by Pradeep K. Mittal Past Central Council of

1. by Pradeep K. Mittal Past Central Council of The Institute of Company Secretaries of India, New Delhi Corporate Lawyer & Advocate Delhi High Court, Delhi Ph No. 9811044365 pkmittal171@gmail.com SECTION 185,186,187 COMPREHENSIVE ANALYSIS PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

2. Section 185 Loan to Directors • Critical Analysis • Unlike Section 295 of Companies Act, 1956 Section 185 is applicable to both Private and Public companies • This section virtually prohibits making loans either directly or indirectly, giving guarantees or providing securities, by a company to its directors or to any other person in whom such director is interested • There is no provision for Central Government approval unlike Section 295 of Companies Act,1956 PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

3. The objective of this prohibition is to prevent Directors from abusing their position of trust to grant loans to themselves or to persons in whom they are interested, at the cost of the company • Companies (Amendment) Act, 2017 completely rehashed this section PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

4. Companies (Amendment) Act, 2017 substituted entire section 185 and has substantially liberalised • This section was notified effective May 7, 2018 PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

5. Before getting started let us first understand the meaning of the term “Loan” • Loan is not defined under the Companies Act • According to Black’s Law dictionary ‘loan’ means • Lending or advancing money with absolute promise to repay • A borrowing with a promise to repay • Delivery of money by one party and receipt of money by another on agreement express or implied PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

6. DEFINATION OF LOAN • The Hon’ble Supreme Court in the case of Shree Ram Mills Ltd Vs. Commissioner of Excess Profit Tax, MANU/SC/0054/1954 = AIR 1953 SC 485 has defined the word “Loan” in the following words:- • This is a question of fact. Of course, money so, left could, by a proper agreement between the parties, be converted into a loan, but in the absence of an agreement mere inaction on the part of the managing agents cannot convert the money due to them, and not withdrawn, into a loan. A loan imports a positive act of lending coupled with an acceptance by the other side of the money as a loan. PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

7. The relationship of borrower and lender cannot ordinarily come about by mere inaction. The clause in the Articles of Agreement quoted above was relied on for the purpose of showing that there was such an agreement in the case. We are unable to construe the provisions in that way. They merely give the managing agents a right to receive their commission at a certain time. If the money is not paid in time it remain with the assessee as a debt due to the agents. PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

8. The Calcutta High Court in the case of SaradinduSekharBanerjee Vs. Lalit Mohan MANU/WB/0045/1941 = AIR 1941 Cal. 538 • It is contended on behalf of the appellant that the appellant is entitled to the benefit of the Bengal Money-lenders Act, 1940. That Act deals with money-lending and money-lenders. Leaving the purchase money unpaid is leaving a debt unpaid. Every loan is a debt but every debt is not a loan. The purchase money due to the plaintiff is a debt due to the plaintiff but is not a loan. PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

9. The Division Bench of Allahabad High Court in the case of M/s Laxmi & Co. Vs. Commissioner Of Income Tax MANU/UP/0063/1960=AIR 1960 ALL. 278 • The actual nature of the transaction was the supply of goods on credit to the assessee by Messrs J. K. Kothi and thereupon the assessee accepted the liability to pay the price of those goods to Messrs J. K. Kothi in future together with interest on that amount of price. Such a transaction could not be a transaction of loan and no question of borrowing of money arose. PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

10. The Bombay High Court in the case of Dr FredieArdeshir Mehta Vs. UOI MANU/MH/0090/1991 = 1991 (70) Company Cases 210 Bombay has observed as under:- • As against this, Mr. Mehta, learned counsel for the respondents, emphasised that section 295 prohibited a company from giving a loan to its director without the permission of the Central Government, whether directly or indirectly. In his submission, the company had given the seventh petitioner a loan in an indirectly manner by permitting him to defer payment of the balance purchase price of the flat and pay interest thereon. PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

11. The essential requirement of a loan is the advance of money (or of some article) upon the understanding that it shall be returned, and it may or may not carry interest. • The debt here arose not out of an advance but out of the sale of the flat by the company to the seventh petitioner. The company gave to the seventh petitioner time to pay a part of the purchase price. The seventh petitioner was, thus given financial accommodation by the company in the matter of payment of the debt. Such financial accommodation was not and did not amount to a loan. PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

12. Loan transactions • To attract Section 185 of Companies Act, 2013, there must be a transaction of a loan and it is to be so intended and understood by both parties • Terms of Loan are to be decided and accepted by both parties PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

