Loans to Directors & inter-corporate loan - Section 185 & 186 of The Companies Act, 2013

Section 185 – Loans to Directors

Section 185 is designed to prevent companies from giving undue financial benefits to their directors or persons closely connected to them. It promotes corporate governance and avoids conflicts of interest.

Key Provisions (After Amendments)

1. Absolute Prohibition

A company cannot directly or indirectly:

• Give loans,

• Provide guarantees, or

• Provide security for any loan

• Any director of the company,

• Any director of its holding company,

• Any partner or relative of such director,

• Any firm in which such director or relative is a partner.

  
  

2. Permitted Transactions with Conditions

Loans, guarantees, or securities may be given to the following entities only if a special resolution is passed:

• Any private company where the director is a director or member.

• Any body corporate in which such director exercises at least 25% of voting power.

• Any body corporate whose board or management acts in accordance with the directions of such director(s).

  
  

3. Exemptions (Allowed Without Special Resolution)

The prohibition does not apply in these cases:

• Loans to managing director (MD) or whole-time director (WTD) as part of service conditions or under approved employee loan schemes.

• Loans/guarantees/securities provided in the ordinary course of business by an NBFC or banking company at a prescribed interest rate.

  
  

Penalties for Contravention

• Company: Fine between ₹5 lakh to ₹25 lakh

• Director or recipient: Imprisonment up to 6 months or fine between ₹5 lakh to ₹25 lakh or both

Section 186 – Loans & Investments by Company

Section 186 regulates how companies can use their financial resources for investments, inter-corporate loans, and providing guarantees/securities. It protects creditors and shareholders from excessive or risky financial exposure.

Key Provisions

1. Investment & Loan Limits

A company may:

• Give loans,

• Provide guarantees or securities, or

• Make investments Up to a limit of:

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

  • 100% of its free reserves + securities premium (whichever is higher)

Beyond this limit:→ Prior approval by special resolution of shareholders is mandatory.

2. Board Resolution Requirement

Every loan, guarantee, investment, or security must be approved through a unanimous Board resolution at a meeting of the Board.

3. Interest Rate Condition

Loans must carry interest not lower than the prevailing government security (G-Sec) rates.

4. Restrictions

A company cannot:

• Make loans or investments in other companies exceeding two layers of investment (except permitted exceptions).

• Give loans to persons or entities that are in default of earlier loan repayments.

  
  

5. Register of Loans & Investments

A company must maintain a register in Form MBP-2 containing particulars of:

• loans given

• guarantees issued

• securities provided

• investments made

This register must be kept at the registered office and be open for inspection.

Exemptions

The limits under Section 186 do not apply to:

• Banking companies

• Insurance companies

• Housing finance companies

• Companies engaged in financing industrial enterprises

• Government companies engaged in defense-related activities

Penalties

• Company: Fine between ₹25,000 to ₹5 lakh

• Officers in default: Imprisonment up to 2 years and fine between ₹25,000 to ₹1 lakh

Difference Between Section 185 and Section 186

Basis	Section 185	Section 186
Focus	Loans, guarantees, securities to directors and related parties	Inter-corporate loans, investments, guarantees, securities
Intent	Prevent misuse by directors	Regulate financial exposure and protect stakeholders
Type of restriction	Mostly prohibitory with limited exceptions	Permissive but controlled with limits
Approval required	Special resolution for permitted related entities	Special resolution when limits are exceeded
Penalties	Stricter; includes imprisonment	Moderate penalties

Conclusion

Sections 185 and 186 form a critical part of India's corporate governance framework. While Section 185 protects companies from director-related financial abuse, Section 186 ensures responsible corporate financing and investment practices. Together, they promote transparency, safeguard shareholder interests, and maintain corporate discipline.