Restrictions eased for related-entity lending

By Soumyajit Mitra and Kawaljeet Kaur, SNG & Partners
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The much awaited Companies (Amendment) Act, 2017, received the president’s assent on 3 January 2018 and was notified in the Official Gazette on 9 February and 7 May 2018.

Soumyajit MitraPrincipal associateSNG & Partners
Soumyajit Mitra
Principal associate
SNG & Partners

The 2017 act was based on suggestions of the Companies Law Committee, constituted by the Ministry of Corporate Affairs (MCA), in its report dated 1 February 2016, with the aim to strengthen corporate governance and ease doing business in the country, in the wake of concerns raised by various stakeholders on account of implementation of the Companies Act, 2013, which was enacted to align Indian company law with company laws globally.

Sections 61 and 62 of the 2017 act brought about key amendments to sections 185 and 186 of the 2013 act, dealing with loans to directors and loans and investments by companies, and their corresponding rules. The legal framework on this has been a matter of much debate, despite the issuance of several clarifications and amendments on the provisions under sections 185 and 186 in view of concerns that rules may have been overriding the 2013 act. Before the 2017 act, companies had been struggling with structuring lending transactions backed by credit support, collateral or a guarantee from a parent company or a group company due to the restrictions contained in these provisions.

Section 185, which was applicable to both public and private companies, prevented companies from advancing any loan (including a loan represented by a book debt) or giving any guarantee or any security in connection with a loan to the company’s directors or any other person in whom the directors were interested. Private companies raised a huge commotion over this section. Section 185(1) provided certain exemptions, however, the restrictions were still stringent for group companies with common directors. Although a notification of the MCA dated 5 June 2015 granted relief by way of certain exemptions to private companies, it was subject to stipulated conditions.

Kawaljeet KaurAssociateSNG & Partners
Kawaljeet Kaur
Associate
SNG & Partners

The restrictions contained in section 185 posed major challenges for fund-raising, inter-group credit support and collateral. These restrictions have been eased by the 2017 act. The key relaxations are:

  • Omission of the words “save as otherwise provided in the Act” to avoid confusion as to whether the provisions of section 186, which starts with “without prejudice to the other provisions”, can exclude section 185.
  • Companies are allowed to grant loans, guarantees and security to entities in which directors are interested, in certain cases, subject to prior approval of the shareholders by a special resolution and on the condition that such loans are used by the borrower for its principal business activities. The amended section 185 is partly prohibitive and partly restrictive as it continues to prohibit the grant of loans or guarantees to some, while restricting the others.
  • The ambit of the penalties has been widened and as a result, the obligations of every “officer” of a company – as defined in section 2(59) of the 2013 act – have been increased to ensure that all loans, security and guarantees are in compliance with the provisions of the 2017 act, thereby imposing onerous responsibility on the management of the company to clearly identify transactions entered into with persons in whom its directors are interested.

Under section 186, no exemption was available to allow a holding company to provide loans, guarantees or security to its wholly owned subsidiary companies in the 2013 act itself though it was allowed in the rules. Owing to this restriction, subsidiary companies faced tremendous hardship and challenges in raising funds as they are dependent on their parent companies for financing. Further, the word “person” in section 186(2) of the 2013 act unwittingly seemed to cover employees. The key relaxations are:

  • The word “person” shall not include individuals who are employees of the company, since the section was meant to cover inter-corporate loans. Accordingly, companies can provide loans to their employees based on the company’s policies without any statutory restrictions on the limits of the loan.
  • Inclusion of the exemption from shareholders’ approval, in the case of loans, guarantees and security from a holding company to its wholly owned subsidiary, in the operative part of the act itself.

The relaxations granted under the 2017 act for sections 185 and 186 provide much needed relief for private and public companies, since they remove the prohibition on inter-corporate lending, while at the same time providing adequate safeguards which are effective and not onerous, thereby allowing the flexibility of innovative structuring options.

SNG & Partners has offices in Delhi, Mumbai, Singapore and Doha. Soumyajit Mitra is a principal associate and Kawaljeet Kaur is an associate.

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