or providing security/guarantee with connection to any loan:

• A company cannot advance loans to directors, relatives or partners. Any security or guarantee with connection to loan can also not be provided to them. 
• A company cannot advance loans to a firm in which a director is a relative or a partner. Any guarantee or security with connection to any loan can also not be provided to them. 
• Loans, guarantee or security can be given to the person in whom the director of the company is interested after passing a resolution in the general meeting.
• Only the persons and entities mentioned in Section 185 (2) are considered as persons in whom the director of the company is interested. Hence, the company is required to check if the persons to whom they want to grant loan comes under the list of persons mentioned in section 185 (3) of the Act.