Section 185,186 & 188 explained

1. Technical Session-I: Loans to Directors &
Related Party Transactions
BY MVSK Ruthvik

2. Section 185-Loans to Directors
Section 186-Inter Corporate Loans
Section 188-Related Party Transactions
Coverage of the Session

3. Section 185: Loans to Directors
• Section 185 of Companies Act, 2013 was notified on 12th
September 2013 and it was applicable from that same day. It
mainly relates to giving of loans by the companies to the
directors of the companies.
• The key points of departure from the 1956 Act that emerge
are the wiping out of any Central Government approvals and
the applicability of the restriction to private and public
companies alike.

4. In Brief, what is
Section 185
About

5. • Section 185 restrict the company on giving loans, guarantee or
provide security to Directors or any other person in whom
Director is interested.
It covers the Director and his relatives too which include:-
1. Any Director of Lending Company.
2. Any Relative of Director of the company.
3. Director of a Company which is its holding company.
4. Any partner of such Director.
5. Any Firm in which Such Director is Partner or a relative is a
partner.

6. However the Below include only Director not relative-
1. Any Private Limited company in which such director is a Director or
member.
2. Any Body corporate in which such Director or Directors hold more
than 25% shares.
3. If such Body Corporate, MD, BOD or manager accustomed to act in
accordance with direction of board or Director of lending company.
However there was huge cry from the corporate for having imposed
such regulations to operate & making business tough to continue.

7. Notification on 5th June 2015
• Section 185 is not applicable to private companies subject to the
following conditions :-
1. Companies where other body corporate have not invested.
2. If borrowing of such company from banks or financial
Institutions or any other corporate is less than twice of its paid
up share capital or र 50 crores whichever is lesser.
3. Such company should not have defaulted in the repayment of
borrowings subsisting at the time of making transactions under
this section
It means that DIRECTORS OF PRIVATE COMPANIES CAN TAKE
LOANS FROM THE COMPANIES subject to above limits.

8. Exceptions To Section 185
Whole time Director/Directors
As a part of service extended to all of its employee
Any Scheme Approved by members by special resolution.
Is such loan is given in ordinary Course of Business. But the
Question is “How to check ordinary Course”?
Is the company engaged in lending activity regularly
Lend not only to Directors and related parties but also to Arm
Length Parties or parties.
In this regard, interest is charged at a rate not less than the bank
rate declared by RBI
Important Point to be noted is that all NBFC may not be engaged in
lending activities in ordinary course.

9. Penalties for non compliance
• The penalties and fines are very hefty as can be seen in section 185(2)
as given below. So all companies including private companies (exceed
the limits prescribed) should take care and ensure strict compliance
with the provisions of section 185 of the Companies Act, 2013.
IN CASE OF COMPANY-
• Company shall be punishable with fine which shall not be less than र्
5,00,000 but which may extend to र् 25,00,000.
IN CASE OF DIRECTOR-
• The director or the other person to whom any loan is advanced or
guarantee or security is given or provided in connection with any
loan taken by him or the other person

10. punishable with imprisonment which may extend to 6 months or fine
which shall not be less than 5,00,000 rupees but which may extend to
25, 00,000 rupees, or with both.
Important Note for exceptions-
• Loan given to Managing Director or Whole Time Director as part
of the conditions of services etc or pursuant to the scheme approved
by the member by Special Resolution.
• A company make loan or give guarantee or provide security in
ordinary course of its business for due repayment of loan. In this
regard interest is charged at a rate not less than the bank
rate declared by RBI.

11. LOANS AND INVESTMENT BETWEEN HOLDING &
SUBSIDIARY COMPANY
Section 185 Exempts loan between Holding Company and
Subsidiary Company
Any loan made by a holding company to its wholly owned
subsidiary company or any guarantee given or security provided
by a holding co in respect of any loan made to its wholly owned
subsidiary co is exempted from the requirements under this
section.
Any guarantee given or security provided by a holding company in
respect of loan made by any bank or financial institution to its
subsidiary company is exempted from the requirements under this
section, provided that loans are utilized by the subsidiary
company for its principle business activities.

