LEGAL UPDATES



Relaxing the Prohibitions on Financial Lending between Related Entities in India Download as PDF

01-06-2018

Introduction

The Government of India has enacted the Companies (Amendment) Act, 2017 (“2017 Amendment Act”) which received the President’s assent on January 1, 2018. The provisions of the 2017 Amendment Act are being notified in tranches, with the latest set of provisions being enforced with effect from May 7, 2018. As part of these notified provisions, the much awaited and crucial amendment to Section 185 of the Companies Act, 2013 (“2013 Act”) has also been enforced, which pertains to the lending powers of a company. Prior to the 2017 Amendment Act, the maze of restrictions under the 2013 Act had led the companies into a persistent struggle to structure their lending transactions. 

Earlier Regime: Restrictions imposed by Section 185 under the 2013 Act

Section 185 under the 2013 Act1 created hurdles in fund raising and credit lending within group companies. It prohibited a company from providing loans, guarantee or security to any of its directors or any other person in whom the director is interested. The meaning of the phrase “person in whom director is interested” was very wide and included within its ambit, a private company in which a director (of the lending company) is a director or member, any firm in which a director (of the lending company) or his relative is a partner and any body corporate whose management acts as per the directions of the lending company.

The restrictions under Section 185, however, did not apply to: 

  1. giving of loans to managing or whole-time directors
  2. loans, guarantees or securities provided by a company in its ordinary course of business
  3. any loan, guarantee or security provided by a holding company to/for its wholly-owned subsidiary
  4. any guarantee or security provided by a holding company for any subsidiary against loans availed by the subsidiary from banks or financial institutions, provided loans covered under (3.) and (4.) are utilised only for the principal business activities of the borrowing entity (“Exemptions”).

With the definition of “person in whom the director is interested” being of wide import, and the exemptions being limited and narrow, the aforementioned restrictions resulted in constricting the scope of intra-group lending. 

Current Regime: Highlights of changes in Section 185 under the 2017 Amendment Act

The 2017 Amendment Act has replaced Section 185, as it existed under the 2013 Act. The substituted provision has revamped the provisions pertaining to providing loans and giving of guarantees/securities by companies.

While the 2017 Amendment Act continues to restrict giving of loan, guarantee or security to/for any director of a company/holding company or any firm in which such director (or his relative) is a partner, the amended Section 185 permits an entity to extend loans and/or provide guarantees to “persons in whom director [of the lending company] is interested”. Such loans or guarantees/securities can, however, be provided if the following two conditions are met:

  1. the loan, guarantee or security has to be utilized by the recipient company for its principal business activity;
  2. the loan, guarantee or security has to be approved by the shareholders of the lending company by way of a special majority, at a general meeting.

The 2017 Amendment Act has retained all the Exemptions. Therefore, the lending company does not require a special resolution from the shareholders approving the loan/security/guarantee, if the loan/guarantee falls within the ambit of any one of the four Exemptions.
Further, the 2017 Amendment Act has extended the scope of the penal provisions and brought any ‘officer’ of the company within its ambit. This has created an obligation on every ‘officer’ of the company to ensure compliance with the provisions of the 2017 Amendment Act. Under the 2013 Act, penalties were imposed only on the non-compliant companies or directors or any person who benefitted from the loan, guarantee or security.

Conclusion

The amendment to Section 185 under the 2017 Amendment Act relaxes the funding and lending options in case of wholly owned subsidiaries and group companies. While this is a welcome change, it also extends the penal provisions to ensure higher compliance without hampering the ability to extend and receive loans, guarantees, and securities between such companies.

For more details, please contact [email protected]


1 Pursuant to the June 5, 2015 notification, certain private companies were exempted from the ambit of Section 185 and were as such not required to comply with the conditions and restrictions under the said provision. This exemption continues to be applicable to the relevant private companies post-enactment of the amended Section 185.


Last Updated on 25th January 2019

© 2019 J. Sagar Associates All Rights Reserved.