Sections 185 & 186 of Companies Act 2013
A Comprehensive Guide to Loans, Guarantees, Security & Investments
📋 Table of Contents
- 1. Introduction
- 2. Section 185 – Loans to Directors
- 3. Section 186 – Loans and Investments by Company
- 4. Judicial Interpretation
- 5. Practical Application
- 6. Compliance Requirements
- 7. Penalties for Non-Compliance
- 8. Time Periods and Deadlines
- 9. Comparative Analysis
- 10. Frequently Asked Questions
- 11. Conclusion
1. Introduction
Sections 185 and 186 of the Companies Act, 2013 are among the most critical provisions governing corporate financial transactions. These sections impose strict regulations on companies regarding loans, guarantees, security provisions, and investments to ensure transparency, prevent misuse of corporate funds, and protect stakeholder interests. The Ministry of Corporate Affairs (MCA) has consistently emphasized the importance of these provisions in maintaining corporate governance standards.
Key Objectives:
- Prevent misuse of company funds by directors and related parties
- Ensure proper authorization for significant financial commitments
- Maintain transparency in corporate financial dealings
- Protect minority shareholders and creditors
2. Section 185 – Loans to Directors
2.1 Overview
Section 185 prohibits companies from directly or indirectly advancing loans, providing guarantees, or giving security in connection with loans to directors, their relatives, firms, or other bodies corporate in which directors are interested. This provision aligns with international corporate governance standards recommended by the OECD Principles of Corporate Governance.
2.2 Prohibited Transactions
| Transaction Type | Description | Prohibition Status |
|---|---|---|
| Direct Loans | Loans advanced directly to directors | Prohibited |
| Indirect Loans | Loans to entities controlled by directors | Prohibited |
| Guarantees | Guarantees given for director’s obligations | Prohibited |
| Security | Security provided for director’s loans | Prohibited |
2.3 Exceptions
While Section 185 is largely prohibitive, certain limited exceptions exist. For a comparative analysis with Section 186, see our detailed comparison section.
Limited Exceptions Allowed:
- Banking Companies: Normal banking transactions in ordinary course of business
- Subsidiary Companies: Loans to wholly-owned subsidiaries or guarantees for their borrowings
- Private Companies: Specific exemptions with member approval
2.4 Scope of “Director”
The term “director” under Section 185 includes:
- Any director of the company
- Any other director of the holding, subsidiary, or associate company
- Any partner or relative of such director
- Any firm in which such director or relative is a partner
- Any private company of which director is a member or director
- Any body corporate at a general meeting of which not less than 25% of voting power may be exercised by such director
3. Section 186 – Loans and Investments by Company
3.1 Overview
Section 186 regulates loans, guarantees, security provisions, and investments made by companies to other persons or bodies corporate. It requires board resolution and, in certain cases, special resolution for such transactions. The SEBI LODR Regulations also mandate additional disclosures for listed companies under similar transactions.
3.2 Covered Transactions
| Transaction | Threshold Limit | Authorization Required |
|---|---|---|
| Loans | ≤60% of paid-up capital, free reserves & securities premium | Board Resolution |
| Loans | >60% of limits | Special Resolution |
| Guarantees | ≤60% of limits | Board Resolution |
| Investments | ≤60% of limits | Board Resolution |
| Security | ≤60% of limits | Board Resolution |
3.3 Exemptions under Section 186
Companies Exempt from Section 186:
- Banking companies
- Insurance companies
- Non-Banking Financial Companies (NBFCs)
- Housing Finance Companies
- Companies whose principal business is acquisition of shares, stock, debentures
3.4 Calculation of Limits
Understanding the calculation methodology is crucial for compliance. For practical applications of these calculations, refer to our practical application section.
Formula for 60% Limit:
Base Amount = Paid-up Share Capital + Free Reserves + Securities Premium Account
Maximum Limit = 60% of Base Amount
Note: Free reserves means all reserves other than reserves created out of revaluation of assets, write-back of depreciation, and amalgamation.
4. Judicial Interpretation
4.1 Key Judicial Pronouncements
Courts have provided significant clarifications on the interpretation and application of Sections 185 and 186. The Supreme Court of India and various High Courts have consistently held that these provisions must be strictly interpreted to maintain corporate governance standards:
4.1.1 On Section 185
- Strict Interpretation: Courts have held that Section 185 must be interpreted strictly with no room for liberal construction
- Indirect Loans: Any transaction that results in a benefit to directors is covered, regardless of form
- Criminal Nature: Violations attract criminal liability, not just civil consequences
4.1.2 On Section 186
- Prior Approval: Board/shareholders’ approval must be obtained before making investments or loans
- Purpose Specification: The purpose and terms must be clearly specified in resolutions
- Aggregate Limits: All transactions must be considered cumulatively for limit calculation
⚠️ Important Judicial Guidelines:
- Retrospective regularization of violations is not permissible
- Good faith or business necessity cannot justify violations
- Directors cannot escape liability by claiming ignorance
5. Practical Application
5.1 Section 185 – Practical Scenarios
Understanding practical scenarios helps in better application of Section 185. For more detailed compliance frameworks, refer to our compliance section below.
