Companies Act 2013

Loans and investments

  • Share

Do you have a question? Click here to post a query

  • Loans to directors and subsidiariese

    What the Companies Act 2013 states:

    In accordance with section 185 of the 2013 Act, a company cannot, directly or indirectly, give any loan, including 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.

    The 2013 Act explains the expression ‘any other person in whom director is interested’ to include “a 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.” Apparently, this explanation may cover subsidiary companies. Hence, one interpretation was that a holding company cannot give any loan to/guarantee/ security on behalf of its subsidiary. This view, along with the fact that section 185 is applicable from 12 September 2013, has created significant hardship for many companies. This was particularly for the reason that in many cases, a subsidiary may not be able to raise finance without support of its holding company.

    Since the notification of section 185, the MCA has tried addressing this hardship through various circulars; however, these circulars were not very clear.

    To address this issue, the Board Rules provide the following exemptions. These exemptions are subject to a condition that loans should be utilized by the subsidiary company for its principle business activities.

    • 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 is exempted from the requirements under 185.
    • 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 (includes subsidiaries that are not wholly owned) is exempted from the requirements under this section.

    In other words, there seems to be prohibition only with respect to giving of loans to a subsidiary that is not a wholly owned subsidiary. It is understandable that most companies will take the position stated in the Board Rules, though the concern whether the rules can override the 2013 Act remains.

  • Loans and investments by companies

    What the Companies Act 2013 states:

    Section 186 of the 2013 Act requires that a company will not (i) give loan to any person/other body corporate, (ii) give guarantee or provide security in connection with a loan to any person/other body corporate, and (iii) acquire securities of any other body corporate, exceeding the higher of:

    • 60% of its paid-up share capital, free reserves and securities premium, or
    • 100% of its free reserves and securities premium.

    The 2013 Act states that for providing loan/giving guarantee/ security or acquiring security exceeding the above limit, a company will need to take prior approval by means of a special resolution passed at the general meeting.

    Unlike the 1956 Act, the 2013 Act did not contain any exemption for loan made/guarantee given/security provided by a holding company to its wholly owned subsidiary companies. Consequently, it was required that a company will includethe amount of loan/guarantee/security to its wholly owned subsidiary as well in the 60%/100% limit. This was likely to create hardship for many subsidiary companies, which are significantly dependent on their parent for financing. Also, in many cases, loans given, guarantee and security provided by the parent may have immediately breached the 60% or 100% limit.

    To address the above challenge, the Board Rules provide that where a loan or guarantee is given or where a security has been provided by a company to its wholly owned subsidiary company or a joint venture company, or acquisition is made by a holding company of the securities of its wholly owned subsidiary company, the requirement concerning special resolution atthe general meeting will not apply. However, the company will disclose the details of such loans or guarantee or security or acquisition in the financial statements.

    EY insights

    From a reading of the Board Rules concerning section 185 and186, the following position emerges:

    • A parent company can give loan to/ provide security or guarantee on behalf of its wholly owned subsidiary company or acquire securities of wholly owned subsidiaries. These loans/guarantees/security will not be included to determine whether the company has breached the 60%/100% limit. This effectively brings the position at par with what was prevalent under the 1956 Act.
    • A parent company can provide security or guarantee on behalf of its subsidiary company which is not wholly owned subsidiary company. However, it cannot give any loan to such subsidiary company. These guarantees/security willbe included in determining whether the company has breached the 60% or 100% limit.
    • Loan given to, security/guarantee provided on behalf of the joint venture company will not be included in determining whether the company has breached the 60% or 100% limit.
    • In the Board Rules, there is no relaxation/exemption on the requirement concerning charging of interest on loans. Hence, it appears that a company may need to charge interest at the specified rate on all its loans, including loans given to wholly owned subsidiaries and joint ventures. In accordance with the 2013 Act, rate of interest cannot be less than prevailing yield on one year, three year, five year or ten year Government Security closest to the tenor of the loan.

    These changes in the rules help resolving many practical challenges that were likely to arise. However, an unresolved issue is that a company can no longer give interest free loan to its wholly owned subsidiary. This is likely to create significant hardship for many groups. Also, the concern regarding rules overriding the law remains.

    Omnibus resolution

    One of the paragraphs in the Board Rules states that special resolution passed at a general meeting to give any loan or guarantee or investment or provide any security will specify the total amount up to which the board of directors is authorizedto give such loan or guarantee, to provide security or acquire investments. This suggests that omnibus resolution will be permitted. The draft rules had permitted omnibus resolution only for guarantees.