13. Payment of advance for supply of goods, or against purchase of a property or for services to be rendered, it can’t be treated as a loan • The above does not fall in ‘Indirect Loans’ • A debt which is not in the nature of a loan can’t held to be subsequently converted into a loan PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

14. SECTION 185 (As per Companies (Amendment) Act, 2017 ) • Section 185 (1) provides for complete ban on advancing any loan directly or indirectly, including any loan represented by a book debt, providing any guarantee or security in connection with a loan taken by • any director of the company, • any director of its holding company: PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

15. any partner of the director of the Company or of the holding company; • any relative of the director of the company or of the holding company; • any firm in which any such director or relative is a partner. PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

16. Advancing loan, including loan represented by a book debt, providing guarantee or security in relation to any loans to the ‘persons in whom the director is interested’ is now permitted subject to the condition that - • the approval of members obtained by Special Resolution in General Meeting • (this should be a prior approval. Advancement of loan is subject to the condition) (Section 185(2)) PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

17. disclosure in explanatory statement full particulars and the purpose for which the loan, guarantee or security is proposed to be utilised by the recipient • loans are utilised by the borrowing companies for its principal business activities PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

18. Explanation.—For the purposes of this sub-section, the expression "any person in whom any of the director of the company is interested" means— • any private company of which any such director is a director or member; • (b) 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 PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

19. Here public companies are covered provided the Director(s) hold or control not less then 25% of the voting power • Voting power held by the lending company is immaterial (c) 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. PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

20. The Hon’ble Supreme Court in case of K.K. Birla Vs. R.S. Lodha, MANU/SC/1693/2008 , while defining “accustomed to act” has observed as under: After the death of late Madhav Prasad Birla in or about July, 1990 the deceased who has had no formal education relied and continued to rely on the petitioner and reposed and continued to repose complete trust and confidence in the petitioner in the matters pertaining to all her financial affairs by reason whereof, the petitioner, was at all material times, privy to all information concerning the personal and financial affairs of the deceased. PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

21. The deceased also sought and obtained advice from the petitioner with regard to her assets, savings and investments and with regard to and in the management and affairs of several companies and institutions where the deceased had a stake in the shareholding and/or management and the deceased was at all material times accustomed to act as per the wishes and dictates of the petitioner. PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

22. WHAT IS THE MEANING OF WORD “ADVANCE” The Hon’ble Madras High Court in the case of KM. Mohammed Abdul Kadir Rowther Vs. S. Muthia Chettiar MANU/TN/0424/1959that advancemeans literally a payment beforehand. In certain cases, it may be a loan but it cannot be said that a sum paid by way of advance is necessarily a loan. PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

23. The Hon’ble Privy Council in the case of Raja of Venkatagiri vs. KrishnayyaRaoBahadurMANU/PR/0017/1948  : AIR 1948 PC 150 at p. 155, has observed that ordinarily advance does not connote any idea of repayment is, therefore, clear that the word advanced used in Sec. 296 means an advance in the nature of a loan and not merely an advance as is understood in the common parlance in the sense of payment of money beforehand and which is likely to become due at some future time. PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

24. Further, at the same time, it is also necessary to understand the distinction between “loan” and “deposit” - in view of the fact that these words have been intermittently used in the trade, industry and commerce. The distinction has been succinctly carved in a latest judgment of the Division Bench of the Hon’ble Delhi High Court in the case of Commissioner of Income Tax Vs. Vishisht Chay Vyapr Limited MANU/DE/4478/2011, in the following words:- PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

25. In any case, we would like to point out that there is a settled distinction between the loan and deposit.. These are: (i) A loan is payable immediately on receipt thereof as per the directions of the lender, while a deposit has a term for repayment, which may be a fixed date or it may be as per terms and conditions of the agreement, PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

26. (ii) The loan is obtained at the request of the borrower while a deposit is made at the instance of the depositor and (iii) The limitation period in case of a loan starts from the date of the loan, while it starts from the date of repayment in the case of deposit. PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

27. In this case, the parties were disputing on the fact that the money given by appellant to the Respondent Company was of the nature of Loan and Not Deposit. • Hon’ble Supreme Court of India held that to ascertain that whether a transaction is a transaction of Loan or Deposit does not depend merely on the terms of the document, what has to be judged in each case is the intention of the parties and the circumstances of the case. V. E. A. AnnamalaiChettiar v. S. V. V. S. VeerappaChettiar, MANU/SC/0084/1952 PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