| Scenario | Permissible | Remarks |
|---|---|---|
| Loan to director for medical emergency | No | No exceptions for personal emergencies |
| Guarantee for director’s home loan | No | Prohibited under all circumstances |
| Investment in director’s private company | Depends | May be covered under Section 186 if not prohibited transaction |
| Loan to wholly-owned subsidiary | Yes | Specific exemption provided |
5.2 Section 186 – Common Applications
Section 186 covers various types of corporate transactions. For detailed penalty structures related to violations, see our penalties section.
- Inter-corporate Deposits: Short-term loans between companies
- Strategic Investments: Equity investments in other companies
- Corporate Guarantees: Guarantees for subsidiary or associate company loans
- Security Provision: Pledging assets for third-party obligations
💡 Best Practices:
Implementing these best practices is crucial for maintaining compliance. For comprehensive time periods and deadlines, refer to our detailed timeline section.
- Maintain detailed records of all transactions
- Obtain proper board/shareholder approvals before transactions
- Regular monitoring of aggregate limits
- Ensure arm’s length pricing for all transactions
- Proper disclosure in board meetings and annual reports
6. Compliance Requirements
6.1 For Section 185 Compliance
Mandatory Requirements:
- Complete Prohibition: No loans, guarantees, or security to directors (with limited exceptions)
- Board Vigilance: Board must ensure no direct or indirect violations
- Due Diligence: Verify beneficial ownership before any transaction
- Documentation: Maintain records proving compliance
6.2 For Section 186 Compliance
| Step | Requirement | Documentation |
|---|---|---|
| 1 | Calculate available limits | Financial statements, limit calculation sheet |
| 2 | Board resolution (if within 60%) | Board resolution with specific terms |
| 3 | Special resolution (if exceeding 60%) | General meeting minutes, special resolution |
| 4 | Execute transaction | Loan agreement, investment documents |
| 5 | Regular monitoring | Monthly/quarterly compliance reports |
6.3 Disclosure Requirements
Proper disclosure is essential for regulatory compliance and transparency. Companies must adhere to disclosure requirements under various regulations:
- Board Report: Details of loans and investments in annual board report as per Companies (Management and Administration) Rules, 2014
- Financial Statements: Proper disclosure in notes to accounts following Indian Accounting Standards (Ind AS)
- Related Party Transactions: Disclosure as per accounting standards and SEBI regulations for listed companies
- Regulatory Filing: Form MGT-7 and other applicable forms with Ministry of Corporate Affairs
7. Penalties for Non-Compliance
7.1 Section 185 Violations
Criminal Penalties:
| Defaulting Party | Imprisonment | Fine |
|---|---|---|
| Company | Not applicable | Minimum ₹5 lakhs, up to ₹25 lakhs |
| Every officer in default | Up to 6 months | Minimum ₹5 lakhs, up to ₹25 lakhs |
| Director (if recipient) | Up to 6 months | Minimum ₹5 lakhs, up to ₹25 lakhs |
7.2 Section 186 Violations
| Defaulting Party | Fine Amount | Additional Consequences |
|---|---|---|
| Company | Minimum ₹1 lakh, up to ₹10 lakhs | Transaction may be void |
| Every officer in default | Minimum ₹25,000, up to ₹1 lakh | Personal liability for recovery |
7.3 Additional Consequences
⚠️ Beyond Monetary Penalties:
- Transaction Voidability: Violating transactions may be declared void
- Recovery Liability: Directors personally liable for recovery
- Disqualification: Directors may face disqualification under Section 164
- Reputation Risk: Regulatory action and public disclosure
- Audit Qualification: Auditor qualification in financial statements
8. Time Periods and Deadlines
8.1 Section 185 – Time Considerations
- No Grace Period: Prohibition is absolute from the date of transaction
- Immediate Repayment: Any violating amount must be repaid immediately
- Statute of Limitations: Criminal prosecution can be initiated within specified limitation periods
8.2 Section 186 – Key Deadlines
| Requirement | Timeline | Consequence of Delay |
|---|---|---|
| Board Resolution | Before transaction | Transaction becomes invalid |
| Special Resolution | Before exceeding 60% limit | Violation of Act |
| Annual Disclosure | With Annual Return (within 60 days of AGM) | Filing penalties |
| Limit Monitoring | Continuous | Inadvertent violations |
8.3 Regulatory Filing Deadlines
Important Filing Deadlines:
- Form MGT-7: Within 60 days of AGM – file through MCA21 Portal
- Board Report: To be placed before AGM as per statutory requirements
- Financial Statements: Within 30 days of AGM to ROC through official portal
- Compliance Certificate: Annual filing with details of compliance under relevant provisions
9. Comparative Analysis
9.1 Section 185 vs Section 186
| Aspect | Section 185 | Section 186 |
|---|---|---|
| Nature | Prohibition (with limited exceptions) | Regulation with limits |
| Scope | Directors and related parties | Any person or body corporate |
| Approval | Generally not permitted | Board/Special resolution required |
| Penalties | Criminal (imprisonment + fine) | Civil (fine only) |
| Exceptions | Very limited | Several categories exempt |
9.2 Changes from Companies Act 1956
Key Changes Introduced in 2013 Act:
- Enhanced Scope: Broader definition of “director” and related parties aligned with international standards
- Stricter Penalties: Introduction of minimum penalties and imprisonment following recommendations from the Law Commission of India
- Better Disclosure: Enhanced disclosure requirements in line with global corporate governance practices
- Regulatory Oversight: Increased monitoring by regulatory authorities including MCA and SEBI
10. Frequently Asked Questions (FAQs)
10.1 Section 185 Related FAQs
Q1: Can a company provide a guarantee for a director’s personal loan?
