Companies (Amendment) Act, 2017 brings relief under sections 185 and 186

By CS Nikita Snehil | (corplaw@vinodkothari.com)

Manager | Vinod Kothari & Company

The intent behind bringing the amendment in Companies Act, 2013 is to clear the ambiguities in the current provisions in order to strengthen the corporate governance and to help improve ease of doing business in the country. Therefore, in order to remove the ambiguities and to bring clarity, the Companies (Amendment) Bill, 2017 which was passed by Rajya Sabha on December 19, 2017 and received the assent of the President on January 01, 2018[1], has brought many changes. Among the various changes, the present Article deals with the changes brought under the sections 185 and 186 of the Companies Act, 2013.

Changes in section 185

With the very introduction of Companies Act, 2013, section 185, being a prohibitory section, was of great importance. There was no scope of any carve out or any route to apply to Central Government’s approval for non-applicability of such restrictions, unlike section 295 of the Companies Act, 1956. Further, the said section was applicable to both pubic as well as private companies, which was totally unacceptable by private companies. Then MCA vide exemption notification dated June 5, 2015[2] exempted private companies form the provisions of section 185 which brought great relief to the private companies, however, such relief is even subject to stipulated conditions. Therefore, to promote ease of doing business, the entire section has been substituted.

Deletion of the non obstante clause

The extant provision of section 185 starts with the following words “Save as otherwise provided in this Act”, which provides that if there is any other provision of the Act permitting lending as covered by the section then such specific permission shall prevail over this section. This creates confusion as to whether specific sanction of section 186 which starts with “without prejudice to the other provisions” can exclude section 185. To avoid such ambiguity the same has been omitted in the amended provision.

The new provisions of section 185 is partly restrictive and partly prohibitive

The intent of the current provisions of Section 185 is to ensure that directors who hold a fiduciary position with respect to shareholders do not utilize the funds of the company for their own benefit. However, the company laws over the world do not provide for a complete blanket prohibition on advancement of such loans/guarantee/security to directors and their related entities.

It is pertinent to note that where the shareholders of the company, being the ultimate owners, themselves approve the utilization of the funds of the company in the specified manner, the law need not create a bar on the same. Thus, at par with the global company laws, the provision has been amended to remove the prohibition to an extent and provides for the passing of shareholders’ resolution for granting of loans/guarantees/securities to entities in which directors are interested.

The amended provisions are partly prohibitive and partly restrictive. The section continues to prohibit the granting of loan/guarantee/security to some, while restricts the others in the following way:

• Prohibitive to:
• directors of the co., or
• directors of a co. which is its holding co.; or
• any partner of such director; or
• relative of such director
• Restrictive to:
• any private co. of which any such director is a director or member;
• any body corporate at a general meeting of which not less than 25% of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together;
• any body corporate, the BoD, MD or manager, whereof is accustomed to act in accordance with the directions or instructions of the BoD, or of any director or directors, of the lending company.

The amended provisions allow the companies to grant loans/guarantees/securities to entities in which directors are interested, in the above mentioned restrictive cases, subject to prior approval of the shareholders by a special resolution and on the condition that such loans are utilised by the borrower for its principal business activities.

Significance of principal business activity in the amended provisions

In order to ensure that the companies do not take advantage of the relief, the amended provisions ensure that there is no siphoning of funds received by the companies, as the amount received under the section should be utilised by the borrower for its principal business activities and not for further investment or grant of loan.

Further, loans extended to persons, including subsidiaries, falling within the restrictive purview of Section 185 should be used by the subsidiary for its principal business activity only, and not for further investment or grant of loan.

Shareholders’ approval — whether ‘prior’ or ‘post’?

It is pertinent to note that the provisions of the amended law, do not explicitly requires any prior approval, as is the case in section 186 and 188 of the Companies Act, 2013.

Though, the Report of the Companies Law Committee, 2016 recommended the special resolution to be a prior resolution. However, the language of the amended section 185 does not specify whether the special resolution should be prior to advancing the loan/guarantee/security.