    Investment in mutual funds

    Section 186 of the 2013 Act deals with all loans and investments made by a company, including loans etc. to a person. Hence, there is a concern whether investments in mutual funds will also be included in the 60%/100% limit. Under the 1956 Act, section 372A dealt only with inter-corporate loans and investments. Hence, such investments were not included in the 60%/100% limit.

    It may be noted that in section 186, sub-paragraph dealing with loans, guarantee and security refer to person as well as body corporate. However, the sub-paragraph dealing with investment covers only acquisition of securities of a body corporate. Inan earlier decision, the Supreme Court has held that mutual funds constituted as trust are not body corporate. This seems to suggest that section 186 does not apply to investments in mutual funds and they will not be included in the 60%/100% limit.

    Foreign currency loans

    Under the 2013 Act, the rate of interest cannot be less than prevailing yield on one year, three year, five year or ten year Government Security closest to the tenor of the loan. This is likely to result in an apparent issue in case of foreign currency loans. For example, an Indian company is making loan to a body corporate in Japan where interest rates are negligible. In such a case, it may not be appropriate to require companies to charge interest based on the rates applicable to government securities in India. To address this issue, the MCA should clarify that currency of the government securities should be consistentwith the currency of loan.

    Loan between fellow subsidiaries

    As mentioned earlier, there appears to be a prohibition on the parent company giving loans to its subsidiary that is not a wholly owned subsidiary. This raises an interesting issue whether a company can give loan to its fellow subsidiary.Assume that parent P has two subsidiaries, viz., S1 and S2. The parent owns 75% equity capital of S1 and 100% equity capitalof S2. It seems clear that P cannot give loan to S1. The issue is whether S2 can give loan to S1.

    One view is that S2 will not have any business/commercial reason to give loan to S1, except their relationship with the Parent P. Hence, it may be argued that S2 is giving loan toS1 on behalf of its parent. Since section 185 of the 2013 Act prohibits provision of both direct and indirect loans, some believe that loan proposed to be given by S2, in substance, contravenes the 2013 Act.

    According to the supporters of the second view, one should not generalize the situation to state that a subsidiary will alwaysact on behalf of its parent and apply all the restrictions of the parent to its subsidiary. In their view, if one can establish that P has not provided any back-to-back funding to S2 and S2 hasmade its independent decision to provide loan to S1, S2 will not be acting on behalf of its parent P. The supporters of this view believe that in such cases, S2 can provide loan to S1, without getting impacted by the prohibition on its parent company.

    Companies should consider fact pattern specific to their situation and seek legal consultation before proceeding on these matters.

    Loan from foreign parent

    It appears that the restrictions under sections 185 and 186 of the 2013 Act apply to a company which is providing the loan. These sections do not prohibit the borrower company from accepting loan from its parent. Let us assume that an overseas company intends to provide interest free loan to itspartly owned Indian subsidiary. In this case, one may argue that since sections 185/186 do not apply to the foreign company, there is no restriction on the company giving loan to its Indian subsidiary. Similarly, these sections do not prohibit Indian subsidiary from accepting loan from its foreign parent. Hence, it may be argued that such loan is not in contravention of sections185 and 186 of the 2013 Act. It may be appropriate for theMCA to clarify this.

    Transitional requirements

    One paragraph in the Board Rules state that where the aggregate of the loans and investment so far made, guarantee and security so far provided, along-with the investment,loan, guarantee or security proposed to be made, exceed the limits prescribed, then no investment or loan will be madeor guarantee will be given or security will be provided unless previously authorized by special resolution passed at the general meeting.

    An explanation to the above paragraph of Board Rules clarifies that it would be sufficient compliance if such special resolution is passed within one year from the date of notification of this section.

    The main paragraph in the Board Rules and explanation thereto are drafted in a confusing manner. A collective reading of the two indicates that for loans existing at the enactment date, i.e.,1 April 2014, and new loans granted during the first year, a company can pass special resolution by 31 March 2015 if the60%/100% limit is breached. In other words, a company is not required to take prior-approval by special resolution for making loans or investment or providing security/guarantee during the first year in excess of the limit. In such cases, resolution may be passed by 31 March 2015.

    It is understandable that many companies may prefer taking this view. However, like many other instances, there is aconcern that Board Rules may be overriding the 2013 Act since the 2013 Act requires prior approval by special resolution. We suggest that before taking final view, a company may like to consults its legal professionals.