Section 185 - An indepth analysis
sachin cs
- No company shall, directly or indirectly, advance any loan, including any loan represented by a book debt, to any of its directors or to any other person in whom the director is interested or give any guarantee or provide any security in connection with any loan taken by him or such other person.
- Exemptions under the section relate to:-
- the giving of any loan to a managing or whole-time director if it is given as a part of the conditions of service extended by the company to all its employees; or pursuant to any scheme approved by the members by a special resolution; or
- a company which in the ordinary course of its business provides loans or gives guarantees or securities for the due repayment of any loan and in respect of such loans an interest is charged at a rate not less than the bank rate declared by the Reserve Bank of India.
- Herein, the expression “to any other person in whom director is interested” means—
- any director of the lending company, or of a company which is its holding company or any partner or relative of any such director;
- any firm in which any such director or relative is a partner;
- any private company of which any such director is a director or member;
- any body corporate at a general meeting of which not less than twenty five per cent. of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together; or
- any body corporate, the Board of directors, managing director or manager, whereof is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company.
The section has been so much in limelight since its notification because it withdraws the exemptions with respect to such transactions among private limited companies, transactions between holding and subsidiary companies as were available under the Companies Act, 1956 and even the provision of undertaking such transaction with the approval of the Central Government. Though on the overall reading of Companies Act, 2013 it seems that most of the related party transactions herein are relaxed as compared to Companies Act, 1956; with the requirement of Central Government approval at most of the places withdrawn, and more trust exerted on proper disclosures and transparency. However, with reference to the transactions regarding loan, guarantee, and security to directors and other specified persons, the law is certainly more restricted.
While the new law has defined the duties of directors more precisely vide Section 166, perhaps more emphasis has been laid on the following duties; ‘A director of a company shall not involve in a situation in which he may have a direct or indirect interest that conflicts, or possibly may conflict, with the interest of the company’ and ‘A director of a company shall not achieve or attempt to achieve any undue gain or advantage either to himself or to his relatives, partners, or associates and if such director is found guilty of making any undue gain he shall be liable to pay an amount equal to that gain to the company’; and some such conflicting transactions completely prohibited.
Though the section, as a matter of fact, calls for only a few changes with its corresponding section under the Companies Act, 1956; however, such changes have created lots of chaos in the Industry and also rendered some contentious issues which are still not clear. Majorly the following issues needs attention:-
- Importantly this section starts with the words; ‘Save as otherwise provided in this Act’as against ‘Save as otherwise provided in sub-section (2)’ provided in Section 295 of the Companies Act, 1956.
With the usage of words ‘save as otherwise provided under this Act’, whether the intent of law is such that once Section 186 of the Companies Act, 2013 comes into effect, loans to director and other person in whom Director is interested may also be made after complying with the provisions of such Section 186?
It is pertinent to mention here that Section 186 of the Companies Act, 2013 corresponds to Section 372A of the Companies Act, 1956 and provides for provisions relating to loans and investment by Company. As against Companies Act, 1956, the said provision under Companies Act, 2013 is wider and enables Corporates to make loan, give guarantee or provide security in connection with any loan taken, to any person (including individuals) as against only to bodies corporate as provided under Companies Act, 1956.
If the answer to the aforesaid question is positive, then the whole purpose of legislation to have Section 185 of the New Law seems redundant. On the other hand, if the answer to it is negative, then there seems some drafting error in the legislation or where else do we see the effect of the section in law if not Section 186?Now presuming we consider the reply to the aforesaid question as negative and go with the intent of legislature which seems to restrict the transactions of making loan, giving guarantee or providing security in connection with any loan taken, to the Director and any other person in whom the Director is interested; following issues under section 185 of the New Law are worth consideration:-
- Besides exempting grant of loan to Managing or Whole-time Director under given circumstances, the law has also granted exemption to companies which is ordinary course of its business provides loan or gives guarantee or securities for due repayment of loan with specified interest rate. Now a significant question here is whether the intent here is to cover just Banking Companies or NBFCs or for that matter, any other entity which undertake such transaction with bonafied intent to achieve its main objects i.e in ordinary course of its business? The term ‘ordinary course of its business’ being very subjective in itself leaves lot of scope for different interpretations.