12. SECTION 186-INTER CORPORATE LOANS

13. SECTION 186-INTER CORPORATE LOANS
• This is a most important section which is being used by every
company in the ordinary course of business to fulfill its day to day
requirement of Funds, and to optimally use the capital base.
• Every Company wishes to deploy its surplus funds in an optimum
manner within the legal frame work. The Companies Act, 2013 has
come up with a change in the concept of ‘Loan and Investment by
Company.
• This section enlists the exceptions and specifies the limits up to
which a company can give loan or make inter corporate
investments

14. Non Applicability of the section
• Section 186 is not applicable to the following companies-
• Banking Company, Insurance Company, Housing Finance
Company etc.
• Any company whose main business of acquisition of shares or
securities.
• A company should not make investment of its money in more than
Two Layer. The limit has been fixed. It is showing a good sign for
transparency.
• “Layer” in relation to a holding company means its subsidiary or
subsidiaries.

15. Exceptions to 2 layers of investments
1. A company from acquiring any other company incorporated in a
country outside India if such other company has investment
subsidiaries beyond two layers as per the laws of such country.
2. A subsidiary company from having any investment subsidiary for the
purposes of meeting the requirements under any law or under any
rule or regulation framed under any law for the time being in force.
No company shall directly or indirectly involve in the any kind of the
below Specified transactions-
1. Loans to any person or other body corporate.
2. Give any guarantee or provide security in connection with a loan to
any other body corporate or person.

16. 3. Acquisition by way of subscription, purchase or otherwise, the securities
of any other body corporate.
Thebelowarethelimitsforabovekindoftransaction:-
60%of(ShareCapital+FreeReserves+SecurityPremium)
OR WHICHEVER IS HIGHER
100%of (FreeReserves+SecurityPremium)
However, if company wishes to invest or give loan for a amount higher than
the above then a prior approval of Shareholders is required i.e by the way of
passing a special resolution.

17. No investment shall be made/loan given/guarantee or security given by
the company unless,
• The resolution sanctioning it is passed at a meeting of the Board
meeting
• With the consent of all the directors present at the meeting
• And the prior approval of the public financial institution concerned
where any term loan is subsisting, is obtained.
Prior Approval of the public financial institution is required only-
• if the loan, guarantee exceeds the prescribed limit as stated above
Limit
• ensuring that there would be no default in repayment of loan
instalments or payment of interest

18. • As per the general circular 06/2015 dated 9th April 2015 has
clarified that where the effective yield on tax free bonds is greater
than the prevailing yield of one year, three year, five year or ten year
Government Security closest to the tenor of the loan shall not be
considered as the violation of the section 186. Bank rate presently is
8.25 %.
• Every company giving loan or giving a guarantee or providing
security shall keep a register which shall contain such particulars
and shall be maintained in such manner as may be prescribed. Form
MBP-2 Is to be used For This purpose
• Any deviation from the conditions laid under this section, then the
Auditor is required to report the same in his Audit Report. A non
qualified report would hold auditor in default. The lending company
and the receiver both would be liable for the penalty under the same
section.

19. Penalties for contravention
IN CASE OF COMPANY:
The company shall be punishable with fine which shall not be less
than र् 25,000 but which may extend to र् 500,000.
IN CASE OF OFFICER IN DEFAULT:
Every officer of the company who is in default shall be punishable
with imprisonment for a term which may extend to 2 years and with
fine which shall not be less than र् 25,000 but which may extend to र्
100,000.

20. SECTION 188-RELATED PARTY TRANSACTIONS

21. Section 188-Related Party Transactions
• The introduction of Companies Act, 2013 has brought out a new
phase to the corporate sector. To make Corporate Law more
effective, much reliance is placed on the disclosure.
• There are good number of sections which places reliance on
disclosure norms, one of such section is section 188 relating to
'Related Party transaction' which combines the provisions of
Sections 297 & 314 along with some more provisions of the
companies act 1956.

22. Let’s understand some basic definitions
Who is a related party????
A related party is defined as per section 2(76) which includes:-
• a director or a KMP and their Relatives
• a firm, in which a director, manager or his relative is a partner
• a private company in which a director or manager is member or
director
• a public company in which a director or manager is a director of
another company or holds along with his relatives, more than 2%
of its paid-up share capital of such company.
• any body corporate whose Board of Director, Managing Director,
Manager is accustomed to act in accordance with the advise,
directions or instructions of a director or manager.
• any person on whose advice, directions or instructions a director
or manager is accustomed to act Provided such advise,
instructions are given in a professional capacity.

23. • any company which is a holding/subsidiary/associate of such
company. a subsidiary of a holding company to which it is also a
subsidiary;
This provision has been removed in the Recent notifications related
to Exemptions to private companies dated 5th June 2015.
Now lets Understand the meaning of the term “Relative”
Relative refers to any person who is related to another,
Being members of a Hindu Undivided Family;
Husband & Wife or
Any other person who is related to the other in such manner as may
be prescribed as per Schedule 11A.

