Section 185 of the Companies Act, 2013 vis-a-vis Section 295 of the Companies Act, 1956

The Companies Act, 2013 received the assent of the President of India on 29th August, 2013 and was published in the Gazette of India on 30th August, 2013. Since then the Ministry of Corporate Affairs has initiated the process to implement the new Companies Act and placed the Draft rules and Forms on its website in a phased manner for inviting public suggestions and comments. In furtherance of its efforts, the Ministry has notified 98 sections of the Companies Act, 2013 to come into force with effect from 12th September 2013.

Among 98 Sections notified, Section 185 of the Companies Act, 2013 (New Act) contains provisions relating to loan to director, etc and provides the circumstances and manner in which a company shall advance any loan to any of its directors or to any other person in whom he is interested or give any guarantee or provide any security in connection with any loan taken by him or such other person. Section 185 of the New Act corresponds to Section 295 of the Companies Act, 1956 with certain modifications. Further in terms of General Circular No.16/2013, Section 295 has ceased to have effect from 12th September 2013.

A brief summary of changes incorporated in the Section 185 of the new Act is given below for easy understanding:

	Section 295 of the Companies Act, 1956	Section 185 of the Companies Act, 2013
Approval	Prior approval of Central Government was required. Power was delegated to Registrar of Companies.	Shareholders’ consent is required. No need to approach Central Government for any approval.
Eligible Directors	Loan could be provided to any director, whether executive or non-executive with the approval of the Central Government, wherever required.	Loan to Non-executive Directors is clearly prohibited. However, loans to managing and whole time directors are allowed subject to conditions provided in the section.
Exemptions	Private Companies were not covered under this section.	This section is now applicable even to Private Companies.
	Loan made/ Guarantee given/ Security provided by a holding company to its subsidiary company was exempted.	No exemption to holding company has been provided.
Penalty  for contravention	Parties to the contravention were punishable with fine of Rs.50,000/- or with simple imprisonment for  term which may extend to 6 months.	Company - Fine not less than Rs.5,00,000/- but which may extend to Rs.25,00,000/-. Director/any person to whom the loan is made - Fine not less than Rs.5,00,000/- but which may extend to Rs.25,00,000/- for the company or with simple imprisonment for  term which may extend to 6 months or with both.

The intention of Section 185 is to prohibit loans by a company to its directors or relatives of directors or other entities in which such directors have any interest or concern. The new Section 185 seeks to simplify the approval process on one hand by moving onto shareholder’s approval based regime and increase transparency on the other hand by including erstwhile exempted transactions/ persons within its purview.

Since section 185 of the Companies Act, 2013 has already come into effect, we should be aware of the significant changes in this section as compared to ceased Section 295 of the Companies Act, 1956.

1. Prohibition to advance loan except to MD/WTD:

As per Section 185, a company is explicitly prohibited from advancing loans/ giving guarantees/ providing securities to the following parties (similar parties covered under ceased Section 295):

(a) any director of the lending company, or of a company which is its holding company or any partner or relative of any such director;

(b) any firm in which any such director or relative is a partner;

(c) any private company of which any such director is a director or member;

(d) 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

(e) 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.

Earlier, if a public company or its subsidiary wanted to advance any loan to any of the abovementioned parties, it required previous approval of the Central Government (powers delegated to ROC) and on receipt of the approval, the company could easily enter into transactions covered by ceased Section 295 of the Companies Act, 1956.

But now, with the introduction of Section 185 of the Companies Act, 2013 no company is allowed to advance any loan/ give any guarantee/ provide any security to any of the parties as mentioned above except advancing loan to the managing/ whole-time director subject to the specified conditions discussed next.

2. Eligible Directors:

Under the ceased Section 295, a public company or its subsidiary, with the approval of Central Government, could advance loan to “any director” which expression included both executive and non-executive directors. Further, granting of house building loans by public companies to its managing/ whole-time directors in terms of any scheme laid down by the Company did not require any approval from the Central Government. It was specifically exempted by the Department of Company Affairs vide its Press Release dated 20.08.1993.

Under the new Section 185, a company cannot give any loan to its non-executive directors/ part time directors. Further, the company can advance loan to its managing/ whole-time directors only if any of the following conditions are satisfied:

(i) the loan is given to MD/WTD as part of the conditions of service extended to all the employees.i.e. no special treatment should be provided to the Directors.; or

(ii) the loan is given pursuant to any scheme (Housing Scheme) formulated by the company with the approval of the shareholders by a special resolution. Once such schemes are approved by the shareholders by special resolution, loans under such schemes may be allowed to eligible directors, without again going to shareholders for approval.

3. Shareholder’s approval based regime:

The requirement of approval of Central Government has been completely done away with under the new Section 185. Shareholder’s approval is enough. This is based on the following recommendation made by The Irani Committee on new Company Law (2005) in connection with restrictions for loans to directors:

“―5.1 Generally the directors should not be encouraged to avail of loans or guarantees from companies. They should be allowed remuneration or sitting fees only. In case company decides so, loans to directors should be allowed only when company by special resolution approves such loans. Disclosures to be made to shareholders, through the explanatory statement, should be specified in the rules. It should be open to a company to formulate schemes (such as Housing Loan Schemes) for the benefit of Executive Directors. “

4. Erstwhile exempted Parties covered:

(i) It is very common in private companies to advance loans to directors. Advance of loan to its directors by private companies were not covered under ceased Section 295. Section 295 of the Companies Act, 1956 was not applicable to private companies.

But under the new Section 185, no such exemption is available to private companies. Even private companies shall be required to now follow the procedure of obtaining shareholder’s approval for advancing loan to its MD/WTD, even though it shall remain a mere formality considering their closely-held nature or include it as a part of conditions of service extended to all employees.

(ii) Any loan made by a holding company to its subsidiary company, which was earlier exempted, is now covered under Section 185 of the Companies Act, 2013.

As on 31.12.2012, 78 applications were pending before the Central Government for approval under ceased Section 295 of the Companies Act, 1956. Now after the commencement of Sec 185 of Companies Act, 2013, it has to be seen how the Ministry deals with such pending applications. Also clarifications are expected in respect of existing loans already granted by the companies to its directors/holding to its subsidiary under ceased Section 295 but not fulfilling the conditions laid down under Section 185 of the new Act and still due for repayment such as the time limit within such loan shall be repaid, time period within which necessary approvals as applicable to be obtained, etc.