It’s an Act in half motion. The piecemeal notification of the Companies Act, 2013 has led to considerable confusion. Some of it focused on Section 185. It prohibits a company from giving loans to its directors and providing guarantees or securities on their behalf. This kills a company’s ability to fund a wholly owned subsidiary if the two companies share a common director. So the Ministry has issued a Circular to explain the scope of Section 185. Payaswini Upadhyay finds out if the Circular clarifies or confuses?
Until September last year, private companies were allowed to lend money to its directors or entities of interest and provide guarantees and security for loans availed by them without central government approval. This under Section 295 of the Companies Act, 1956
The equivalent of Section 295 is Section 185 under Companies Act, 2013 but it’s more restrictive. Section 185 prohibits any company from giving loans, guarantees and securities in favor of its directors or to any other person in whom the director is interested in. The language of Section 185 i.e. any other person in whom the director is interested in - led experts to interpret that holding companies cannot give loans, securities and guarantee for their subsidiaries by virtue of common directors.
Sandip Bhagat Partner, S&R Associates:
“Section 185 is applicable to loans to directors but it also picked up companies which are accustomed to acting in accordance with the directions or instructions of the lending company. And so, there is a bit of debate out there that whether or not it even applies to all situations of a holding – subsidiary relationship. And if you were on the Board of the holding company as a Director, there is an argument that may be it applies to the loans given or guarantee given by the holding company or security taken by the holding company in favor of the subsidiary.”
Vaibhav Thakkar Partner, Luthra & Luthra:
“As a result of 185, we were resulting in a situation where – it is a very common business practice – in order to be able to avail bank funding and loans at the level of project company and special purpose vehicles, holding companies have to provide for guarantees and securities. Now because these exemptions are not there in Section 185 of the Companies Act, it was becoming extremely difficult for the banking industry to be able to function and for Indian corporate to avail loans for genuine business purposes.”
What added to the confusion was Section 372A of the old Companies Act which has not been repealed. Section 372A specifically allows holding companies to provide loans, give guarantee or security to its wholly owned subsidiary. Its equivalent is Section 186 under the new Companies Act that allows a holding company to give loans of a specified amount and provide guarantees and securities on behalf of its subsidiary without a special resolution. But this Section has not been notified.
So, for the last 5 months, corporate India was dealing with Section 185 and Section 372A that were contradictory in nature.
To address this concern, the Ministry has now clarified that Section 372A of the old Companies Act will continue to apply till such time Section 186 is notified. But in its clarification, the Ministry has allowed holding companies to give only guarantees and securities on behalf of wholly owned subsidiaries but not provide them with loans. Sandip Bhagat Partner, S&R Associates:
“This MCA circular seems to broadly say that every holding company and subsidiary relation is picked up now under Section 185 which I think is problematic. One was hoping that the clarification goes the other way especially in cases where the Directors on the Board of the holding company is not even a director on the Board of the subsidiary. One is hoping that the clarifications go that way as opposed to where it has gone now.”
Vaibhav Thakkar Partner, Luthra:
“This clarification does not really help any loans being given by a holding company to its subsidiary company. So this clarification does give reprieve but only to a limited extent. This clarification makes one more onerous requirement that the monies have to be used for the business of the subsidiary. Now this wasn’t really necessary if the intent was to let 372A operate in this space.”
Add to this a possibility that Section 372A may be applicable only if the loan is availed from a bank or financial institution and not all lenders. A poorly worded, factually incorrect in one place and half helpful clarification- one would have hoped that after 5 months of notifying the Section, the Ministry would have done better. But this is what companies will have to live with until Section 186 of the Act is notified!
In Mumbai, Payaswini Upadhyay
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