Section 185 of Companies Act, 2013: Loans to Directors — Rules, Exceptions, and Penalties

Introduction to Section 185 of Companies Act, 2013

This rule aims to stop companies from giving money or help (like guarantees) to directors or connected people in a shady way. This helps avoid conflicts of interest and keeps company funds safe and properly used.

Applicability of Section 185: Who Does It Cover?

Section 185 applies to all companies in India—both private and public. It includes:

• Any director of the company or its holding company.
• Relatives or partners of such directors.
• Firms, private companies, or other businesses where such directors or their relatives have a controlling interest (like 25% of votes or guiding with instructions).

Section 185 Loans to Directors: Rules and Restrictions

General Rule (Sub-section 1)

Companies cannot directly or indirectly advance:

• A loan (even disguised as a promise to pay—called a book debt).
• A guarantee for a loan taken by a director or related person.
• Security, like collateral, for such loans.

When It Might Be Allowed (Sub-section 2)

If any loan/guarantee/security is to be made to someone director-connected, two conditions must be fulfilled:

1. Get a special resolution passed by at least 75% of shareholders.
2. Ensure the loan is used only for the borrower’s main business activities, not for other purposes.

Exceptions under Section 185 of Companies Act, 2013

There are important exceptions where the rules don’t apply:

• If a Managing or Whole-Time Director gets a loan:
  • As part of their service terms, or
  • Under a scheme approved by shareholders through a special resolution.
• If a company provides loans/guarantees/security as part of its ordinary business, with interest at or above RBI bank rate.
• Holding company loans to its 100% subsidiary, or guarantees for bank loans to that subsidiary—if used for its main business.

Conditions for Granting Loans to Directors

To grant a loan under exceptions:

1. Conduct a general meeting and pass a special resolution of at least 75% vote.
2. Include in the meeting notice details like:
   • Loan amount.
   • Who is involved.
   • Purpose of the loan.

All documentation must be transparent and kept carefully.

Penalties for Violation of Section 185 Provisions

Breaking Section 185 leads to serious consequences:

• Company: fined between ₹5 lakh to ₹25 lakh.
• Director or defaulting officer: may face imprisonment up to 6 months, or a fine of ₹5 lakh to ₹25 lakh, or both.

Amendments to Section 185: Key Updates Over the Years

• 2015 Amendment: Allowed holding companies to provide loans/guarantees to wholly-owned subsidiaries under conditions.
• 2017 Amendment (effective May 2018): Made the law less strict, clarifying the exceptions and harmonizing with other corporate laws.

Practical Examples and Case Studies on Loans to Directors

• Example 1: A company gives a business loan to a director’s relative with no shareholder approval—this breaks Section 185.
• Example 2: A holding company guarantees a bank loan for its 100% subsidiary used in normal business—allowed under exception.
• Example 3: A managing director gets a salary advance following a board-approved scheme—allowed as part of service terms.