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The clauses of contention need more clarity

| Updated on: Jan 12, 2014
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It’s high time the government cleared ambiguities over sections 185 and 186 of the new Companies Act.

In the Companies Act, 2013, two key sections deal with provision of loans, guarantees and securities by companies — sections 185 and 186.

Section 185 prohibits provision of loans to directors or a person in whom the director is interested. The section also contains prohibition on giving guarantee or providing security in connection with loan taken by a director or such other person.

In accordance with an explanation given in the section, interested person includes a corporate body whose board is accustomed to act in accordance with the direction of the lending company’s board. Unlike corresponding section 295 in the old Act, section 185 does not contain any exemption for loan given by a holding company to its subsidiary.

Limiting support Section 186 of the new Act fixes the overall limit within which a company can give loan or provide guarantee/security, and so on. For giving loan or providing guarantee/security exceeding limit, a company needs prior approval by means of a special resolution passed at the general meeting. Particularly, section 185 is a matter of significant debate and concern for many companies.

Since the board of a subsidiary company is accustomed to act in accordance with the directions of the board of holding company, one view is that a parent cannot give any loan to its subsidiary or provide guarantee/security. If this view stands, it is likely to create significant hardship for many companies. The experience of dealing with many group structures suggests that in many cases, a subsidiary may not be able to raise finance without support from the holding company. The counter argument is that section 185 intends to avoid a situation where directors use company’s funds for their personal benefit.

The arm that gives In case of subsidiaries, particularly, wholly-owned subsidiaries, no such misuse is possible. Since the company owns majority stake in subsidiary, it will benefit the most from the activities of the subsidiary. Hence, section 185 does not intend to prohibit provision of loan to or guarantee/security on behalf of subsidiary. A company can advance loan to its subsidiary within the limits prescribed in section 186.

Neither the new Act nor the draft rules provide clarification on this matter. While companies continue to debate this matter, the Ministry of Corporate Affairs (MoCA) on 12 September 2013 notified section 185, without notifying section 186. This resulted in further confusion and hardship on the issue. Particularly, there is even strong argument that since section 186 is not notified, only the first view is possible on this matter. Subsequently, the MCA issued a General Circular dated 19 November 2013. The Circular stated that the MCA has received many representations on notification of section 185, without notifying section 186. The Circular stated that till the time section 186 is notified, section 372A in the old Act, which corresponds to section 186, will continue to apply. Proactive approach taken by the MCA to resolve issue in implementation of section 185 is appreciated. However, the circular is not clear as to how the issue of different interpretations of section 185 will be resolved.

The argument Particularly, proponents of the first view argue that section 185 prohibits loans, and so on to directors and interested persons. Section 186 or its corresponding section 372A in the old Act deal with loans and investment by the company in general and they cannot remove specific prohibitions.

This is a significant business issue for many companies. The MCA should resolve it by clarifying in final rules that loans and other similar exchangesto subsidiaries will be governed under overall limits of section 186.

( The author is senior professional in a member firm of Ernst & Young Global.)

Published on January 12, 2014

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