Companies Act Section 185

Companies Act, Section 185: Loans to Directors, etc.

1. Prohibition on Granting Loans to Directors and Related Entities

According to Section 185(1) of the Companies Act, no company is permitted either directly or indirectly to extend any form of loan, including a loan represented by a book debt, or to offer any guarantee or provide any form of security in connection with a loan taken by the following individuals or entities:

(a) Any director of the company, or any director of its holding company, as well as any partner or relative of such director.
(b) Any firm in which any such director or relative is a partner.
This provision is designed to prevent conflicts of interest and self-dealing, ensuring that directors do not misuse their positions to access company funds for personal or connected-party benefits.

2. Permitted Loans to Persons in Whom Directors are Interested- Subject to Conditions

Despite the general prohibition, Section 185(2) allows a company to extend loans (including book debts), or to provide guarantees or securities in relation to loans availed by persons or entities in whom a company’s director is interested. However, this is permitted only if the following conditions are satisfied:

(a) Special Resolution Requirement
The company must pass a special resolution in a general meeting. Additionally, the explanatory statement attached to the notice of the meeting must disclose:
Complete particulars of the proposed loan, guarantee, or security;
The intended purpose for which the funds or support are to be used by the recipient;
Any other relevant facts that stakeholders should be made aware of before voting.
(b) Utilisation for Principal Business
The loan or financial support must be used by the borrowing entity solely for the purposes of its principal business activities.
Explanation: Who Qualifies as a Person in Whom a Director is Interested?
For the purposes of sub-section (2), the term "any person in whom any of the director of the company is interested" includes:

(a) Any private company in which such director is either a director or a member;
(b) Any body corporate in which the director, alone or along with other such directors, controls or exercises not less than 25% of the total voting power;
(c) Any body corporate whose board of directors, managing director, or manager acts in accordance with the instructions of the Board or any director(s) of the lending company.
This aims to regulate financial transactions with closely linked entities that may be subject to the influence of the company’s directors.

3. Exceptions Where Restrictions Do Not Apply

Section 185(3) outlines specific exceptions where the restrictions in subsections (1) and (2) do not apply. These exceptions include:

(a) Loans given to a managing or whole-time director:
As part of the conditions of service applicable to all employees of the company; or
Pursuant to a scheme approved by the shareholders via a special resolution.
(b) Loans, guarantees, or securities provided by a company that is in the ordinary business of financing, provided:
The interest charged on the loan is not less than the prevailing yield of government securities for one-year, three-year, five-year, or ten-year maturities, whichever is closest to the loan's tenure.
(c) Loans granted by a holding company to its wholly-owned subsidiary, or guarantees/security provided for loans taken by such a subsidiary, provided that:
The loan is utilised strictly for the principal business activities of the subsidiary.
(d) Guarantees or security provided by a holding company in respect of loans made by banks or financial institutions to its subsidiary company, again subject to the condition that:
The loan must be used for the subsidiary’s principal business activities.
These exemptions ensure that legitimate business operations and group-level financing arrangements are not impeded by the restrictions of this section.

4. Penalties for Contravention

If any company violates the provisions outlined in this section, whether by advancing a loan, or by giving a guarantee or providing security in contravention of the law, the following penalties shall apply under Section 185(4):

(i) Penalty on the Company:
A fine not less than ?5,00,000 (five lakh rupees), and which may extend up to ?25,00,000 (twenty-five lakh rupees).
(ii) Penalty on Officers in Default:
Every officer of the company who is in default shall be liable to:
Imprisonment for a term that may extend up to 6 months, or
A fine not less than ?5,00,000, and which may extend to ?25,00,000, or both.
(iii) Penalty on the Recipient (Director or Other Person):
The director or the other person to whom the loan was advanced, or in whose favour the guarantee or security was provided, shall be punishable with:
Imprisonment up to 6 months, or
A fine not less than ?5,00,000, and which may extend to ?25,00,000, or both.