Does the usage of word ‘its’ in the phase ‘ordinary course of its business’; creates any difference; as far as interpretation of the phase is concerned?
- Further one of the relationship with reference “to any other person in whom director is interested” which intends to cover any body corporate, the Board of directors, managing director or manager, whereof is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company. It seems that all wholly owned subsidiaries would be covered within the purview of this provisions while for identifying whether or not other subsidiaries (not wholly owned) are included in its purview of not; some analysis would be required especially for listed subsidiary which tend to have Independent Directors on its Board. Fact here remains that there being no specific yardstick or parameter to address or analyse such issue; this criteria has added much subjectivity to the provision and thus leaving scope for different interpretations. More so, because under Section 295 of the Companies Act, 1956 subsidiaries were excluded from the scope of Section 295; hence this issue has gained so much impetus.
- Another issue worth consideration right now is the clarification of the Ministry of Corporate Affairs vide General Circular No. 18/2013 dated 19.11.2013 stating that the provisions of Section 372A of the Companies Act, 1956 is still operative. The clarification from the Ministry has added on to the confusions of the Industry rather than resolving them. The different views now are:-
- Section 372A of the Companies Act, 1956 which provides for provisions related to Inter-corporate loans and investments grants an exemption to private limited companies (unless it is a subsidiary of public company) and wholly owned subsidiaries from the applicability of the provisions of the Section. Now, one view which goes with this clarification is that with specific mention of the fact that Section 372A of the Companies Act, 1956 is still applicable; it has been clarified by the Ministry that the exemptions from the applicability of Section 372A of the Companies Act, 1956 are still applicable even though Section 185 of the Companies Act, 2013 has been notified. It is noteworthy to mention here that Section 372A of the Companies Act, 1956 corresponds to Section 186 of the Companies Act, 2013 which has not been notified; hence is still operative. It’s important to note that the exemption of Section 372A of the Companies Act, 1956 is with respect to the limits given in the section and not the charging of relationship onto which such provisions would be applicable.
- Another view on the situation is that the clarification is just an initiative of the Ministry to clarify doubts regarding applicability of Section 372A of the Companies Act, 1956 after notification of Section 185 of the Companies Act, 2013. Though 372A of the Act does not corresponds to Section 185 of the New Act for that matter; however its notification and immediate effect created some confusions regarding its applicability; which the Ministry intended to clarify.
It seems that per se all subsidiaries might not be included in this criterion and for each subsidiary; specific analysis is required.
- Another interesting aspect of this section is its applicability on book debts. While under the Companies Act, 1956, Section 296 specifically stated that Section 295 shall apply to any transaction represented by a book debt which was from its inception in the nature of a loan or an advance;no separate mention of nature of such book debt is mentioned under the provisions of Section 185 of the Companies Act, 2013 as it straight away includes ‘any loan represented by a book debt’ in its purview. It remains to be seen now whether undertaking of any related party transaction for e.g. relating to purchase or sale of goods or services which are otherwise allowed within the purview of Section 188 of the Companies Act, 2013; for credit (not for cash); also end up in a violation of this section for the Directors and other person in whom Directors are interested. Perhaps the nature of credit extension to directors and other person wherein directors are interested would also be required to be reviewed for each transaction.
