When we talk about companies, we focus on profits, employees, or shareholders. But one of the most important aspects of a company is how it is governed — how decisions are made and how the money is handled. One of the essential parts of corporate governance is ensuring that people who run the company, especially directors, do not misuse their power. Directors of the company have to perform their duties and functions within the defined ambit. Section 185 of the Companies Act, 2013 sets clear rules about giving loans, guarantees, or security to directors and others related to them.
In this blog, we will understand the meaning and scope of Section 185 of the Companies Act, 2013.
What is the meaning of section 185 of the Companies Act, 2013?
Section 185 prevents the misuse of company money by directors or people close to the company by banning or restricting the companies from:
- Giving loans to directors,
- Giving guarantees on their behalf, or
- Giving security for loans taken by them.
Why was this law made?
Imagine you are a shareholder of a company. You invest your money, hoping the directors will use it wisely. Now imagine if the director starts borrowing money from the company for their personal needs, or their family or friends. This would be a clear conflict of interest and can be harmful to the company and its investors.
To prevent such situations, the government introduced strict rules under Section 185. These rules make sure that directors don’t take advantage of their position for personal benefit.
Who cannot be given loans under section 185?
There are some categories of people who are directly related to the directors, and allowing loans to them can lead to unfair advantage or misuse of funds. Thus, under Section 185(1), a company cannot give a loan (direct or indirect), guarantee, or security to:
- Any of its directors,
- Any director of its holding company,
- Any relative of a director,
- Any partner of a director,
- Any firm in which the director or their relative is a partner.
Exceptions to the rule under Section 185
Yes, the law does allow loans or guarantees in some situations, but only if strict conditions are followed. These exceptions are described under Section 185(2) and Section 185(3) of the Companies Act, 2013.
- Loan companies where the director has an interest
A company can give loans to another company in which its director is also a director or member, but only if:
- The company gets approval from shareholders by passing a special resolution, AND
- Full details of the loan and the reason for it are shared with shareholders in advance, AND,
- The loan must be used by the borrowing company only for its core business, not for personal use.
- Loans to managing or whole-time directors as part of employment
A company can also grant a loan to its managing director or whole-time director, but only if:
- It is part of their employment terms, and the same benefit is given to all other employees too, or
- It is part of a scheme approved by shareholders through a special resolution.
- Lending companies in the ordinary course of business
The companies that are engaged in the business of providing loans, such as finance companies or non-banking financial companies (NBFCs). For these companies, giving a loan is a regular business activity. They can give loans to directors or related persons only if:
- The loan is given at a rate of interest not less than the rate on government bonds, and
- Lending loans is part of their usual business practice.
- Loans from holding company to 100% subsidiary
A holding company that owns 100% of another company can give loans to its fully owned subsidiary, but only if the loan is used for business purposes, such as buying machinery, paying salaries, or expanding operations, etc., of the subsidiary company.
Similarly, the holding company can provide guarantees or securities for loans taken by the subsidiary from a bank, again only if the money is used for actual business and not for personal or unrelated purposes.
What happens if a company breaks this rule?
If a company breaks any of the rules mentioned in Section 185 of the Companies Act, 2013, the company can be strictly penalised:
- The company can be fined between ₹5 lakh and ₹25 lakh.
- The person responsible, like the director who approved the loan:
- Can be fined between ₹5 lakh and ₹25 lakh, and/or
- Can be jailed for up to six months.
- The person who received the loan (illegally) can also face punishment for a term of up to six months.
Difference between section 185 and section 186
People often get confused between these two sections:
- Section 185 is about not giving loans to directors or their relatives or associated firms.
- Section 186 is about limits on investments and loans in general, like how much money a company can invest or lend to others.
So Section 185 is about who not to lend to, while Section 186 is about how much to lend or invest.
How can companies stay safe?
- Know the rules: Directors and finance teams must be aware of Section 185 of the Companies Act, 2013
- Check relationships: Before lending any loan, see if the borrower is related to a director.
- Get approvals in advance: If a loan falls under an exception, make sure to follow the correct process and get approvals before giving the loan.
- Maintain proper records: Keep documents like board minutes, shareholder resolutions, and loan agreements properly.
- Lend loans wisely: Ensure that loans are used only for genuine business purposes.
Conclusion
Section 185 of the Companies Act, 2013 is a powerful tool that helps protect companies from misuse by insiders. It keeps a check on loans and financial support to directors and related people, ensuring that all decisions are taken in the company’s best interest. The rules are designed to keep businesses clean and trustworthy. When companies follow these rules carefully, they not only avoid legal trouble but also build a reputation for good governance and fair play, which is suitable for everyone: directors, employees, shareholders, and society as a whole.
Related Services