Further, as per the provision of the amended law, the explanatory statement to the notice of the general meeting is required to disclose the full details of the loan/guarantee/security given. Thus, one may infer that such resolution may be passed after granting of such loan/guarantee/security.

Rate of interest to be charged for the loans granted under the amended section

As per the Report of the Companies Law Committee 2016, the rate of interest for loans granted under section 185 was proposed to be aligned with section 186(7). Further, the report also suggested that it may not be appropriate to apply Indian interest rates bench marks prescribed under section 186(7) to loans given by companies to foreign entities and the effective yield against the loan given, irrespective of whether the loan is given to a company incorporated outside India should not be less than the prescribed rate under section 186(7).

Though the exemption provided to companies which in the ordinary course of its business provides loans or gives guarantees or securities for the due repayment of any loan requires the rate not to be less than the rate of prevailing yield of one year, three year, five year or ten year Government security closest to the tenor of the loan, however, no such interest rate is provided for the persons falling within the restrictive purview of Section 185.

Extension of the penal provisions

The amended section 185 has extended the penal provisions to an officer of the company, which has been defined in section 2 (59) to include any director, manager or key managerial personnel or any person in accordance with whose directions or instructions the Board of Directors or any one or more of the directors is or are accustomed to act. Therefore, the ambit of the penal provision has been widely extended.

Status of exemptions provided to the private companies

The amended section 185 seeks to completely replace the existing provisions of section 185 of Companies Act, 2013. However, the exemption notification dated June 5, 2015 shall continue to hold good and the amended provisions of section 185 shall be not applicable to private companies subject to the conditions prescribed in the notification.

As per the exemption notification dated June 5, 2015 only those private companies which fulfil the prescribed conditions are exempted from the provisions of section 185. Hence, private companies which do not fulfil the conditions prescribed are subject to the prohibition as per the amended section 185, i.e., the private companies, which do not fulfil the conditions for availing the exemption, will be able to grant loan/guarantee/ security under the restrictive purview.

Comparison between the current and amended provisions of section 185

Changes in section 186

Incorporating MCA’s clarification in the provisions of law

The amended provision clearly excludes employees of the company from the term ‘person’ to whom a company cannot directly or indirectly give loan exceeding the prescribed threshold. The same was clarified by the Ministry vide its General Circular^[3] dated 10th March, 2015. However, the said Circular provided two conditions for such exclusion i.e. the loan being given should be in terms of service policy of the company along with the same being in terms of remuneration policy of the company – these conditions are no more applicable, as the provision directly excludes employees from the term ‘person’.

Exemption from shareholders’ approval in certain cases

As per the amended provisions the shareholders’ approval will not be required where a loan or guarantee is given or where a security has been provided by a company to its:

• wholly owned subsidiary company or
• a joint venture company, or
• acquisition is made by a holding company, by way of subscription, purchase or otherwise of, the securities of its wholly owned subsidiary company.

The exemption will increase the investing power of the company.

Other changes

• The exemption of the non-applicability of the provision of section 186 (except the provision relation to restriction on layers of subsidiaries) has been extended to a rights issue made by a body corporate specifically to include foreign company.
• The meaning of the investment company has been clarified, which is in line with the explanation provided by the RBI in its FAQ’s on NBFC. As per the amended provisions:

“a company will be deemed to be principally engaged in the business of acquisition of shares, debentures or other securities, if its assets in the form of investment in shares, debentures or other securities constitute not less than fifty per cent. of its total assets, or if its income derived from investment business constitutes not less than fifty per cent. as a proportion of its gross income”

The same is also referred as the 50-50 test, and is applied to test whether the company is into financial business or not. Therefore, this provision will bring clarity in determining the non-applicability.

Therefore, the relief brought under both the section will be widely accepted by all and we hope that the said provisions shall be enforced soonest.

[1] http://ca2013.com/wp-content/uploads/2018/01/181439.pdf

[2] http://www.mca.gov.in/Ministry/pdf/Exemptions_to_private_companies_05062015.pdf

[3] http://www.mca.gov.in/Ministry/pdf/Notice_29062017.pdf