The Companies Act, 2013, stands as a cornerstone of Indian corporate legislation, it is an act that regulates the incorporation of a company, along with regulating the responsibilities of directors and the company and the dissolution of the company. The act replaced the previous Companies Act, 1956 introducing a host of new provisions including a total of 183 more sections coming into force. Section 186 of Companies Act 2013 outlines the borrowing powers of companies, both of which are either public or private.
It ensures transparency and accountability in a company’s borrowing activities and also sets limits and conditions for companies to borrow money. Companies always indulge in investing in other companies or providing a loan, provisions for such borrowings and investments are provided under Section 186 of the Companies Act, 2013. All of the companies are subjected to these sections except a few like Housing loan companies, banking companies, etc.
Provisions of the Section 186 of Companies Act 2013
Section 186(1) Limitation on Investments
To ensure that excessive loans or investments aren’t provided by similar investors, which can lead to dilution of shares and interests in the market. The provision talks about the limits and manner a company provides loans or investments to another company. According to Section 186(1) of the Companies Act, 2013, the Companies Act does not permit a company to make investments in more than 2 layers of investment companies. In other words, a holding company cannot own investments in more than two layers of its subsidiaries. However, there are exceptions to this provision. For instance, companies can invest in more than 2 layers if the company being invested in is outside of India. Another exception is when multi-layer subsidiary investment is essential for the company.
Section 186(2) Restrictions on Loans, Guarantees, and Securities
(2) “No company shall directly or indirectly —
- give any loan to any person or other body corporate;
- give any guarantee or provide security in connection with a loan to any other body corporate or person.
- acquire by way of subscription, purchase, or otherwise, the securities of any other body corporate, exceeding sixty percent. of its paid-up share capital, free reserves, and securities premium account or one hundred percent of its free reserves and securities premium account, whichever is more.”
This section places restrictions on a company’s ability to provide loans, guarantees, or security, or acquire securities of other companies. These provisions are designed to ensure that companies don’t engage in risky financial transactions that could potentially degrade their financial stability.
Section 186(3) Special Resolutions for Exceeding Limits
In some special cases, where the amount of loan, investment, guarantee, security, etc., is to exceed the limits set in the provisions of Section 186(2), the company must conduct a general meeting with the board of directors and major company members. During this meeting, they discuss the details of the proposed investment or loan and pass a motion for approval. To pass a special resolution, it requires the affirmative votes of 75% of the members and major stockholders.
Section 186(4) Transparency in Financial Activities
The provision is designed to ensure that transparency is maintained and that members of the company are well-informed about the company’s financial activities. The company should maintain transparency by disclosing information about loans given, investments, securities, and guarantees made, along with their respective purposes.
Section 186(5) Prior Approval from Public Financial Institution (PFI)
When a company has taken a term loan from a Public Financial Institution (PFI), it is mandatory to obtain prior approval from the concerned PFI before giving loans, making investments, providing guarantees, or offering securities. This requirement applies only when the investment company plans to exceed the prescribed limit for investments and is in the process of obtaining approval from its members and board of directors. However, all of this is not necessary when the company does not breach provisions under Section 186(2). Additionally, if the company maintains a good credit history with the PFI by not defaulting on payments or breaching the terms and conditions of the term loan, these requirements do not apply.
Section 186(6) Exemptions for SEBI-Registered Companies
Companies falling within the ambit of SEBI registration under Section 12 of the SEBI Act, 1992, are not bound by the regulatory limitations of Section 186(2) of the Companies Act, 2013. SEBI-registered companies can make intercorporate loans and investments beyond the limits set by Section 186(2) by disclosing them in their annual financial statements. These provisions aim to regulate inter-corporate loans and investments while providing flexibility and exceptions for certain situations, especially concerning PFIs and SEBI-registered companies.
Section 186(7) Interest Rate Standards
“No loan shall be given under this section at a rate of interest lower than the prevailing yield of one
year, three-year, five-year, or ten-year Government Security closest to the tenor of the loan”.
This section ensures that loans provided under Section 186 should not carry an interest rate lower than the prevailing yield of government securities with tenors closest to the loan’s tenor. This safeguards against companies offering loans at unreasonably low-interest rates that could distort the financial landscape.
Section 186(8) Rectification of Defaults
This section applies to companies that have accepted deposits, loans, or investments in the past and currently hold these deposits or have held them in the past. The restriction comes into play when a company has defaulted on the repayment of these deposits, their installments, or interests, and these defaults continue to exist.