28. The Division Bench of Allahabad High Court in the case of Commissioner of Income Tax MANU/UP/1781/2014 Apart from the aforesaid, the word "loan" means anything lent, especially money on interest. On the other hand, "deposit" means something which is deposited or put down, namely, a sum of money paid to secure an article, service, etc. The legislature has made a conscious distinction between the expression "loan' and "deposit". The two are not identical in meaning. PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

29. Exempted categories (Section 185(3)) (3) Nothing contained in sub-sections (1) and (2) shall apply to— (a) the giving of any loan to a managing or whole-time director— (i) as a part of the conditions of service extended by the company to all its employees; or (ii) pursuant to any scheme approved by the members by a special resolution; or PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

30. As a part of the conditions of service extended by the Company to all its employees; Loan could be any of the following nature:- • a) Housing Loan b) Vehicle loan c) Education loan d) Marriage loan • . • If in case the proposed loan is not covered as a part of conditions of services, the company may, by passing a board resolution, amend the service conditions and uniformally and provide for giving of loan to all employees subject such approval either by Board or its Committee thereof; PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

31. (ii): pursuant to any scheme approved by the members by a Special Resolution; or Under this head, if the proposed loan is not covered as a part of conditions of service, then the company may formulate “Scheme” to cover giving loan under any of the above “Head” but, of course, such Scheme must be approved by way of Special Resolution. PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

32. (b) 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 rate of prevailing yield of one year, three years, five years or ten years Government security closest to the tenor of the loan; or (c) any loan made by a holding company to its wholly owned subsidiary company or any guarantee given or security provided by a holding company in respect of any loan made to its wholly owned subsidiary company; or PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

33. (d) any guarantee given or security provided by a holding company in respect of loan made by any bank or financial institution to its subsidiary company Provided that the loans made under clauses (c) and (d) are utilised by the subsidiary company for its principal business activities. PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

34. WHAT IS MEANT “IN THE ORDINARY COURSE OF ITS BUSINESS” • The Hon'ble Supreme Court in the case of State of Gujarat v. Raipur Manufacturing Co. Ltd. MANU/SC/0223/1966  : [1967] 19 STC 1(SC) has defined any activity to be called as “business” in the sense of an occupation, or profession which occupies the time, attention and labour of a person, normally with the object of making profit. PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

35. The Division Bench of Allahabad High court in the case of KishoriLal Vs. CIT MANU/UP/0904/2014, while dealing with the issue of giving loan as permitted as a part of Ancillary Object and not as a Main Objects, has held under:- In holding that the advance was not intheordinary courseofbusiness, the sole consideration which weighed with the Tribunal was that the main object of the two companies was not to engage in money-lending business, though the ancillary object was to invest and deal with the funds of the company not immediately required, PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

36. The Tribunal was of the view that the two companies were not involved in the business of money-lending. Consequently, the Tribunal came to the conclusion that since the main object of the two companies was not money-lending but the companies were permitted to invest their surplus funds for the time being, this could not be regarded as being in the ordinary course of the business. PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

37. Penal provisions (Section 185(4)) • Earlier if any loan is advanced or a guarantee is given or security is provided in contravention of the provisions, it was a punishable offence. • Under the amended provisions ‘the loan advanced is utilised in contravention’ of the provisions is also a punishable offence • Every officer of the company who is in default shall be punishable with imprisonment or with fine • earlier only the company, the Director and the recipient were liable PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

38. Officer in Default Sec.2(60) "officer who is in default", for the purpose of any provision in this Act which enacts that an officer of the company who is in default shall be liable to any penalty or punishment by way of imprisonment, fine or otherwise, means any of the following officers of a company, namely:— (i) whole-time director; (ii) key managerial personnel; (iii) where there is no key managerial personnel, such director or directors as specified by the Board in this behalf and who has or have given his or their consent in writing to the Board to such specification, or all the directors, if no director is so specified; PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

39. (iv) any person who, under the immediate authority of the Board or any key managerial personnel, is charged with any responsibility including maintenance, filing or distribution of accounts or records, authorises, actively participates in, knowingly permits, or knowingly fails to take active steps to prevent, any default; (v) any person in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act, other than a person who gives advice to the Board in a professional capacity; PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

