Introduction to Section 186 of Companies Act, 2013
This important law makes sure companies don’t lend or invest recklessly and stay transparent with their financial choices.
Applicability: Who Must Follow Section 186?
Most Indian companies must comply—unless they are banks, NBFCs, insurance companies, or finance businesses acting within their usual operations.
What the Law Says: Key Rules of Section 186
Companies must follow these rules:
- Only two layers of investment are permitted to prevent convoluted ownership structures.
- Financial exposure limit:
- Up to 60% of paid-up capital + free reserves + securities premium, or
- Up to 100% of free reserves + securities premium, whichever is higher.
- Transactions must be fully disclosed in financial statements.
Legal Requirements for Compliance
- Board Approval: Before any loan, investment, guarantee, or security, a board meeting is required, with unanimous consent from all present directors. Email or committee approval is invalid.
- Shareholder Special Resolution: If the total transactions breach the limit, a special resolution (75% approval) must be passed at a general meeting, authorizing the amount.
- Public Financial Institution Approval: If the company has an existing term loan, it must seek approval from the lending public financial institution—unless the new transaction stays within limits and there’s no default.
- Interest Rate Compliance: For any loan, the interest must match or exceed the closest matching government’s security yield (1, 3, 5, or 10 years).
- Default Restrictions: If the company has defaulted on deposit payments or interest, it cannot enter into new loans, guarantees, or investments until the default is cleared.
- Mandatory Register: A formal register of such transactions must be maintained—kept at the registered office and open to inspection—and should include all the essential details.
Loans and Investments: Understanding the Rules
Lending or investing must stay within the limits and layers set by the law. Document everything, get approval, and be transparent.
Guarantees and Securities: Handling with Care
Providing guarantees or securities is okay—but only within legal limits and with proper approval and disclosure to maintain corporate integrity.
Exceptions That Make Life Easier
- Financial institutions doing their usual business are exempt.
- Holding companies funding wholly-owned subsidiaries or joint ventures don’t need shareholder approval—though they must disclose it.
- SEBI-regulated companies may exceed these limits if they follow securities regulations and disclose appropriately.
Approval Process Flow
- Secure board approval in a formal meeting.
- If limits are exceeded, pass a special resolution via shareholder vote.
- Get PFI approval if there’s an outstanding term loan.
- Offer interest at or above government security rates.
- Clear deposit defaults before new financial commitments.
- Keep and allow access to a detailed transaction register.
- Disclose every such transaction in financial statements.
Penalties for Violating the Law
If you don’t follow Section 186:
- Company fines: ₹25,000–₹5 lakh.
- Officers in default: Up to 2 years imprisonment or ₹1 lakh fine, or both.
History and Purpose of Section 186
The section modernized older, government-controlled rules to allow more company flexibility—while still enforcing accountability and financial prudence.
Real-Life Examples to Understand Better
- Crossing the limit? Get shareholders’ approval and disclose it.
- Funding a subsidiary? Hold co can do it without extra formalities, but must record it.
- Bank lending? Exempt, since it’s part of normal banking operations.
Conclusion: Section 186 helps companies stay financially wise and honest. By following its legal steps—board and shareholder approvals, interest compliance, disclosure, and documentation—companies protect their money and maintain trust with stakeholders.
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