While the main motive of New Company Law is to liberalise the transaction from operational front by making proper disclosures therein; the drafting and interpretation issues with Section 185 of the Companies Act, 2013 hardly seems to meet the objective. In midst of all the issues confronted by virtue of the provisions of this section we believe that the questions raised above might be catered to resolve the situation in a manner with meets the motive of the legislation along with resolving the issues for the Industry, which we have attempted to in the below said portion:-
- To analyse whether or not with the usage of words ‘save as otherwise provided under this Act’, whether the intent of law is such that once Section 186 of the Companies Act, 2013 comes into effect, loans to director and other person in whom Director is interested may also be made after complying with the provisions of such Section 186; we may refer to the Rule of Harmonious Construction for understanding the intent of legislation.
Rule of Harmonious Construction states:
A statute must be read as a whole and one provision of the Act should be constructed with reference to other provisions in the same Act so as to make a consistent enactment of the whole statute. In other words, when there are two provisions in a statute, which are in conflict with each other, they should be interpreted such that effect can be given to both and the construction which renders either of them inoperative and useless should not be adopted except in the last resort. Bengal immunity Co. vs. State of Bihar (1955) 6 STC 446 (SC
As we apply the rule of Harmonious Construction to the situation wherein Section 185 and Section 186 of the Companies Act, 2013 exist; if upon exercise of provisions specified under Section 186, Section 185 is rendered inoperative, then both the sections should be read independently so as to give effect to Section 185.
Hence, while the usage of words ‘save as otherwise provided in Act’; seems redundant; on application of the Rule of Harmonious Construction it may be construed that loans to directors or other person in whom director is interested is restricted by virtue of Section 185 of the Companies Act, 2013 and section 186 is not an enabling provision for such transactions.
- With reference to the usage of term ‘ordinary course of its business’ to analyse whether the intent of law is just to cover Banking Companies or NBFCs or for that matter, any other entity which undertake such transaction with bonafied intent to achieve its main objects i.e in ordinary course of its business it is important to understand what ‘ordinary course of business’ means.
It is interesting to note here that the law has specifically, at several instances mentioned the reference of banking company or NBFC wherein it was so intended. Not mentioning of the same specifically under section 185 add on to the belief that the intent of the section is to grant exemption to transactions undertaken by any company in its ordinary course.In order to be within the ordinary course of business, a transaction must adhere to the practices and customs that are considered normal for an industry. It would not be unusual for businesses in the same industry to engage in transactions similar to a transaction under examination. Determining whether something is within the ordinary course of business or not can involve evaluating similar types of businesses and industries to see if they engage in similar types of transactions. Other tests can include questioning the parties to the transaction and checking regulations to see if they outline any practices for a given profession or industry.
In the case of Dillip Kumar Swain vs Executive Officer, Cuttack, the Hon’ble High Court of Orrisa, observed: “Expression "in the ordinary course of business" means in the usual course of routine of business. It is used to detect current routine of business. It is trite law that definition or interpretation given in respect of a particular entry has to be judged in the background of that statute itself and cannot always throw a guiding light in respect of other statutes. It has to be judged in the background and context in which it is used in a particular statute.”
Having stated the meaning of term ‘ordinary course of business’ its important to mention that the specific mention of term ‘its’ in the phase implies that the legislation relates to undertaking of business by the particular entity, in its ordinary course; hence might not just relate to Banking companies, NBFCs etc. Having said that it is pertinent to see where else in the Companies Act, 2013, the term ‘ordinary course of business’ used. The law has used the term at numerous instances some of which are reproduced herewith for reference purposes:-
Section 67: Restrictions on purchase by Company or giving of loans by it for purchase of its shares
Nothing in sub-section (2) shall apply to—
(a) the lending of money by a banking company in the ordinary course of its business;Section 180: Restrictions on powers of Board
Provided that the acceptance by a banking company, in the ordinary course of its business, of deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, order or otherwise, shall not be deemed to be a borrowing of monies by the banking company within the meaning of this clause.Section 186: Loan and Investment by Company
(11) Nothing contained in this section, except sub-section (1), shall apply—
(a) to a loan made, guarantee given or security provided by a banking company or an insurance company or a housing finance company in the ordinary course of its business or a company engaged in the business of financing of companies or of providing infrastructural facilities;
Section 188: Related Party Transactions
(1) Except with the consent of the Board of Directors given by a resolution at a meeting of the Board and subject to such conditions as may be prescribed, no company shall enter into any contract or arrangement with a related party with respect to—
(a) sale, purchase or supply of any goods or materials;.............