Answer: No, Section 185 strictly prohibits companies from providing guarantees for directors’ personal loans, including home loans, vehicle loans, or any other personal financing needs.
Q2: Are there any exceptions for emergency situations?
Answer: No, Section 185 does not provide exceptions for emergency situations. The prohibition is absolute except for the specific exemptions mentioned in the Act, such as loans to wholly-owned subsidiaries.
Q3: What if the director is also a shareholder?
Answer: Being a shareholder does not exempt a director from Section 185 restrictions. The prohibition applies regardless of the director’s shareholding in the company.
10.2 Section 186 Related FAQs
Q4: How is the 60% limit calculated for Section 186?
Answer: The 60% limit is calculated as: 60% of (Paid-up Share Capital + Free Reserves + Securities Premium Account). Free reserves exclude reserves created from asset revaluation, depreciation write-back, and amalgamation.
Q5: Can the 60% limit be exceeded with special resolution?
Answer: Yes, companies can exceed the 60% limit by passing a special resolution in the general meeting, provided proper disclosures are made to shareholders.
Q6: Are startups exempt from these provisions?
Answer: No, startup companies are not exempt from Sections 185 and 186 unless they fall under specific exempt categories like NBFCs or banking companies.
10.3 Compliance and Penalty FAQs
Q7: What happens if a violation is discovered during audit?
Answer: Auditors are required to report violations in their audit report. This can lead to regulatory action, penalties, and potential criminal prosecution for directors and officers.
Q8: Can violations be regularized retrospectively?
Answer: No, courts have clearly held that retrospective regularization of violations under Sections 185 and 186 is not permissible. Compliance must be ensured before undertaking any transaction.
Q9: How often should companies monitor compliance?
Answer: Companies should implement continuous monitoring systems with monthly reviews to ensure ongoing compliance with prescribed limits and avoid inadvertent violations.
Q10: Where can I get professional help for compliance?
Answer: For expert compliance assistance, consult qualified Company Secretaries, Chartered Accountants, or corporate lawyers. You can also visit ComplianceGyan.in for professional guidance and compliance services.
11. Conclusion
Sections 185 and 186 of the Companies Act 2013 represent crucial corporate governance provisions designed to prevent misuse of corporate funds and ensure transparency in financial transactions. While Section 185 imposes an almost absolute prohibition on loans to directors, Section 186 provides a regulated framework for corporate investments and loans.
Key Takeaways:
- Strict Compliance: Both sections require strict adherence with severe penalties for violations
- Prior Approval: Proper authorization must be obtained before undertaking any covered transaction
- Regular Monitoring: Companies must continuously monitor compliance with prescribed limits
- Professional Guidance: Given the complexity, professional legal and financial advice is essential
Companies must establish robust internal controls, regular monitoring mechanisms, and ensure that all stakeholders are aware of these provisions to maintain compliance and avoid legal consequences. For ongoing updates on MCA notifications and regulatory changes, follow our comprehensive compliance blog.
📚 Additional Reading:
Enhance your understanding with these related compliance guides and official resources:
⚠️ Legal Disclaimer
Important Notice: This blog post is for informational and educational purposes only and does not constitute legal advice. The information provided here is based on the Companies Act 2013 and related regulations as understood at the time of writing. Given the complexity and evolving nature of corporate law, readers are strongly advised to consult with qualified legal professionals, chartered accountants, or company secretaries before making any decisions based on this information. For expert consultation and compliance services, you may reach out through ComplianceGyan.in.
No Liability: The authors and publishers of this content disclaim all liability for any actions taken or not taken based on this information. Each company’s situation is unique and requires specific professional assessment. Corporate laws and regulations are subject to amendments and judicial interpretations, and readers should verify the current legal position before relying on any information provided herein. While every effort has been made to ensure accuracy, we make no representations or warranties about the completeness, accuracy, reliability, or suitability of the information contained in this blog post.