Thursday, March 6, 2014

Section 185 & how ill-drafted, ill-implemented provisions cause serious consequences

The manner in which the Companies Act, 2013, is being implemented is causing ongoing grief to numerous companies. As the financial year comes to a close, several violations with potentially serious consequences are being noticed by auditors and others. The deservedly much maligned Section 185 is one example that is focus of this post (several earlier posts have also discussed many issues). Section 185 makes an almost absolute and comprehensive prohibition, with few exceptions, of loans to persons in which directors have interest. While widely held listed companies too suffer from the broad provisions, it hits even more harshly closely held companies who tend to have regular transactions in the group almost as running current accounts.

To give a specific situation, Section 185 prohibits giving of loans to companies within the same group even if the borrower private limited company has one common director. For most closely held groups, this would practically mean all companies in the group. It is routine for companies to have running current accounts with group companies to manage liquidity without charging interest. Section 185 prohibits this almost totally.

This was not so under the Companies Act, 1956 and the few instances where there were restrictions, internal approvals usually resolved the issue. Section 185, however, has no method to permit it by approval of the board or shareholders or even Central Government. Granting of such loans is a violation that attracts fine/imprisonment.

Looking at the provision even more closely reveals the inherent complexities that arise when a law is in transition, which gets worsened when the provisions are implemented ambiguously on one hand and then “clarified” to create fresh creases. While bringing Section 185 into effect, the Central Government issued a circular stating that “corresponding” provisions were “repealed”. This created an ambiguity as to which provisions are repealed.

Then the Central Government compounds matter further by further “clarifying”, taking into account representations made regarding Section 185, that Section 372A will remain in force till Section 186 is notified. It may be recollected that, arguably, Section 185 and Section 372A operate in different fields for different purposes. And while linking Section 372A with Section 186 does make sense, giving the clarification in context of section 185 creates further confusion. Yet another “clarification” regarding Section 185/372A in light of guarantees to subsidiary companies creates more confusion.

The result is that companies are queuing up at offices of auditors and legal advisors to reassure that the audit reports will not be splashed with red and penal consequences are, if possible, avoided. Resolving such issues is not easy in many cases and at times create complications of income-tax, which can be costly. Needless but considerable energy is being wasted on issues as to legal standing of a notification/circular, powers of clarification, meaning in law of terms used, etc. 

Considering the elections, one wonders whether there will be any resolution of this in the near horizon.


vswami said...

Reaction (rooted in common sense):

While ‘ill- drafting’ is the root cause, ‘ill-implementation’ (or authority’s inherent inability to implement or enforce itself) is the necessarily unavoidable / inevitable effect /consequence. To put it with a different stroke, ‘ill- drafted’ implicitly means many things; loopholes, lacunae, incomprehensibility, complexity, so on. More often than not, going by wisdom mostly gathered only in hindsight, one is invariably left wildly wondering, musing, perplexed, -are not all or most of such deficiencies, not merely in drafting , being the initial stage, so also in all the subsequent stages of bureaucratic /legislative procedure in place – to the end of final enactment /nod or assent, mainly attributable to an oversight, deliberately or unwittingly so. It goes without having to add, - any such deficiency has the necessary potential to serve as a source of provocation for the vested interests, to try and avoid enforcement to the extent possible.
Perhaps, legal pundits, having the unique privilege of firsthand / field experience, may be better equipped to firstly edit, then elaborate or dilate, the foregoing sporadic reflections!

Keshav Garg said...

sec 185 is simply monstrous devoid of application of mind with simple one goal to crush the corporate body and all the professionals getting work to haaandle them. Message is clear -do not work under a pvt ltd co but closure has many implications in terms of stamp duty on its properties ,their valuations ,carry forward of losses/depreciaion/other statutory allowances, permissions in the backward areas for continuation of sales tax/excise benefits. The section did not apply earlier to private ltd co;su/s 295 under the old Act which needs to be ressstored to enable pvt ltd co;s to continue in peace . There can be restrictions in terms of closely held co;s that they can deal with only co;s wherein they are entrenched with their own folks only and not the outsiders as the intent is to protect outsiders/public under the garb of a shareholderor otherwise
keshav garg FCA