When we read Section 185 for the first time, it looks restrictive. When we read it carefully, we realise it is a control mechanism. The objective is simple: directors should not misuse company funds, either directly or through layered structures.
After the
2017 amendment, the section is no longer a total prohibition. It now works in
three levels:
- Absolute Prohibition
- Conditional Permission
- Specific Exemptions
Unless we understand these three layers clearly, confusion continues.
I. Absolute Prohibition – Section 185(1)
A company
cannot, directly or indirectly:
- Give loan
- Give guarantee
- Provide security
to:
- Its own director
- Director of its holding company
- Any partner or relative of such
director
- Any firm in which such director
or relative is partner
This part is
strict. There is no relaxation. No special resolution can cure it.
The law intentionally uses the words “directly or indirectly”. That means even structured arrangements can fall under violation if substance shows benefit to director.
II. Conditional Permission – Section 185(2)
Now comes
the balanced part.
A company
may give loan, guarantee or security to a “person in whom any director is
interested”, but only if:
- Special Resolution is passed
- Full disclosure is made in
explanatory statement
- Loan is used for principal
business activities
Now the key
question: who is this “person in whom director is interested”?
The
Explanation defines it.
It includes:
- Any private company where
director is director or member
- Any body corporate where
director alone or together controls 25% or more voting power
- Any body corporate whose Board
acts according to directions of the lending company’s director
This is where most practical complexity arises.
III. Exemptions – Section 185(3)
Certain
transactions are fully exempt from both sub section (1) and (2).
These
include:
- Loan to Managing Director or
Whole Time Director under employee scheme
- Loan by company in ordinary
course of lending business at proper interest
- Loan by holding company to
wholly owned subsidiary
- Guarantee or security by holding company for
bank loan of subsidiary
Now here
lies an extremely important distinction.
Direct
Loan to Subsidiary
Allowed only
if subsidiary is wholly owned (100%).
Guarantee or Security for Bank Loan
Allowed even
if subsidiary is not wholly owned.
This difference is not drafting accident. It is deliberate.
IV. Penalty – Section 185(4)
Violation
attracts:
Company –
Fine between ₹5 lakh to ₹25 lakh
Officer in default – Imprisonment up to 6 months or fine or both
Recipient – Imprisonment up to 6 months or fine or both
Minimum fine of ₹5 lakh makes this non-trivial.
Case Study 1
ABC Pvt Ltd
gives ₹25 lakh loan to its director Mr. Arjun to expand his personal
consultancy business. The Board believes the consultancy indirectly benefits
the company.
Analysis
The
transaction directly falls under Section 185(1). It does not matter whether the
business benefits the company indirectly. The law prohibits giving loan to
director in his personal capacity.
The
intention behind the loan is irrelevant. Once the borrower is a director, the
prohibition applies.
Conclusion
This loan is
illegal. Both company and Mr. Arjun face penalty exposure.
Case Study 2
XYZ Ltd
gives corporate guarantee for housing loan taken by director’s spouse. The
company argues that spouse is financially independent.
Analysis
Spouse is a
relative under the Act. Section 185(1) prohibits loan, guarantee or security to
relative of director. The financial independence of spouse is legally
irrelevant.
Conclusion
Guarantee is
prohibited and amounts to violation.
Case Study 3
Director
holds just 2 shares in a private company where he is not involved in
management. Lending company proposes to give loan to that private company.
Analysis
In case of
private company, even minimal shareholding makes it covered under Explanation
clause (a). Percentage is irrelevant. Law treats private companies more
strictly.
Special
Resolution must be passed and utilisation must be for principal business
activity.
Conclusion
Loan can be
given only after complying with Section 185(2).
Case Study 4
Director
holds 22% shares in a public company. Another director holds 5%. Loan proposed
to that public company.
Analysis
Individually
first director holds less than 25%. But law states “two or more directors
together”. Combined holding is 27%.
This crosses
25% threshold. Therefore Section 185(2) applies.
Conclusion
Special
Resolution mandatory before advancing loan.
Case Study 5
Holding
company owns 100% shares in Subsidiary A. It gives loan for working capital.
Analysis
Covered
under Section 185(3)(c). Since subsidiary is wholly owned and funds are for
business activity, exemption applies.
No special
resolution required under Section 185.
Conclusion
Transaction
valid if utilisation condition satisfied.
Case Study 6
Holding
company owns 90% shares in Subsidiary B. It gives direct loan to B.
Analysis
Clause (c)
clearly uses the term “wholly owned subsidiary”. 90% is not wholly owned.
Therefore
exemption does not apply. If director interest exists, Section 185(2) must be
followed.
Conclusion
Direct loan
not automatically exempt.
Case Study 7
Holding
company owns 60% shares in Subsidiary C. Bank sanctions term loan to C. Holding
company gives corporate guarantee.
Analysis
Clause (d)
allows guarantee by holding company for loan taken by its subsidiary from bank
or financial institution.
Here
subsidiary need not be wholly owned. 60% shareholding is sufficient.
Conclusion
Guarantee is
allowed, subject to utilisation for principal business activity.
Case Study 8
Loan given
to wholly owned subsidiary. Subsidiary uses funds to purchase land as
speculative investment.
Analysis
Even under
exemption, condition of principal business activity must be satisfied.
Speculative investment unrelated to business fails the condition.
Conclusion
Exemption
collapses. Transaction becomes non-compliant.
Case Study 9
Company
gives loan to a company whose Board is informally controlled by lending
company’s director, though no shareholding exists.
Analysis
Explanation
clause (c) covers situations where Board is accustomed to act according to
directions. Control can be practical, not only numerical.
If evidence
shows consistent influence, Section 185(2) applies.
Conclusion
Special
Resolution required.
Case Study 10
Company
advances loan first. Special Resolution passed after 3 months to regularise it.
Analysis
Section
185(2) requires prior approval. Post approval does not cure violation.
Conclusion
Company
remains in default and may face penalty.
Final Message
Section 185
is not merely about directors borrowing money. It is about preventing diversion
of corporate funds through influence and control.
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