40. (vi) every director, in respect of a contravention of any of the provisions of this Act, who is aware of such contravention by virtue of the receipt by him of any proceedings of the Board or participation in such proceedings without objecting to the same, or where such contravention had taken place with his consent or connivance; (vii) in respect of the issue or transfer of any shares of a company, the share transfer agents, registrars and merchant bankers to the issue or transfer; PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

41. PENALTY OFFICER IN DEFAULT COMPANY BORROWER FINE : 5 LAKHS TO 25 LAKHS IMPRISONMENT UPTO 6 MONTHS OR FINE OF MINIMUM 5 LAKHS EXTENDABLE UPTO 25 LAKHS OR WITH BOTH IMPRISONMENT UPTO 6 MONTHS OR FINE OF MINIMUM 5 LAKHS EXTENDABLE UPTO 25 LAKHS OR BOTH PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

42. Think Tank • Whether a Company being a surety can give guarantee / Security to lender when lender is providing credit facility to the Subsidiary Company when loan taken from other than Bank and financial Institution? • The exemption provided in the Act is only Guarantee or security in respect of a loan made any bank or FI to its subsidiary. Hence such exemption is not available to loans taken from others PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

43. 2. Public companies per se does not fall under “persons in whom the director is interested”, then why under sub-section 3 full exemption to wholly owned subsidiary and partial exemption to subsidiaries is given? • wholly owned subsidiary and subsidiaries are presumed to be ‘accustomed to act as per the instructions’. Hence full exemption to wholly owned subsidiary and partial exemption to subsidiaries is given. • If both companies are public companies with no common directors or members, then they have to establish that they are not accustomed to act as per the instruction of the lending company PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

44. SECTION 186LOANS AND INVESTMENT BY COMPANY • (1) A company shall not make investment through not more than two layers of investment companies • However this provision shall not effect: • i. A company from acquiring any other company incorporated in a country outside India, if such other company has investment subsidiaries beyond two layers as per the laws of such country. PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

45. ii. A subsidiary company from having any investment subsidiary for the purposes of meeting the requirements under any law or under any rule or regulation framed under any law for the time being in force • Key Points: • What is prohibited is more than two layers of investment companies. • One may have more than two layers of any company other than investment company, say for example manufacturing or trading company PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

46. RELEVANT DEFINATIONS: • Section 2(11) “Body Corporate" or "corporation" includes a company incorporated outside India, but does not include-- • (i) a co-operative society registered under any law relating to co-operative societies; and(ii) any other body corporate (not being a company as defined in this Act), which the Central Government may, by notification, specify in this behalf; PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

47. Section 2(43) “Free Reserves" means such reserves which, as per the latest audited balance sheet of a company, are available for distribution as dividend: • Provided that--(i) any amount representing unrealised gains, notional gains or revaluation of assets, whether shown as a reserve or otherwise, or(ii) any change in carrying amount of an asset or of a liability recognised in equity, including surplus in profit and loss account on measurement of the asset or the liability at fair value, shall not be treated as free reserves; PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

48. Securities • ‘Securities’ is defined under Section 2(81) • ‘Securities’ means the securities as defined in clause(h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (SCRA) • Under Section 2(h) of SCRA ‘securities’ include • Shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of alike nature in or of any incorporated company or other body corporate • Derivatives PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

49. Guarantee ‘Guarantee’ is not defined under the Companies Act, 2013, ‘Guarantee’ is a formal promise or assurance especially one in writing, that an obligation will be fulfilled. Section 126 of the Indian Contract Act, defines the expression ‘contract of guarantee’ as a contract to perform the promise or discharge the liability of a third person in case of his default. A guarantee may be oral or written The person who gives the guarantee is called the ‘surety’, the person in respect of whose default the guarantee is given is called the ‘principal debtor’ and the person to whom the guarantee is given is called the creditor PRADEEP K. MITTAL (Corporate Lawyer & Advocate)

50. Explanation under Section 186(13): (a) the expression “Investment Company" means a company whose principal business is the acquisition of shares, debentures or other securities and a company will be deemed to be principally engaged in the business of acquisition of shares, debentures or other securities, if its assets in the form of investment in shares, debentures or other securities constitute not less than fifty per cent. of its total assets, or if its income derived from investment business constitutes not less than fifty per cent. as a proportion of its gross income. PRADEEP K. MITTAL (Corporate Lawyer & Advocate)