To become eligible to engage in inter-corporate loans and investments, the company must first resolve and clear these defaults. Once the defaults are rectified, the company can then consider making new investments or providing loans to other entities. This provision aims to ensure that companies that have failed to meet their financial obligations to creditors do not engage in further financial transactions without first addressing and resolving their existing defaults.
Section 186(9 and 10) Maintenance of Register
Every company involved in inter-corporate loans, investments, guarantees, or securities must create and maintain a register to record such transactions. This register should be regularly updated to include details of recent loans, investments, guarantees, or securities provided by the company.
Entries in the register should include relevant particulars and comply with the requirements specified in Section 186(9) and (10) of the Companies Act, 2013, as well as the company’s constitutional documents.
Maintaining this register is essential for transparency and regulatory compliance, allowing stakeholders, including members of the company, to access information about the company’s inter-corporate financial transactions.
Procedure for Making Inter-corporate Loans and Investments
Making inter-corporate loans and investments in India involves a specific legal and procedural framework outlined in the Indian Companies Act, 2013, and its related rules and regulations. Here’s a general procedure for making inter-corporate loans and investments:
Review the Company’s Articles of Association:
The first step is to review the company’s Articles of Association to ensure that it allows for inter-corporate loans and investments.
Board Resolution:
The board of directors involving company members should pass a resolution approving the proposal for inter-corporate loans or investments. The resolution should specify the terms, purpose, and conditions of the loan or investment.
Shareholder Approval:
Depending on the amount of the loan or investment, shareholder approval may be required at a general meeting. This is typically the case when the transaction exceeds certain prescribed limits, as per section 186(2) of the Companies Act, 2013.
Loan Agreement or Investment Agreement:
Drafting a formal loan agreement or investment agreement, depending on the nature of the transaction. The agreement should outline all terms and conditions, including interest rates, repayment schedules, or the nature of the investment.
File with Registrar of Companies (RoC):
In accordance with Section 186 of the Companies Act, if the loan or investment exceeds prescribed limits, you may need to le the details of the transaction with the RoC. This includes Form MGT-14, which contains the particulars of the transaction.
Compliance with Section 185:
Ensure compliance with Section 185 of the Companies Act, which places restrictions on giving loans to directors and related entities.
Board Approval by Borrowing Company:
If your company is borrowing money or receiving investments, the borrowing company’s board of directors should pass a resolution approving the transaction.
Execution:
Execute the loan agreement or investment agreement as per the approved terms.
Register of Loans and Investments:
Maintain a register of loans and investments, which should be kept at the registered office of the company. This register should include details of the transactions, parties involved, and terms.
Filing and Disclosure:
Ensure that you comply with the disclosure and ling requirements under the Companies Act and other relevant laws, including reporting to the shareholders and RoC as required.
Statutory Compliance:
Following other statutory compliance requirements, such as income tax, GST, or other applicable tax regulations.
Internal Record-Keeping:
Maintain proper records and documentation related to the transaction for audit and compliance purposes.
Applicability of the section
The restrictions of section 186 are not applicable to companies engaged in defense-related activities and production.
Except for sub-section 1 of the act,
- These provisions are not applicable to companies involved in providing housing loans, insurance companies, companies involved in providing loans, acquiring shares and security in the ordinary course of business, etc.
- Companies allotted as per provisions of Section 62(1)(a) of the Companies Act, 2013.
- Provisions are not applicable to the acquisition of shares by a Non-Banking Financial company(NBFC) registered under Section IIIB of the Reserve Bank of India Act,1934.
Penalties
Section 186(13) discusses penalties, and they exist in two forms: either the company holds liability, or the officers involved are held liable for the violation. If the company breaches any provision, it may face a minimum penalty of rupees 25,000 and a maximum penalty of rupees 5,00,000. The authorities may sentence every involved officer to two years of imprisonment, along with imposing a minimum penalty of rupees 25,000 and a maximum penalty of rupees 1,00,000, depending on the severity of the violation.
Conclusion
In conclusion, Section 186 of the Companies Act, 2013, plays a pivotal role in regulating the borrowing powers of companies in India. Section 186 of the Companies Act, 2013, seeks to strike a balance between facilitating business transactions and safeguarding the financial health and interests of companies, shareholders, and creditors. It encourages responsible financial management while promoting transparency and regulatory compliance in the corporate sector. Companies operating in India should carefully adhere to these provisions to ensure legal and regulatory compliance.
Aditya Sahijpal wrote this blog.
