Companies Act Section 186

Companies Act, Section 186: Loans and Investments by a Company

Section 186 of the Companies Act, 2013 governs the extent to which a company may provide loans, make investments, offer guarantees, or provide securities to other entities. The section aims to ensure financial prudence and transparency in inter-corporate financial transactions and to curb misuse of corporate resources by management. The provisions apply to all companies, subject to certain exceptions, and are designed to promote accountability and protect the interests of stakeholders.

1. Restriction on the Number of Layers in Investment Structures

As per Section 186(1), a company is not permitted to make investments through more than two layers of investment companies, unless otherwise prescribed. This limitation is meant to prevent the creation of complex and opaque investment structures that can obscure beneficial ownership and financial accountability.

Exceptions to This Rule:

A company may acquire another company incorporated outside India even if that foreign entity has more than two layers of investment subsidiaries, provided such structure is permissible under the laws of the foreign country.
A subsidiary company may hold an investment subsidiary if it is mandated by any prevailing law or regulation.
2. Limits on Loans, Guarantees, Securities, and Investments

Under Section 186(2), a company is restricted in the extent to which it may:

(a) Grant loans to any person or body corporate;
(b) Provide guarantees or securities in connection with a loan to any person or body corporate;
(c) Acquire securities of any other body corporate, whether by subscription, purchase, or otherwise.
These transactions must not exceed the following thresholds:

60% of the company’s paid-up share capital, free reserves, and securities premium account, or
100% of the company’s free reserves and securities premium account, whichever is higher.
Explanation: The term "person" in this context does not include employees of the company.

3. Requirement of Special Resolution for Transactions Beyond Limits

If a company proposes to exceed the limits specified under subsection (2), then under Section 186(3):

The transaction must first be authorised by a special resolution passed in a general meeting of shareholders.
Exemptions from Special Resolution Requirement:

Loans, guarantees, securities, or acquisitions made:
To or on behalf of a wholly-owned subsidiary company;
In respect of a joint venture company;
By a holding company acquiring securities of its wholly-owned subsidiary.
However, the company is still required to disclose the details of such transactions in its financial statements as per subsection (4).

4. Disclosure in Financial Statements

Section 186(4) mandates that the company must disclose the following in its financial statements:

Full particulars of loans granted, investments made, guarantees given, or securities provided; and
The purpose for which such financial assistance or acquisition is intended to be utilised by the recipient.
This ensures transparency for shareholders and regulators.

5. Board Approval and Public Financial Institution (PFI) Consent

According to Section 186(5):

No loan, investment, guarantee, or security may be made or given unless a resolution is passed by the Board of Directors at a meeting, with the consent of all directors present.
If the company has any outstanding term loans from a Public Financial Institution (PFI), it must obtain the prior approval of that PFI before proceeding, unless:
The transaction is within the limits specified in subsection (2); and
The company is not in default in repaying any existing loan or interest to the PFI.
6. Limit on Inter-Corporate Loans or Deposits by Certain Companies

Under Section 186(6), companies that:

Are registered under Section 12 of the SEBI Act, 1992; and
Belong to such prescribed classes of companies shall not take inter-corporate loans or deposits beyond prescribed limits. These companies must also disclose the details of such borrowings in their financial statements.
7. Minimum Interest Rate for Loans

As per Section 186(7), any loan provided under this section must carry an interest rate that is not lower than the prevailing yield of Government Securities with tenors closest to that of the loan (i.e., 1-year, 3-year, 5-year, or 10-year securities). This protects the company from losses due to lending at unreasonably low interest rates.

8. Prohibition During Defaults on Deposits

Section 186(8) prohibits a company from:

Granting any loan,
Providing any guarantee or security, or
Making any acquisition if the company is in default in repayment of deposits or interest thereon, whether such default occurred before or after the commencement of the Act.
Such financial misconduct must be rectified before undertaking further financial commitments.

9. Maintenance of a Register

In compliance with Section 186(9):

Every company making loans, investments, or guarantees/securities under this section must maintain a register, containing details as may be prescribed by law.
Under Section 186(10):

The register must be kept at the company’s registered office and must:
Be open to inspection by members;
Allow copies or extracts to be taken by any member upon payment of prescribed fees.
10. Exemptions from Provisions (Other Than Layering Restriction)

Per Section 186(11), except for subsection (1) (regarding layers of investments), the remaining provisions do not apply to:

Loans, guarantees, securities, or investments made by:
Banking companies, insurance companies, or housing finance companies in the ordinary course of business;
Companies engaged in financing industrial enterprises or providing infrastructural facilities;
Investments made by:
Investment companies;
Acquisition of shares pursuant to Section 62(1)(a) or via rights issues;
Non-Banking Financial Companies (NBFCs) registered under the RBI Act, whose principal business is investment or lending.
11. Rulemaking Authority of the Central Government

Under Section 186(12), the Central Government is empowered to make rules for implementing the provisions of this section.

12. Penal Provisions for Non-Compliance

As per Section 186(13), in the event of contravention:

The company shall be liable to a fine of not less than ?25,000, which may extend up to ?5,00,000.
Every officer in default may be punished with:
Imprisonment of up to 2 years, and
A fine between ?25,000 and ?1,00,000.