Loan to Directors - Basic concept with examples

Granting of loan to directors or providing guarantee or security in connection with any loan taken by directors is usually experienced in almost every company. Directors are responsible for managing the company and therefore, directors also have access to all the financial information of the company. Having access to such information is a crucial aspect as directors may use it for their personal benefit by lending funds to themselves. This is known as self-funding. To curb the same, Section 185 of the Companies Act, 2013 (Act) prohibits companies to advance loan to directors and imposes certain restrictions on persons in whom director may be interested.

In this write-up, we will discuss the certain examples or practical situations related to Section 185 of the Act.

Before we dive into the illustrations, here’s a snapshot of the legal provisions.

Illustrations of loan to directors

Examples shared in below table depicts certain real life practical situations related to Section 185 and how they should be dealt with.

Issue: Z is a director in Senior Ltd and also in Junior Pvt Ltd. Can Senior Ltd give loan to Junior Pvt Ltd?

Ans: Junior Pvt Ltd will be treated as person in whom director is interested. Loan can be given after passing Special Resolution

Issue: Can Parent Ltd grant loan to its director through its subsidiary Child Ltd?

Ans: As per Section 185 of the Act, a company shall not advance any loan either directly or indirectly

Issue: Black Ltd grants loan to White Pvt Ltd. Z is a shareholder of Black Ltd and a director in White Pvt Ltd.

Ans: Allowed. As this transaction is not covered under Section 185.

Issue: Housing Ltd is engaged in providing home loans. It grants loan to its Non-Executive Director for buying a car.

Ans: Not allowed. Because such loan is not in the ordinary course of its business of the company

Issue: Housing Ltd is engaged in providing home loans. It grants loan to its Non-Executive Director for buying home.

Ans: Allowed. Because such loan is in the ordinary course of its business of the company

Issue: Child Ltd (subsidiary Co.) grants loan to Parent Pvt Ltd. (Holding Co.)
Z is Director of Child Ltd and shareholder of Parent Pvt Ltd.
Ans: Parent Pvt Ltd will be treated as person in whom director of the company is interested. Loan can be given after passing Special Resolution

Issue: Child Ltd (subsidiary Co.) grants loan to Parent Ltd. (Holding Co.) Z is Director of Child Ltd and shareholder of Parent Ltd. Ans: Allowed. As this transaction is not covered under Section 185.

Issue: Rich Ltd grants loan to Poor Pvt. Ltd.
No common director.
R is director in Rich Ltd. P (wife of R) is director in Poor Ltd.

Ans: Allowed. As this transaction is not covered under Section 185.

Issue: Rich Ltd is partner in LLP and Z (director of Rich Ltd) is also a partner in LLP. Can Rich Ltd grant loan to the LLP?

Ans: LLP is a Body corporate and will be treated as person in whom director of the company is interested. Loan can be given after passing Special Resolution

Issue: Can Parent Ltd. grant loan to Z [director of Child Ltd (Subsidiary)]?

Ans: Yes, it nowhere falls under Section 185

Issue: Parent Ltd (Holding Co.) give guarantee to bank for completion of project by Child Pvt Ltd (Wholly Owned Subsidiary)

Ans: Yes, performance guarantee nowhere falls under Section 185

Issue: Rich Ltd grants loan to Z (Marketing Head) for 1 year. Z During the tenure of 1 year becomes a Whole-time Director (WTD). Can the loan be renewed after 1 year?

Ans: Yes, after complying Section 185 because at the time of renewal, Z is a WTD.

Conclusion

Section 185 of the Act is one of those provisions which are mainly inserted to curb conflict of interest and protect the interest of shareholders of the Company. However, in case of private or family-owned enterprises, generally directors are themselves the shareholders and then who is conflicting with whose interest becomes a question in itself. Nevertheless, the carve out of passing Special Resolution in Section 185(3) works in best interest of the whole time directors of these privately owned entities.