Provided also that nothing in this sub-section shall apply to any transactions entered into by the company in its ordinary course of business other than transactions which are not on an arm’s length basis.Section 189: Register of contracts or arrangements in which directors are interested
(5) Nothing contained in sub-section (1) shall apply to any contract or arrangement—
(a) for the sale, purchase or supply of any goods, materials or services if the value of such goods and materials or the cost of such services does not exceed five lakh rupees in the aggregate in any year; or
(b) by a banking company for the collection of bills in the ordinary course of its business.
Section 193: Contracts by One Person Companies
Where One Person Company limited by shares or by guarantee enters into a contract with the sole member of the company who is also the director of the company, the company shall, unless the contract is in writing, ensure that the terms of the contract or offer are contained in a memorandum or are recorded in the minutes of the first meeting of the Board of Directors of the company held next after entering into contract:
Provided that nothing in this sub-section shall apply to contracts entered into by the company in the ordinary course of its business.
Section 195: Prohibition on Insider Trading of Securities
No person including any director or key managerial personnel of a company shall enter into insider trading:
Provided that nothing contained in this sub-section shall apply to any communication required in the ordinary course of business or profession or employment or under any law.
- With reference to the clarification given under Section 372A of the Companies Act, 1956, while a set of people believe that with this clarification corporate are now free to grant loans to its wholly owned subsidiary or inter-corporate loan amongst private limited companies which tend to fall in the definition of ‘any other person wherein the director is interested” as was exempted under Section 372A of the Companies Act, 1956; the fact remains that the very purpose of exemption under Section 372A of the Companies Act, 1956 was for excluding the said entities from the limits of intercorporate loans and investments. While the charging section or the section which restricted grant of loans etc to Directors and other such person was Section 295 of the Companies Act, 1956 itself, exemption granted u/s 372A of the Act was just procedural. It’s worth mentioning here that the Section 295 of the Companies Act, 1956 itself granted exemption to private limited companies and subsidiary companies from the applicability of its provisions; corresponding to which there is no exemption under Section 185 of the Companies Act, 2013.
Hence, with this clarification also there seems to be no change in the situation and no specific exemption to wholly owned subsidiaries and private limited companies under such consideration.
- Regarding the aspect of this section as to its applicability on book debts; it is pertinent to refer to the case of Pennwalt India Ltd. v. RoC, wherein the Hon’ble High Court of Bombay has held that to ascertain whether a transaction is a loan or not, surrounding circumstances, relationship and character of the transaction and the manner in which parties treated the transactions will have to be considered. Hence, with reference to each transaction with Directors and other person in whom the Directors are interested; the nature of transactions has to be studied, in case they relates to book debts.
It is a possibility that in order to meet the requirement of Industry and cater to such confusions; the Ministry may come up with some exemptions from the applicability of provisions of Section 185 to any specified class of companies by virtue of Section 462 of the Companies Act, 2013 which gives power to exempt class or classes of companies from provisions of the Act or atleast through some clarification on the provisions. Further clarification regarding applicability may be given over the same in the rules also which may resolve the situation. Prior such notification the issues remain a cause of concern.
csyogan .
--
--
************************************************
Mail your comments, feedback and suggestions on CSMysore to Moderator: datta...@gmail.com and Manager: vivekhe...@gmail.com
---
You received this message because you are subscribed to the Google Groups "CSMysore" group.
To unsubscribe from this group and stop receiving emails from it, send an email to csmysore+u...@googlegroups.com.
For more options, visit https://groups.google.com/d/optout.