24. PROVISIONS
• Section talks about the approval which is required in order
to enter into related party transactions.
• The section provides for the various transactions which
cannot be entered into by the company without the consent
of the Board of Directors. Meaning thereby unless the Board
of Directors have given their consent by way of a
resolution at a meeting of the Board, the company cannot
enter into the prescribed transactions.
Section 188(1) prescribes the following transactions:
Sale, Purchase or supply of any goods or materials;
Selling or otherwise disposing of, or buying, property of any
kind;
Leasing of property of any kind

25. Availing or rendering of any services;
Appointment of any agent for purchase or sale of goods,
materials, services or property;
Such related party's appointment to any office or place of
profit in the company, its subsidiary company or associate
company; and
Underwriting the subscription of any securities or
derivatives thereof of the company

26. • As per the notification released on 16th August 2014,
prescribes various threshold limits with respect to the various
transactions as discussed earlier.
• Revised provision states that a company shall not enter into
transactions or transactions without the previous approval of
shareholders, where the transaction(s) to be entered into
involves the following:-
• Sale, purchase or supply of any goods or materials, whether
directly or through any agent and wherein the amount
involved exceeds 10% of the turnover of the company or
र्100 crore, whichever is lower;
• Selling or otherwise disposing of or buying property of any
kind, directly or through any agent and where the amount
involved exceeds 10% of the net worth of the company or
र्100 crore, whichever is lower;

27. • Leasing of property of any kind and the amount involved
exceeds 10% of the net worth of the company or 10% of
the turnover of the company or र्100 crore, whichever is
lower;
• Availing and rendering of any kind of services, directly or
through appointment of agent and which involves amount
10% of the turnover of the company or र्50 crore,
whichever is lower.
• The recent notification dated 5th June 2015 relating to
exemptions to private limited companies however clearly
states that restriction for voting by members being related
party to transaction holds no more valid for a private
limited company.

28. • Appointment of any person in the office or any place of profit in
the company, its subsidiary or associate company at a monthly
remuneration exceeding 2,50,000 INR.
• Remuneration for underwriting of subscription of any
securities or derivatives of the Company exceeding 1% of net
worth of the company.
Notification on 17th July 2014
Transactions arising out of compromises, Amalgamations &
Arrangement shall not attract section 188.

29. • The Notification issued by Ministry provides the explanation
in regard to above provisions that the turnover or the net
worth shall be computed on the basis of the Audited
Financial Statements of the preceding financial year.
• Further the rules provides that, in case of wholly owned
subsidiary, the special resolution passed by the holding
company for entering into the transactions between the
wholly owned subsidiary and the holding company shall
suffice.
• The Ministry provides that the explanatory statement which
is required to be annexed to the notice of General Meeting
shall contain the following:
• Name of the related party,
• Name of the director or key managerial personnel interested in
such transaction

30. • Nature of relationship, material value or monetary terms attached to
such transaction or
• any other information which is necessary or important for the
members for taking the decision on proposed resolution respectively
Consequences on Violation
Where any contract or arrangement is entered into by
a director or any other employee,
without obtaining the consent of the Board or approval by a special
resolution in the general meeting under sub-section (1) and
if it is not ratified by the Board or, as the case may be, by the
shareholders at a meeting within 3 months from the date on
which such contract or arrangement was entered into,

31. such contract or arrangement shall be voidable at the
option of the Board and if the contract or arrangement is
with a related party to any director, or is authorized by any
other director, the directors concerned shall indemnify the
company against any loss incurred by it.
• It shall be open to the company to proceed against the
director or any other employee who had entered into such
contract or arrangement in contravention of the provisions
of this section for recovery of any loss sustained by it as a
result of such contract or arrangement.

32. Penalties for Contravention
In case of listed company
imprisonment for a term which may extend to one year;
Punishable fine which shall not be less than 25,000 but which
may extend to 5,00,000; or
Both
In case of any other company
Punishable fine which shall not be less than 25,000 but which
may extend to 5,00,000.

33. CONCLUSION
• The Amendments introduced by Ministry from time to time is a
welcome step, as these amendments have somehow reduced the
problems that are being faced by the companies
• The notification was released by MCA on 5th June 2015 was
welcome move to many private limited companies as it was
making tough for a small businessman to do business & many
were shifting to LLP’s.
• However coming to Section 185 & 186 there are still some
options left to ensure we can obtain loans like taking loans at a
rate not less bank rate i.e 8.25 % OR restructuring the company
organization in such a way that directors of one company don’t
represent in the borrowing company etc OR Borrowing or
lending to WOS.